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While GVCs provide developing countries with the opportunity for economic and social upgrading, such outcomes are not a given. Evidence from Africa suggests that while poorer countries benefit most of the time from increasing GVC integration in the form of more and better employment, such upgrading has been less evident for example in South Africa’s textile industry (OECD, 2014a). Moreover, GVCs are not gender neutral and reflect broader gender inequality and discriminatory social norms within households, communities and economies. While women are important participants in the GVCs, their opportunities for economic empowerment are limited due to gendered division of labour and low economic value attributed to their contributions (Barrientos, 2013). The bargaining position and support provided to weaker value chain participants, such as small producers, unskilled workers and women, are essential to helping them upgrade. Policies need to be tailored to specific upgrading strategies and institutional contexts, which vary by sectors and countries. However, private governance and public policies may strongly affect the inclusiveness of GVC participation and upgrading (Goger A., et al., 2014).

 Technological progress has been more beneficial to higher-skilled workers, especially in OECD countries. For decades, technological progress has raised productivity more quickly in manufacturing than elsewhere, reducing the demand for labour, especially low-skilled labour.20 Combined with greater trade openness, this trend has also created large numbers of low-skilled manufacturing jobs in developing countries and emerging market economies.

The more recent advent of ICT technologies has allowed people with the relevant ICT skills, or those specific to the financial sector, to enjoy significant income gains, while workers with low skills have been left behind. As a result, the earnings gap between high and lowskilled workers has grown. In some countries like the United States, skill-based technical change induced a shift in labour demand towards higher skills. Yet, the supply of such individuals has not kept pace with rising demand, as indicated by the slowing growth of tertiary educational attainment (Denk, O. et al., 2013).

 Regulatory reforms and institutional changes leading to increased competition and greater flexibility in product and labour markets have increased employment opportunities, but also contributed to greater wage inequality. Since the 1980s, OECD countries have carried out significant regulatory reforms to strengthen competition in the markets for goods and services and to make labour markets more adaptable. Reforms include the removal of barriers to competition in product market regulations, more flexible employment protection legislation (EPL) for workers with temporary contracts, and in some cases reductions in the minimum wage. Unionisation rates also fell in most OECD countries.

These reforms had positive impacts by promoting job creation in the short run, but the fact that permanent workers continued to enjoy stricter EPL relative to their peers on temporary contracts in most countries contributed to rising labour market segmentation and deteriorating job quality (OECD 2013a).

 Changes in working conditions have contributed to rising earnings inequality. In many countries, there has been an increase in the prevalence of part-time and atypical labour contracts, as well as a reduction in the coverage of collective-bargaining arrangements. As mentioned in Chapter 1, some population groups, including women and youth, often only work part-time and tend to suffer from a wage gap with other groups.

 Changing family structures are making household incomes more diverse, while reducing economies of scale and making for increased earnings inequalities. Household structures have changed profoundly over recent decades. There are more single-headed households today than ever before; in the mid-2000s, they accounted for 20% of all workingage households, on average, in OECD countries. Smaller households are less able to benefit from the savings associated with pooling resources and sharing expenditures. Therefore, a trend toward smaller households is likely to increase earnings and income inequality.

Marriage behaviour has also changed. People are now much more likely to choose partners in the same earnings bracket, which tends to reinforce income inequality (Chen et al., 2014;

Greenwood et al., 2014). However, the combined effects of demographic and societal changes have accounted only for a minor share of increased household earnings inequality, much less than labour market related factors (OECD 2011a).

Rising shares of non-wage income from capital have also increased household income inequality. Capital income inequality has increased more than earnings inequality in most OECD countries (OECD 2001a). But, at around 7%, the share of capital income in total household income still remains modest on average, although richer individuals tend to receive a larger share of their income from capital. Wealth-to-income ratios have risen sharply in OECD countries since the mid-20th century. The challenge this trend poses for policymaking is that wealth is transmitted across generations, perpetuating inequalities in both wealth and the incomes derived from it. An Inclusive Growth policy response could be progressive taxation of wealth and more progressive inheritance taxes. Both would be difficult to implement in an environment of increased cross-border capital mobility.

