What S&P report means for research on inequality and growth

The research-and-analytics arm of Standard and Poor’s, a rating agency, released a new report yesterday arguing that current high levels of economic inequality are holding back economic growth. As Neil Irwin points out at the Upshot, the report is surprising and interesting not because of its content but rather its source. The report’s publication is a sign that while existing research on this question has sparked quite a bit of interest, more economists and researchers need to think about whether and how economic inequality and growth are linked.

The S&P report doesn’t break new ground or provide any new evidence on the relationship between inequality and growth. Instead, it details some of the research looking to this question. Broadly there are two kinds of research on this topic. First there’s the so called growth regression literature, or papers that use regression analysis to determine which factors are strongly correlated with economic growth. In particular they include a measure of income inequality, most frequently the Gini coefficient. The research by International Monetary Fund economists Jonathan Ostry, Andrew Berg, and Charalambos Tsangarides cited in the report is a very high-quality version of such growth regression research.

Yet the overall findings in this academic arena are mixed. Inequality has been found to reduce growth, boost growth or have no effect at all. The varying methods used in these papers end up producing a variety of results. And even if the results were conclusive, they might not be helpful for further research or for use by policy makers. If we know, for example, that reducing the Gini coefficient by 10 percent boosts growth by, say, one percent, then this knowledge doesn’t really lead to actionable advice. We’d need to know where the changes in the distribution of income are up and down the ladder and the specific way in which inequality was reduced.

Perhaps a more fruitful way to understand the relationship between inequality and growth is the second research avenue: looking at specific economic channels and specific income groups. Examples of research that look at specific channels are the research on the effects of the unequal distribution of debt on consumption by Atif Mian of Princeton University and Amir Sufi of the University of Chicago, which is cited in the S&P report, or the well-documented research by Harvard University economists Claudia Goldin and Larry Katz on the college wage premium.

But research into these two channels or any other one may not result in findings that show ways to reduce inequality and boost growth. Increased college attendance, for example, might not reduce inequality as the demand for cognitive skills appears to be decreasing. Or preliminary research by Equitable Growth grantee and University of Chicago professor Ariel Kalil could find that there is an increasing income-based gap for noncognitive skills in addition to cognitive skills.

Other research can and should investigate how changes in the distribution of income affect the supply and demand sides of our economy in the short term and long term as well as examine the role of economic institutions, entrepreneurship, and innovation in economic growth.

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