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More than 3 out of 4 OECD countries, including traditionally more equal countries registered widening inequality this century when growth was rapid; if anything this trend has accelerated in the aftermath of the crisis, as employment growth remains sluggish and fiscal consolidation takes hold. This disturbing development raises the question of whether greater inequality increases growth? Or, on the contrary, does it hold growth back?
There are a number of ways in which wider inequality might affect growth. It might reduce growth if:
a) Greater inequality becomes unacceptable to voters, so they insist on higher taxation, regulation, or even confiscation of property, all of which may reduce the incentives to invest.
b) In extreme cases, inequality may lead to social unrest, and economic chaos.
c) Poor people cannot borrow money. If this is the case, then they may not be able to afford worthwhile investments, even if the rate of return is high. They may choose to leave full-time education if they cannot afford to pay fees, even though the rate of return (to both the individual and society) is very high.
d) People no longer trust business, and pro-business policies.
On the other hand, greater inequality might increase growth if:
e) High inequality encourages people to invest to take advantage of high rates of return. For example, if highly educated people are much more productive, then high differences in rates of return may encourage more people to seek education.
f) Similarly, if the rewards are high, people might work harder and be prepared to take more risks in order to get higher incomes.
Many empirical attempts to explain the links between inequality and growth have been inconclusive. Up to now, evidence has strongly supported hypothesis b), particularly in low income countries and largely rejected hypothesis a); and has been inconclusive on the other hypotheses. However, this lack of evidence often reflects methodological and data problems, and it is possible to be more assertive about the types of inequality which should concern policymakers. In the real world, inequality often arises from circumstantial factors (socio-economic or family background, race), or individual actions and effort. The former set of causes is bad for growth, not just equality, regardless of whether the latter may be more complex to analyse. Tackling racism, sexism, and promoting equality of opportunity are good for growth and good for equality.
Furthermore, the reality of income inequalities is more complex than the simple Gini coefficient measure.
For example, evidence suggests that rising inequality in the bottom half of the distribution reduces investment in education and is bad for growth, whereas rising inequality in the top half of the distribution encourages entrepreneurship and effort and is good for growth. At the same time, if inequality is restricted to the top 1% of the distribution, there may not be much room for “trickle down” effects of growth. In some OECD countries, more than 40% of long-term income growth has been captured by the top 1%.
Hence the message to policymakers is: understand the causes of changes in inequality. Sometimes increasing inequality will be a prerequisite for higher growth returns. Often, however, tackling inequality will be an important driver for improving growth.
Note: Elasticity estimated from the joint estimation of GDP and household incomes equations.
Source: Causa et al. (2014)
2.3. Defining Inclusive Growth A diversity of approaches There are different approaches to Inclusive Growth, which at their root share a call for growth that combines increased prosperity with greater equity. In some cases, emphasis is placed on productive employment, so that economic growth can generate the jobs needed to absorb growing populations, meets the demands of the private sector for skills and competencies, and ensure that workers reap the benefits of rising productivity. Other approaches emphasise pro-poor growth, aiming to deliver higher income gains for low-income groups than for the rest of the population, and in doing so help to reduce inequalities in living standards. There are still other approaches that focus on the economic and non-economic opportunities generated by growth and on sharing the benefits of growth in terms of quality of jobs, the health and education status of the population and/or the skills of the labour force.
Despite the absence of a unifying concept, governments are increasingly putting Inclusive Growth at the core of their policy strategies. This is the case with India’s 12th Five Year Plan and the European Union’s Europe 2020 Strategy, where Inclusive Growth is presented as an emerging model for growth. Although no explicit mention is made of Inclusive Growth, the New Zealand Treasury has also endorsed a vision of living standards that emphasise both economic growth and distributional considerations. Scholars and international organisations are also working on the definition and measurement of Inclusive Growth (Box 2.3).
Box 2.3. The definition of Inclusive Growth in the work of other International Organisations The World Bank refers to Inclusive Growth to denote both the pace and pattern of economic growth, which are interlinked and assessed together. In the World Bank approach, a rapid pace of economic growth is necessary for reducing absolute poverty. But, for this growth to be sustainable in the long run, it should be broadbased across sectors, and inclusive of most of a country’s working-age population. This definition implies a direct link between the macro and micro determinants of growth. In this perspective, Inclusive Growth focuses on productive employment, rather than on employment per se, or income redistribution. Employment growth generates new jobs and income, while productivity growth has the potential to lift the wages of workers and the returns of the self-employed. The World Bank’s approach adopts a long-term perspective and is concerned with sustained growth, where inclusiveness refers to equality of opportunity in terms of access to markets, resources and unbiased regulatory environment for businesses and individuals.
The Asian Development Bank (ADB) framed its corporate strategy (Strategy 2020) aiming to promote inclusive economic growth as one of its main objectives. In this framework, Inclusive Growth is a concept that goes beyond broad-based growth. It is a type of “growth that not only creates new economic opportunities, but also one that ensures equal access to the opportunities created for all segments of society, particularly for the
poor” (Ali and Hwa Son, 2007). An income growth episode is considered “inclusive” when it:
allows participation of (and contribution by) all members of society, with particular emphasis on the ability of the poor and disadvantaged to participate in growth (the “non-discriminatory” aspect of growth). This implies a focus on the “process” of growth; and is associated with declining inequality in those non-income dimensions of well-being that are particularly important for promoting economic opportunities, including education, health, nutrition and social integration (the “disadvantage-reducing” aspect of Inclusive Growth). This implies a focus on the “outcomes” of growth.