The global crisis and its financial roots have revived a debate on the impact of financial deepening on inequalities.21 By bringing together savers and borrowers, with their very different attitudes and needs regarding liquidity and risk, financial markets aid growth. Lack of access by households and would-be entrepreneurs to credit is often cited as a barrier to development in poorer countries. In rich countries with highly developed financial markets, their impact on long-term growth is less clear-cut: “Finance is a powerful tool for economic development but with important non-linear effects” (Beck, 2013). The recent global financial crisis underlines the importance of regulatory frameworks that discourage financial market operators from risky activities, often divorced from the core business of financing real investment, that bring them exceptionally high rewards in good times, but greatly harm the real economy when risks materialise. The exceptionally high rewards themselves exacerbate inequality of earnings and also attract a high share of the highly-skilled, so that productivity suffers in other sectors that depend on skilled human capital (Kneer, 2013).

Finally, tax and benefit systems have become less redistributive in many countries since the mid-1990s. Until the mid-1990s, tax-benefit systems in many OECD countries offset more than half of the rise in market-income inequality. However, while market income inequality flattened after the mid-1990s, inequality of household disposable income continued to rise as the stabilising effect of taxes and benefits declined. The main reasons for the decline in redistributive capacity are found on the benefit side: reduction in benefit generosity, a tightening of eligibility rules to limit expenditures for social protection, and the failure of transfers to the lowest income groups to keep pace with earnings growth (OECD, 2011a). Currently, cash transfers and income taxes reduce income inequality by one quarter among the working-age population (Figure 2.1).

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30% 25% 20% 15% Note: Redistribution is measured as the difference between "initial" inequality (Gini of market income) and "final" inequality (Gini of disposable income), as a percentage of initial inequality.

1985 refers to 1984 for the United States. OECD average: un-weighted and based on 10 countries for which data are available at all points (Canada, Denmark, Germany, Israel, Italy, Netherlands, New Zealand, Sweden, United Kingdom and United States).

Source: OECD Income Distribution Database (2013), www.oecd.org/social/income-distribution-database.htm

Drivers of inequalities in emerging market economies and developing countries

There are additional driving forces of income inequality in emerging market economies and developing countries. The key culprits are a combination of marked spatial divides, widespread informality in the labour market and among SMEs, and disparities in access to education and skills (OECD 2011a).

In particular:

 Widespread informality is a major cause of inequality. In spite of rapid economic growth in most developing countries, more than 50% of all jobs in the non-agricultural sector worldwide are informal (OECD 2009). Informal workers generally have low-paid, lowproductivity jobs and often do not have access to formal social safety nets. They also work in small, unregistered businesses with limited opportunity for expansion, perpetuating a vicious circle of exclusion, low productivity and inequality. In Latin America, some countries, like Brazil, have seen a significant decrease in informal employment since the mid-1990s, but in others, like China, India, Indonesia, and South Africa, informality has actually increased. In most Sub-Saharan African countries, informal sector employment, in particular selfemployment, remains the dominant form of work (OECD, 2012a).

 Spatial disparities in economic outcomes can stem from power imbalances between advantaged and lagging regions, coupled with institutional weaknesses and ethnic disadvantages. The specific forces behind observed patterns of spatial inequality vary among countries. They might be linked to disparities in access to basic services between rural and urban populations (e.g., China) or imbalances between different regions (India). They may also be linked to historically disadvantaged ethnic and social groups that are concentrated in particular regions (e.g., South Africa, Viet Nam). As mentioned in Chapter 1, emerging market economies like China and India and, to a lesser extent, South Africa, have experienced increases in income inequality within urban and rural areas alike since the early 1990s, with increases particularly in urban regions. Other countries, like Viet Nam, have seen a trend of increasing inequality in rural areas, even if inequality also worsened in urban areas during the crisis (OECD 2014b).

