Trickle down economics is wrong, says IMF

This post has been corrected.

Adding another nail to the coffin of Reaganomics, a recent study published by the International Monetary Fund (IMF) has concluded that, contrary to the principles of “trickle-down” economics, an increase in the income share of the wealthiest people actually leads to a decrease in GDP growth.

“The benefits do not trickle down,” the authors of the study write, directly contradicting the theory that US president Ronald Reagan popularized in the 1980s. Reagan argued that decreasing the tax burden for the rich–investors, executives, corporations and the like–would not only increase their own income but stimulate broad economic growth as they create opportunities for others’ increased prosperity. This belief has been at the center of conservative economic thought in the United States and abroad since Reagan’s presidency, during which he cut tax rates for the rich.

But the IMF study’s five authors say we should instead focus on raising the income of the poor and the middle class. “Widening income inequality is the defining challenge of our time,” they write. “In advanced economies, the gap between the rich and poor is at its highest level in decades.”

Raising up the poor appears to have a dramatic effect: A 1% increase in the income share of the bottom quintile results in a 0.38% increase in GDP. Meanwhile, a 1% increase in the income share of the top 20% results in a 0.08% decrease in GDP growth.

The IMF study comes with caveats. The dataset is from a wide range of countries, some with better available data than others. Also, inequality is far more skewed in developing countries than in countries with advanced economies, producing possible outliers. Lastly, the findings about the top quintile’s adverse effect on GDP growth was significant at the 90% confidence interval (a measure the certainty of the statistic), but fell short of the 95% gold standard within social science research.

Income inequality, both globally and in the United States, has recently found its way into the spotlight after the publication of the French economist Thomas Piketty‘s best-selling book Capital in the Twenty-First Century. And in a speech in 2013, President Obama called income inequality “the defining challenge of our time.” Meanwhile, Pope Francis denounced trickle-down economics in a scathing statement, saying the theory “expresses a crude and naive trust in the goodness of those wielding economic power.”

A recent book published by the Organization for Economic Cooperation and Development (OECD) supports the IMF study’s assertion that inequality suppresses economic growth. Both studies relied heavily on the Gini Coefficient, a measurement of income distribution in which a score of 0 represents a society in which all wealth is shared completely equally and a score of 1 a society in which all the wealth belongs to a single person (currently, the United States has a high Gini Coefficient of .4, falling only behind Chile, Mexico, and Turkey in this measurement of inequality for OECD countries.) The OECD study found that an increase in inequality on the Gini scale of two points corresponded to a 4.7% drop in GDP.

Stefano Scarpetto, the director of the Directorate for Employment, Labour and Social Affairs at the OECD, said that the main conclusion of the OECD book, In It Together: Why Less Inequality Benefits All, is that economic growth is most damaged by the effects of inequality on the bottom 40% of incomes.

“[Increased inequality] tends to reduce the potential of the lowest income classes to invest in quality education,” Scarpetta said, adding that the negative effect of increased inequality on growth that the IMF researchers found holds true for the advanced economies of the OECD.

Correction: A previous version of this post misspelled Thomas Picketty’s last name.

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