Macro-structural policies and income inequality in low-income developing countries

Despite sustained economic growth and rapid poverty reduction, income inequality remains stubbornly high in many low-income developing countries (LIDCs). This pattern is a concern as high levels of inequality can impair growth sustainability and macroeconomic stability, thereby also limiting countries’ ability to reach the Sustainable Development Goals (SDGs). It is therefore critical to understand how policies aimed at boosting economic growth affect income inequality. The paper combines empirical methods with a multi-sector general equilibrium model with heterogenous agents calibrated to seven different LIDCs (Honduras, Guatemala, Uganda, Republic of Congo, Ethiopia, Myanmar, and Malawi) taking into consideration important features of LIDCs like high levels of informality, limited geographic or inter-sectoral labor mobility, large inter-sectoral productivity differences, lack of access to finance, and low levels of infrastructure. The paper examines: (i) the distributional consequences of economic reforms and macro-structural policies that are generally considered to be growth-enhancing; (ii) the channels and mechanisms through which inequality is likely to be affected, given structural characteristics common to most LIDCs; and (iii) the importance for complementary policies to ensure that a reform package can boost growth without widening inequality. We use data from the International Monetary Fund and from household surveys administered by the World Bank in each country, and consider reforms from 2013 to 2016.

The paper finds that some reforms may boost growth and welfare for all with distributional consequences that may not be undesirable from an economic and/or social point of view. Other reforms can bring economic gains only to a few with distributional consequences that may be considered unwelcome by societies. While there is no one-size-fits-all recipe, the paper explores how targeted policy interventions, implemented in conjunction with pro-growth reforms, can be deployed to contain any adverse distributional effects of the reform measures—recognizing that societal views on what constitutes an undesirable distributional outcome will differ from country to country. The analysis focuses on the macroeconomic mechanisms through which such interventions can contain or offset any adverse distributional impact of pro-growth reforms.