Inequality: Why the struggle matters

©Reuters/Luke MacGregor

The economic crisis has been rich in history-defining images, from bank collapses and house foreclosures to street protests and growing lines of the unemployed. In 2011 one image stands out: that of protestors “occupying” major financial districts around the world. These protesters are demonstrating against a system that they accuse of having enriched the few at the expense of those at the bottom of the economic ladder. 

While the story may seem simplistic, it is anchored in truth. Looking at CEO salaries, which can soar to 71 times the average salary in the Netherlands, 85 times in Canada, and a dizzying 183 times in the US–or over US$10 million a year–it is not difficult to see why people are enraged. For a quarter of a century, the gap between rich and poor has been widening in over three-quarters of OECD countries. This was already occurring before the Great Recession of 2007 when many countries were growing at a healthy clip.

In 2008, the income of the richest 10% across OECD countries was, on average, nearly 9 times that of the poorest 10%. True, in some European countries the gap is much smaller, with the incomes of the richest 10% at about 5 times those of the poorest 10%. But in the United States this ratio rises to about 14 to 1, while in Chile and Mexico the gap skyrockets to 27 to 1.

The problem has been worsening in recent decades. In Japan, for instance, the top 10% currently enjoy incomes of more than 10 times those of the poorest 10%, up from 7 times in 1985. Even in more traditionally egalitarian countries, inequality in earnings has been on the rise. In Sweden, for example, the top 10% earned 3.5 times as much as the bottom 10% in 1985, but that the gap has jumped to 6.3 times today. Unemployment has risen into double-digits in several EU countries, particularly among the young, and fiscal austerity has involved cuts in benefits. Wages at the bottom of the ladder are feeling the pressure, and in Greece the statutory minimum wage was cut by a fifth in February.

It is possible that disparities may accelerate further because of the crisis, due in part to austerity programmes. On the other hand, growing inequality may have been arrested by a drop in capital incomes during the crisis, as well as by government-supported low incomes.

The trouble is, inequality is not just a social or moral issue, but an economic one. An International Monetary Fund (IMF) report recently argued that inequality is bad for growth. Meanwhile, an OECD report, Going for Growth, issued in February 2012 focuses on institutional and policy settings in a bid to understand how growth and equity can work together; we will be looking at these issues in forthcoming editions. Another OECD report, Divided We Stand: Why Inequality Keeps Rising also examines the main causes and policy responses.

One major explanation behind diverging incomes is the rapid progress in information and communications technologies, as this has benefited higher skilled workers disproportionately. Demand for the skills of people able to deal with new technologies has ballooned, as have their earnings. The same is true of people with skills in fast-growing high-value sectors, such as finance. Meanwhile, incomes of low-skilled workers have stagnated, and this has widened the earnings gap between the two.

The benefits accruing from the expansion of the most dynamic and innovative sectors have been captured mainly by high-skilled workers, though particularly by the top earners in very specific sectors such as financial services.

Regulatory reforms and institutional changes have increased employment opportunities in recent decades, but have also meant that more people are in low-paid jobs.

This, together with the increase in part-time employment, atypical labour contracts and a decline in the coverage of collective-bargaining arrangements in many countries, helps explain the wider disparities in earnings. In fact, the share of part-time workers in total employment across the OECD area rose from 11% in the mid 1990s to about 16% by the late 2000s. This was good news for many people who wanted jobs but could not find full-time work, and for others who found part-time employment attractive (see “Does part-time work pay?” OECD Observer No. 280, July 2010). But the result was more earnings inequality overall. Moreover, part-time workers often endure inferior workplace conditions than full-timers, with less in the way of training, pension entitlements, paid leave and so on.

Some factors have attenuated the increase in earnings inequality. The rise in the supply of skilled workers, for instance, offset the increase in wage dispersion associated with technological progress, regulatory reforms and institutional changes. The up-skilling of the labour force also helped employment growth.

One driver of inequality has been the uneven distribution of incomes other than wages. In particular, inequality in capital income from the likes of stock market windfalls and property investments has widened the gap more than wage earnings in two-thirds of OECD countries. The share of capital income in total household income, while at around 7%, still remains modest on average, so this does not fully explain why inequality has widened. There is also a generational dimension to inequality. Until recently, parents could reasonably expect their children to earn more than they did over the course of their careers. Today, upward “intergenerational earnings mobility” can no longer be taken for granted. Social mobility is actually low in countries such as Italy, the UK and the US, where income inequality is high, but it is high in countries where income is distributed more evenly. But while most children in, say, the Nordic countries can expect to fall into a different earnings class than their parents, that mobility can be up or down.

Inequality of opportunities has an impact on economic performance by affecting social cohesion, trust and motivation. And as the crisis has shown, this eventually causes the economy as a whole to choke.

What can policy makers do to reduce inequalities? The OECD sees three main pillars for action: tax/transfer redistribution policies, human capital investment and actively promoting employment.

Take tax and benefit policies, which offset much of the rise in market-income inequality before the mid-1990s. Overall, cash transfers and income taxes can reduce income inequality by as much as a third, and by a quarter among the working age population. However, the stabilising effect of taxes and benefits on household income inequality has declined in many countries. To make matters worse, changes in tax burdens and benefit entitlements were mostly regressive, particularly for single individuals and childless families. Also, the number of people entitled to unemployment-related benefits fell, in part as a consequence of tighter eligibility rules. And while benefit entitlement became more generous in value terms, benefits for the lowest income groups failed to keep pace with earnings growth. Addressing these issues is important, but policy makers should be careful to address taxes and benefits as a whole, rather than targeting a particular tax or entitlement in isolation. Redistribution is not only about cash. Governments spend as much on public social services, such as education, health and care services, as they do on all cash benefits taken together, some 13% on OECD average, ranging from 8% in Chile and Turkey to around 20% in Denmark and Sweden. True, the prime objective of such services is not redistribution, but the provision of a decent education, good health care and acceptable living standards for all. Nonetheless, they do reduce income inequality by as much as a fifth. In Brazil for instance, poverty and inequality have fallen, thanks in part to better education (see “Brazil’s economy: Reaching new heights”, OECD Observer No. 287, December 2011).

As for promoting work, training and education are important for everyone, but there is an urgent need in some countries to ensure that the young and rising tides of long-term unemployed get training and do not drift out of the workforce. Also, policies to improve in-work benefits such as earned income or child tax credits could be enhanced to encourage people to take up work. Or additional income support can target low-income households. Such benefits are in place in about half of all OECD countries already. They are generally paid to low-earners and are sometimes limited to a transitional period on taking up employment. In-work benefits often play a central role in “make work pay” strategies. Not only more, but better jobs are needed and it is crucial that policies foster employment gains in jobs that offer genuine career prospects.

In sum, there is nothing inevitable about widening inequalities. If the right policies are applied, the gap between people at the opposite ends of the economic ladder will no longer seem to some like an unfathomable gulf.

See: 

OECD (2011), Divided We Stand: Why Inequality Keeps Rising, Paris.

OECD (2012), Economic Policy Reforms: Going for Growth, Paris.

Berg, A, and JD Ostry (2011), “Inequality and Unsustainable Growth: Two Sides of the Same Coin?” IMF Washington.

Saint-Martin, A. and Venn, D. (2010)“Does part-time work pay?”, OECD Observer No 280, July.

©OECD Observer No 287 Q4 2011




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