Inequality and Growth

Directorate for

Employment, Labour and Social Affairs

December 2014

Does income inequality hurt economic growth?

Widespread increases in income inequality have raised concerns about their potential impact on our societies and economies. New OECD research shows that when income inequality rises, economic growth falls. One reason is that poorer members of society are less able to invest in their education. Tackling inequality can make our societies fairer and our economies stronger .

A long-term rise of income inequality

The gap between rich and poor is at its highest level in most OECD countries in 30 years. Today, the richest 10% of the population in the OECD area earn 9.5 times more than the poorest 10%.

By contrast, in the 1980s the ratio stood at 7:1.

The average incomes at the top of the distribution have seen particular gains.

However, there have also been significant changes at the other end of the scale. In many countries, incomes of the bottom 10% of earners grew much more slowly during the prosperous years and fell during downturns, putting relative (and in some countries, absolute) income poverty on the radar of policy concerns. Broad rises in inequality

The increase in income inequality is evident not just in a widening gap between the top and bottom income deciles, but also in the Gini coefficient, a broader measure of inequality

(which ranges from zero, where everybody has identical incomes, to 1, where all income goes to only one person). In OECD countries in the mid1980s, the Gini measure stood at 0.29; by

2011/12, it had increased by 3 points to 0.32.

The Gini coefficient increased in 16 out of the 21

OECD countries for which long time series are available, rising by more than 5 points in

Finland, Israel, New Zealand, Sweden and the

United States and falling slightly only in Greece and Turkey (Figure 1).

1. Income inequality increased in most OECD countries

Gini coefficients of income inequality, mid-1980s and 2011/12

1985

0.50

2011 or l a test (↗)

Increasing inequality

0.45

Little change Decreasing in inequality inequality

0.40

0.35

0.30

0.25

0.20

0.15

Note: Incomes refer to household disposable income, adjusted for household size.

Source: OECD Income Distribution Database (http://oe.cd/idd).

FOCUS on Inequality and Growth © OECD December 2014

1

How is inequality linked to growth?

New OECD analysis suggests that income inequality has a negative and statistically significant impact on medium-term growth.

Rising inequality by 3 Gini points, that is the average increase recorded in the OECD over the past two decades, would drag down economic growth by 0.35 percentage point per year for 25 years: a cumulated loss in GDP at the end of the period of 8.5 per cent.

What does this imply for the growth path of individual countries? Figure 2 shows by how much the GDP growth rate would have

increased or decreased over the period 19902010 had inequality not changed between 1985 and 2005 (The most recent inequality trends since then are not taken into account as they affect future growth patterns).

Rising inequality is estimated to have knocked more than 10 percentage points off growth in

Mexico and New Zealand, nearly 9 points in the

United Kingdom, Finland and Norway and between 6 and 7 points in the United States,

Italy and Sweden. On the other hand, greater equality prior to the crisis helped increase GDP per capita in Spain, France and Ireland.

2. Estimated consequences of changes in inequality (1985-2005) on subsequent cumulative growth (1990-2010)

Growth rate, in percentages

Note: The chart reports the estimated consequences of changes in inequality on the growth rate of GDP per capita (relative to the population aged 25-64) over the period 1990-2010. “Actual” is the actual growth rate of GDP per capita; “Impact of inequality” is obtained based on the observed changes in inequality across OECD countries (in 1985-2005) and the impact of inequality on growth estimated