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Ian Brinkley
Economic Advisor
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Ian Brinkley

Inequality and growth

Authors: Ian Brinkley

09 December 2014

The most recent OECD report in inequality and growth makes for rather depressing reading. Inequality has increased in most, if not all OECD economies, and in most but not all OECD economies it has reduced the economic growth rate. The OECD provides a measure of inequality and also an estimate of how fast the economy might have grown had there been no increase in inequality since 1985. As can be seen in the table below, we are second among the G7 economies in terms of income inequality (just above Japan) and have experienced the biggest growth loss as a result.

The table estimates the impact of growing inequality on growth between 1990 and 2010 as a result of the increase in inequality between 1985 and 2005. In the UK inequality rocketed between 1975 and 1990 before more or less flattening out. We have been paying the price of the shift to a significantly less equal society in the 1980s.
Source OECD
The figures on lost growth have to be treated with a bit of caution as they rely on a counter-factual – what growth would have been had there been no increase in inequality. The relationship is also complex. Greater inequality can increase growth by increasing work incentives and the value of acquiring educational qualifications. That is why France shows a positive number in the table, although the increase in inequality in France since 1985 was very modest. 

Redistributive policies per se have no impact on growth, although poorly designed redistributive policies could. The OECD notes that top income groups have a greater capacity to pay tax than before and governments should “ensure the wealthier individuals contribute their fair share of the tax burden”. This is not as easy as it sounds, given that the ability of top earners to avoid national tax increases and proposals to increase taxation of the well-off often arouses vocal opposition as recent debates in the UK on how best to tax high value property have shown. Moreover, even if avoidance and opposition are overcome the sums raised may not be very great.

The OECD concludes that the growth penalty is associated with the growing gap between poorer households and the rest, rather than the top income groups pulling way from everyone else. At the heart of the OECD’s analysis is the critical role of access to high quality educational opportunities. Higher inequality reduces the ability of individuals from poorer households to access good quality education and training and it is this lack of investment in human capital that matters most in terms of reducing growth. This can only be partly addressed by policies that cut the cost of participating in higher and further education for poorer households – better schooling, high quality training opportunities and life long learning are also required.

The OECD also notes that these policies must cover not just the poorest 10 per cent of households, but up to 40 per cent of the population by income group – including what the OECD calls “the vulnerable lower middle classes”. Anti-poverty programmes are essential but will not be enough.
Efforts to date by successive UK governments to overcome the inequality inheritance of the 1980s have made little impression, partly because they are battling global changes such as new technologies, globalisation, and falls in collective bargaining that have been pushing in the opposite direction. At best, we have stopped things getting worse.

A future government needs to be much more ambitious about combining redistribution with large scale investment in expanding quality education and training opportunities for the bottom 40 per cent. We need a low pay strategy backed by an effective industrial strategy to increase productivity in low pay industries. And we need a sustained commitment from employers and trade unions to improve progression and productivity in the workplace. Just as increased inequality in the 1980s has imposed a growth penalty on the UK, reducing inequality over the next decade could generate a growth bonus.