 Another important factor driving income inequality is access to quality education and skills. Across the developing world, enrolment in primary and secondary education varies markedly between population groups. Household income has an important effect on the educational attainment of children, and spatial and gender disparities persist, with rural populations generally less educated than urban populations, and girls of primary-school age being more likely than boys to be out of school in several African and Southern Asian countries (OECD, 2012b). Over the past two decades, however, important progress has been made in both primary school attendance, and youth and adult literacy. Primary school enrolment rates in developing countries grew from 83% in 2000 to 90% in 2011, and global adult literacy rates grew from 76 to 84% over the same period.22 In Latin America, 51% of the young population between 20 and 24 years of age completed secondary education in 2006, compared to only 27% in 1990. The increase in enrolment was a key factor in the reduction in income inequality in the region (OECD, 2012d).

In emerging market economies, the benefit and tax systems have a smaller role in easing market-driven disparities in earnings than they do in most OECD countries. The coverage and generosity of social protection systems is generally lower in emerging market economies than in most OECD countries. Public social expenditure is highest in Brazil and Russia, where it represents about three-quarters of the OECD average of about 20% of GDP, whereas in China and India public social expenditure is three to four times lower than the OECD average (OECD 2011a). In low and middle income countries, public social expenditures are much lower than the OECD average (OECD 2014b and Castel, 2014).23 More importantly, the tax system in emerging market economies delivers only modest redistribution, reflecting greater reliance on indirect, rather than direct taxes.

Social protection is underdeveloped in many developing countries. More than 80% of the global population lack basic protection in the event of unemployment, sickness, disability, widowhood, old age or other adverse shocks to income (ILO 2008). In many less-developed nations, social security mainly benefits civil servants and state employees. Informal workers are excluded from the social security system, and fiscal spaces do not allow sufficient domestic resources to be mobilised to fund broad social protection programmes.

2.2. Growing unequal amid rising prosperity: why care about it?

In those countries where inequalities have been widening, it is worrying that the “rising tides” continue to raise the biggest boats the fastest. Some level of inequality is to be expected in all economies. The arguments about the impact of the level of inequality on economic growth go both ways (Box 2.2). In OECD countries, the period of fast GDP growth from the 1950s to the oil shocks of the 1970s was accompanied by generally falling levels of income inequality (Sawyer, 1976). Since then, per capita GDP growth has been on a falling trend, but income inequalities have risen again in many OECD countries, especially at the high ends of the income distribution. In many fast-growing emerging economies, income inequalities are higher than in OECD countries, and they continue to rise. The reasons for these developments are now well understood (see above), but they were not predicted before they became noticeable. Although attitudes towards incomes inequalities differ across societies, very few would argue that persistently rising inequality is an inevitable, healthy and welcome accompaniment to economic growth, and even the current levels of inequality in countries at very different stages of development have become a matter of political concern.

There are many reasons to care about rising income inequality. Income inequality reduces social mobility, making it more difficult for innately talented people from low-income backgrounds to rise above their origins while enabling the descendants of the rich to enjoy high living standards with little effort. Intergenerational earnings mobility is high in the Nordic countries, where income is more evenly distributed, and low in countries with higher inequality, such as Italy, the United Kingdom and the United States (OECD, 2008). Inequality within countries also raises political challenges by breeding social resentment and generating political instability by fuelling populist, protectionist and anti-globalisation sentiment. People will no longer support open trade and free markets if they feel that they are losing out while a small group is prospering. In some parts of the world, such as in Northern and Southern Africa, the effect of persistently high unemployment combined with severe levels of inequality has already resulted in social instability.

Inequalities of income and opportunity undermine the economy’s performance, even if the relationship is not straightforward. The literature shows that income distribution is linked to macroeconomic performance through complex, multidimensional transmission channels. Economic performance might be stimulated or inhibited depending on the prevailing overall level of inequality as well as how inequality is shaped: positive mechanisms running from inequality to GDP growth can be linked to inequality at the top end of the distribution while negative effects can be traced to bottomend inequality e.g. poverty (Barro, 2000). As a result the shape of the income distribution also matters, and inequality at different segments of the income distribution can affect GDP differently. These theoretical findings (see for example Aghion and Bolton, 1997 and Galor and Moav, 2004) are supported by empirical analysis by the OECD (Figure 2.2). Overall, the impact is invariably negative and statistically significant: a 1% increase in inequality lowers GDP by 0.6% to 1.1% depending on the strength of the aversion. However, the symmetry of the curve implies that inequalities at the top and the bottom of the income distribution have almost the same effect on GDP.

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