Income Inequality Significantly Damages Growth, OECD Says

Widening inequality creates a drag on economic growth that can be counteracted by tax policies to benefit the less well-off, according to the Organisation for Economic Cooperation and Development.

In an analysis published today, the Paris-based group said it undermines growth by preventing disadvantaged people from accessing education to develop their skills, impeding social mobility. To offset the damage, policy makers need to be concerned with the general welfare of the bottom 40 percent of society and not just the poverty of the lowest 10 percent.

The study taps into a global debate this year about inequality, an issue also raised by Federal Reserve Chair Janet Yellen in October when she questioned the disparities of wealth and income growth. According to the OECD, inequality knocked about 6-7 percentage points off U.S. gross domestic product growth between 1990 and 2010, while the U.K., Italy and Mexico were among countries that also experienced a drag.

The report “challenges the view that policy makers necessarily have to address the trade-off between promoting growth and addressing inequality,” the OECD said. “Policies that help to limit or reverse inequality may not only make societies less unfair, but also wealthier.”

In general, a widening in inequality comparable to that seen in OECD states over the past two decades would slow growth by a “statistically significant” 0.35 percentage point a year, resulting in a cumulative loss of 8.5 percent over a quarter century.

‘Compelling Evidence’

“This compelling evidence proves that addressing high and growing inequality is critical to promote strong and sustained growth and needs to be at the centre of the policy debate,” said Angel Gurria, secretary-general of the OECD, said in a statement. “Countries that promote equal opportunity for all from an early age are those that will grow and prosper.”

The analysis is based on the Gini coefficient scale, which measures inequality on a scale from zero to 100. The OECD said there was a 3-point average increase recorded in member states from 1985 to 2005.

Changes in wages and salaries have been the biggest direct driver of inequality, according to the report. The earnings of the 10 percent best-paid workers have risen relative to the 10 percent at the bottom, who also saw a drop in annual hours worked.

Slower Growth

Well-designed redistributive policies can address this and need not harm growth, the OECD said, citing tax changes to target high earners and capital income, which is concentrated among wealthy households. It also said tackling poverty won’t be enough and recommended government transfers, including policies to improve access to public services such as health care and education.

“What matters most is the gap between low income households and the rest of the population,” the OECD said. “Inequality undermines education opportunities for disadvantaged individuals, lowering social mobility and slowing human capital accumulation.”

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