Wednesday, 28 August 2013

Austerity and inequality: the IMF going unorthodox?

By Carlos Fortin

Isabel Ortiz has brought to the attention of the Recovery with a Human Face network a recent IMF Working Paper on the distributional effects of fiscal consolidation(1). It makes interesting reading, not least in that it seems to indicate a departure from orthodox thinking on the matter.

The paper explores the impact on inequality of measures of fiscal consolidation, defined as "policy actions—tax hikes and/or spending cuts—taken by governments with the intent of reducing the budget deficit"(p.4). It is based on information on 173 episodes of fiscal consolidation for 17 OECD economies during 1978-2009, whose magnitude ranges between 0.1 and about 5 per cent of GDP, with an average of about 1 per cent of GDP; this is correlated with the behavior of the Gini coefficient as well as with the distribution of income as between profits and wages and with short-term and long-term unemployment in the countries concerned.

What the IMF found... 

Fiscal consolidation episodes have
(i) increased inequality in the very short term and in the medium term;
(ii) led to a significant and long-lasting fall in the wage income share of GDP; and
(iii) raised long-term unemployment over the medium term.

The impact is particularly striking in the correlation with the Gini coefficient. As the Figure below shows, fiscal consolidation episodes, on average, have been typically associated with an increase of the Gini of about 0.3 percentage point in the short term (two years after the occurrence of a consolidation episode) and of about 1.5 percentage points in the medium term (8 years after the occurrence of a consolidation episode).

Figure: The effects of fiscal consolidation on inequality Source: Ball et al. (2013)

Equally striking – although not unexpected – is the finding that reductions in spending tend to have larger distributional effects than tax-based consolidation measures. Specifically, the medium-term effect of fiscal consolidations on income inequality is about 1 percentage point for spending-based consolidations and 0.6 percentage point for taxes-based measures.

Austerity hurts the poor more than it hurts the rich

So, there we have it: the IMF beginning to recognise (2) that the austerity it has advocated for so long hurts the poor more than it hurts the rich. The policy conclusions the authors draw from their findings are, however, rather general and bland: "governments should pay special attention to the fiscal measures that they adopt"; "the distributional effects of consolidation must be balanced against the potential longer-term benefits that consolidation can confer"; "fiscal measures that are approved now but only kick in to reduce deficits in the future—when the global recovery is more robust—would be particularly helpful."(p.11).

And yet, it is possible to conceive of fiscal contraction that would be specifically designed to protect the poor and vulnerable and to reduce, rather than increase, inequality. In another paper (PDF) Isabel Ortiz and Matthew Cummins illustrate this possibility with the example of Iceland:

"In designing fiscal adjustment, the authorities introduced a more progressive income tax and created fiscal space to preserve social benefits. Consequently, when expenditure compression began in 2010, social protection spending continued to rise as a percentage of GDP, and the number of households receiving income support from the public sector increased. These policies led to a sharp reduction in inequality. Iceland’s Gini coefficient—which had risen during the boom years—fell in 2010 to levels consistent with its Nordic peers."

Surely an example to be followed.

Carlos Fortin is an IDS Research Associate currently working on the relationship between the emerging international trade regime and human rights.

  1. Laurence Ball, Davide Furceri, Danie Leigh and Prakash Loungani (2013) The Distributional Effects of Fiscal Consolidation, IMF Working Paper WP/13/151.
  2. The cautious wording takes account of the disclaimer included in all IMF Working Papers to the effect that "views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy."
  3. Isabel Ortiz and Matthew Cummins, "The Age of Austerity: A Review of Public Expenditures and Adjustment Measures in 181 Countries", Initiative for Policy Dialogue and South Centre Working Paper, March 2013 (PDF).
  4. Ibid, p. 38, quoting from Iceland’s IMF Article IV Consultation 2012

Previous Globalisation and Development blog posts on inequality:


Anonymous said...

A short comment on a statement in the concluding paragraph: "Consequently, when expenditure compression began in 2010, social protection spending continued to rise as a percentage of GDP, and the number of households receiving income support from the public sector increased. These policies led to a sharp reduction in inequality"
The number of households in need of income support rose. This outcome, which is tied to a sharp reduction in inequality, seems to suggest that the aim is to make everyone more equal by making them poorer. I'd be happy to learn that this is not the case, though how it is presented here certainly suggests that. Perhaps if additional factors such as stimulus-orientated policies could show that equality was being improved through increasing the wealth of everyone, then it could be a favourable policy. But as it stands, I dont think the 'make everyone poorer but more equal' thrust of this will win favour with many people. I may be wrong in my interpretation though, and happy to accept that if it is the case.

Carlos Fortin said...

The aim of the Icelandic government was precisely to prevent the poorer getting poorer as a result of the austerity policies. For those purposes, it introduced a more progressive income tax (i.e. increased the taxation of the better-off) and preserved the social welfare component of the budget by concentrating expenditure reductions elsewhere. In addition, as the full quote of Iceland's submission to the IMF indicates, "wage increases, agreed among the social partners in May 2011, led to a rise in nominal wages of 6% and the unemployment rate fell to about 7% in 2012". (See the Ortiz paper p. 38). The policy did definitely not make the poor, poorer.

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