The UNDP recently changed the name of its International Poverty Centre in Brasilia to International Policy Centre on Inclusive Growth (IPC-IG), whose work is based on the premise that more equal societies perform better in development. In the UNDP perspective, Inclusive Growth is seen as both an outcome and a process. On the one hand, it ensures that everyone can participate in the growth process, both in terms of decision-making as well as in terms of participating in growth itself. On the other hand, Inclusive Growth is one whose benefits are shared equitably. Inclusive growth thus implies participation and benefit-sharing.
The Europe 2020 Strategy has the notion of Inclusive Growth at its core. In this Strategy, Inclusive Growth is understood as ”empowering people through high levels of employment, investing in skills, fighting poverty and modernising labour markets, training and social protection systems so as to help people anticipate and manage change, and build a cohesive society. It is also essential that the benefits of economic growth spread to all parts of the Union, including its outermost regions, thus strengthening territorial cohesion. It is about ensuring access and opportunities for all throughout the lifecycle”.
The OECD approach to Inclusive Growth
A multidimensional policy framework for Inclusive Growth can be built on the OECD’s work on well-being, income distribution and the effects of structural reforms on economic performance. At the heart of this approach is a definition of Inclusive Growth as “economic growth that creates opportunity for all segments of the population and distributes the dividends of increased
prosperity, both in monetary and non-monetary terms, fairly across society”. In particular, a threepronged approach can be based on:
Multidimensionality. There is widespread recognition that gross domestic product (GDP) captures only part of economic welfare and excludes other dimensions which also matter for well-being, such as jobs, skills and education, health status, environment, and civic participation and social connections. Multidimensionality draws on the OECD work on wellbeing (Box 2.4), which emphasises a set of key outcomes that are essential for the development of people’s capabilities and well-being and that allow them to participate in both the economy and society.
Emphasis on distribution. Inclusive Growth means that people, independently of their socioeconomic background, gender, place of residence or ethnic origin, should have fair opportunities to contribute to growth (i.e., they are part of the growth process), and that their contribution should yield equitable benefits (i.e., they benefit from the outcomes of the process). The OECD work on trends and policy drivers of income distribution, including in Divided We Stand, Going for Growth, Perspectives on Global Development, among other studies, provides an important pillar for the work on Inclusive Growth. In addition, the OECD’s Inclusive Growth approach aims at capturing how particular parts of the population fare not only with respect to income but also with respect to other dimensions of well-being, such as health.
Policy relevance: Inclusive Growth should be policy-actionable and must make a link between policy instruments and the relevant monetary and non-monetary dimensions, taking into account distributional impact. This requires in particular assessing the impact of policies and institutions on the different dimensions, as well as the trade-offs and complementarities that are expected to exist between pro-growth and pro-inclusiveness policies among the relevant dimensions. A policy-relevant and operational approach to Inclusive Growth calls for a policy toolkit that allows policymakers to exploit synergies among mutually-reinforcing policy levers and to take compensatory action when trade-offs are identified. The OECD has done considerable empirical work to “map”, or establish causal linkages, between policies and outcomes which provides a rich body of evidence that informs the work on Inclusive Growth.
Box 2.4: OECD work on well-being
For more than 10 years, the OECD has been looking beyond the functioning of the economic system to consider the diverse experiences and living conditions of people and households. Measuring the well-being of people and the progress of societies is the main goal of the OECD Better Life Initiative (www.oecd.org/betterlifeinitiative). The Initiative, that was launched in May 2011 on the occasion of the OECD’s 50th Anniversary, focuses on developing statistics that can capture aspects of life that matter to people and that, taken together, help to shape the quality of their lives. The OECD conceptual framework for measuring well-being focuses on people, outcomes (average and their distribution) and includes both objective and subjective aspects of well-being. It distinguishes between current and future well-being. Current well-being is measured in terms of outcomes and their distribution across the population achieved in the two broad domains: material living conditions (i.e. income and wealth; jobs and earnings; housing conditions) and quality of life (i.e. health status;
work-life balance; education and skills; social connections; civic engagement and governance; environmental quality; personal security; and subjective well-being). To assess the sustainability of well-being over time, the OECD focuses on four different types of resources (or “capitals”) that can be measured today, and that matter for the well-being of future generations: economic, natural, human and social capital. Two important elements of the Better Life initiative are the How’s Life? report and the Better Life Index. How’s Life?, published every two years, provides a comprehensive picture of well-being in OECD countries and other major economies, by looking at people's material conditions and quality of life across the population. The Better Life Index is an interactive webbased tool that allows citizens to compare well-being across OECD countries and beyond.
Source: OECD (2013b), How is Life? 2013: Measuring Well-being, OECD Publishing, Paris, OECD (2011b), How’s Life?:
Measuring Well-being, OECD Publishing, Paris, and www.oecd.org/betterlifeinitiative.
Which dimensions matter for Inclusive Growth?
The first key pillar of the OECD approach – multidimensionality – draws insights from the Well-Being Framework. In How’s Life? (OECD, 2011b and OECD, 2013a), a set of eleven monetary and non-monetary dimensions are identified as essential for people’s well-being. These include areas such as income and wealth, jobs, skills and education, health, social connections, environmental quality and security. While all dimensions are clearly relevant for well-being, the focus that Inclusive Growth takes is somewhat more specific. This arises in particular from the need to quantify and assess policy links. For the purpose at hand, it was thus necessary to select a sub-set of the well-being dimensions. Three criteria were considered for this selection: an actionable link to policy, measurability in OECD countries and beyond and relative importance as determinants of people’s subjective well-being. This led to the selection of household income, health status and jobs as the three most salient dimensions for the OECD’s policy framework for Inclusive Growth. This will not preclude the examination of additional dimensions in the future, such as education and the environmental quality of life, as these also rank highly as determinants of people’s well-being.