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I. INTRODUCTIONEconomists are increasingly focusing on the links between rising inequality, crisis risk, andsustainable growth. Rajan (2010) underscores how inequality intensified the leverage andfinancial cycle, sowing the seeds of crisis, while Stiglitz (2012) stresses the role of politicaleconomyfactors (especially the influence of the rich) in allowing financial excess to balloonahead of the crisis. Berg and Ostry (2011) document the multi-decade and multi-countryevidence that greater equality can help sustain growth. This work builds on a tentativeconsensus in the growth literature that inequality can undermine progress in health andeducation, cause investment-reducing political and economic instability, and undercut thesocial consensus required to adjust in the face of major shocks, and thus that it tends to reducethe pace and durability of growth (Persson and Tabellini, 1994; Easterly, 2007; Berg, Ostry andZettelmeyer, 2012).2That equality seems to drive higher and more sustainable growth does not, in itself, supportefforts to redistribute. In particular, inequality may impede growth at least in part because itcalls forth efforts to redistribute through the fiscal system, efforts that themselves mayundermine growth. In such a situation, even if inequality is bad for growth, taxes and transfersmay be precisely the wrong remedy. While the literature on this score remains controversial,the notion of a tradeoff between redistribution and growth seems deeply embedded inpolicymakers’ consciousness. The negative effect of redistributive policies is indeed the centraltheme of Arthur Okun’s famous 1975 book on the tradeoffs between efficiency and equity andon the efficiency “leaks” that efforts to reduce inequality engender.We should not jump to the conclusion that a treatment for inequality—redistribution—may beworse for growth than the disease itself. First, we need to ask if equality-enhancinginterventions would invariably lead to a loss of economic efficiency, as Okun and othersassumed. On reflection, that is too broad-brush a conclusion: we are all familiar with win-winpolicies that have potential both to promote efficiency and equality. Examples could includetaxes on activities with negative externalities paid mostly by the better-off but harmful to thepoor (such as, perhaps, excessive risk-taking in the financial sector), cash transfers aimed atencouraging better attendance at primary schools in developing countries, or spending onpublic capital or education that benefits the poor. A number of papers (such as Benabou, 2000,2002; and Bleaney, Gemmell, and Kneller, 2001) point out that some categories of governmentspending—for example, public investments in infrastructure, spending on health and education,and social insurance provision—may be both pro-growth and pro-equality, while othercategories may imply the tradeoffs that preoccupied Okun. The macroeconomic effects ofredistributive policies are likely to reflect a balance between different components of the fiscal
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