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q y is introduced in both cases to allow for the possibility that a number of policies may have a significant impact on household income over and above their indirect effect through GDP (1) or its main determinants (1)’. Per capita GDP itself is of course determined by several policy and non-policy variables, best summarised in Figure 2.8.

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Source: OECD.

The drivers of life expectancy Life expectancy is affected by health policies, but also pollution, lifestyle, education and incomes. The relationships are complex: higher incomes permit more health spending but also give rise to more pollution;

education results in better use of health services and also higher incomes (Figure 2.9). Other factors, not taken into account explicitly here, include poverty, social exclusion, job discrimination and job insecurity. Insofar as they correlate with income inequality, they are captured in the proposed framework, in which life expectancy is

modelled as:

LE  F ( y, env, h, q LE, z LE ), (2) and:

env  F ( gdp, q env, z env ), (2a) where env captures the effect of pollution, q LE is a vector of policies which, in addition to (public) spending on health care, includes ideally factors affecting the efficiency of health care delivery and other potential longevityenhancing policies; zLE denotes a vector of factors linked to the lifestyle (e.g., smoking, alcohol consumption and dietary habits), and which although they can be influenced by policies are treated as exogenous in this framework. q env and z env are vectors of environmental policies and exogenous factors causing pollution, respectively.

Figure 2.9.

The link between policies, non-policy inputs and life-expectancy

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Source: OECD.

An empirical model can be used for the joint estimation of GDP per capita and household income equations (Box 2.8). The long-run determinants of GDP are human and physical capital, labouraugmenting efficiency (captured by a time trend) and population growth. Household disposable income is measured on the basis of general means. Its specification assumes that in the long run the level of income is mainly driven by the level of GDP per capita and includes a proxy for terms of-trade fluctuations and country-fixed effects31, and country-specific time trends to control for potential distortions due to data limitations such as the under-reporting of top incomes (in particular the top one per cent) and the noninclusion of capital gains as a source of incomes.32 To obtain a preliminary assessment of the distributional effects of structural policies, the specification for household disposable income is estimated at four different points of the distribution, again using the general means approach: in addition to the average level, the impact of policies is examined on levels closely corresponding to the median, the lower-middle class and the poor.33 Structural policy indicators can be introduced into this GDP/household disposable income system to assess their joint effects on GDP per capita and household incomes. The remainder of this section presents some evidence on the influence of selected labour market policies and drivers of globalisation.

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The baseline specification takes the following form:

∆ln(GDPt) = β0- β1ln(GDPt-1)+ β2ln(st)+ β3ln(ht) – β4 nt + β5t+δ1∆ln(st) +δ2∆ln(ht) +δ3∆ln(nt)+ε ∆ln(μα (xt))= = η0,α+ η1, αln(TTt)+ η2, α∆ln(GDPt)+ η3, αln(GDPt)- η4, αμα (xt-1)+υ

with cov(ε, υ)≠0 and where:

-∆ln(GDPt) is the variation in GDP per capita between year t and year t-1

-∆μα (xt) is the variation in income standards between year t and year t-1 for a given value of α, i.e. the parameter driving the emphasis on different parts of the income distribution. The baseline specification covers the entire income distribution as measured by top to bottom-sensitive income standards. Household income equations are therefore estimated for a continuous range of αs.

-s is the investment rate defined as the share of investment in productive capital over GDP

-h is the stock of human capital, measured as mean years of schooling

-n is the growth rate of the working age population

-TT measures terms of trade effects (i.e. changes in export relative to import prices). Terms of trade effects are accounted for in in consumer price deflators but not in GDP deflators. This variable is included as a control for one of the known and measurable sources of discrepancies between developments in GDP per capita and in household disposable incomes. See Causa et al (2014) for recent evidence.

- ε et υ are error terms, assumed to be correlated across the two equations These equations are estimated jointly by Seemingly Unrelated Regression Estimation (SURE) procedures. The GDP per capita and household income equations include country fixed-effects. The GDP per capita equation systematically includes a time trend and country specific time-trends. The baseline analysis is presented under two variants defined by a differential treatment of time in the household income equations: i) the household incomes equations are first estimated without and then ii) with time trends and country specific time-trends.





In the baseline setting, the parameters of interest are η3, α/η4, α and measure the household disposable incomes elasticity to GDP per capita for: i) average household income (α=1) and ii) household incomes at different points of the distribution, as measured by top to bottom-sensitive income standards (α≠1). The comparison of GDP per capita elasticities across α allows for assessing the distributional effects of GDP per capita growth.

The baseline estimations cover all OECD countries over the period from mid-80 s to late 2000s.

Empirical evidence on selected labour market and welfare policies

Labour market policy reforms are often designed to boost aggregate employment and via this channel, GDP per capita. At the same time, these policies also affect the distribution of earnings. For example, reducing unemployment benefits and lowering statutory minimum relative to median wages are associated with both higher wage dispersion and higher employment rates (among low-skilled workers), which may result in a very small net change on distribution among the working-age population.34 For other reforms, for example intense job search assistance and other activation measures, wage and employment effects may reinforce each other, resulting in both stronger growth and less inequality. The main findings from the empirical analysis are reported in Table 2.2.

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Note: The entries of this table come from the estimation of the simultaneous effects of policies on long-term levels of GDP and household incomes across the distribution. Since GDP per capita is a determinant of household incomes across the distribution, the total effects of policies on the latter decompose as follows: i) indirect effects, i.e. channelled via reform-driven GDP effects and ii) direct (or additional) effects, i.e. over and above GDP effects. The tables systematically report: i) the effects of structural policies on GDP per capita, which, by construction imply equivalent indirect effects on household incomes; ii) the total (or net) effects of structural policies on household incomes, combining direct and indirect effects; iii) the direct (or additional) effects of structural policies on household incomes. The policy indicators are entered in lagged levels in both the GDP and the household income equations.

The entries can be read as follows. + denotes a positive policy impact while - denotes a negative one. The table also provides (statistical) comparison of estimated policy effects on household income standards at different points of the distribution, respectively the median, the lower-middle class and the poor, with policy effects on average household income. Hence, the cases, and = denote, respectively, a positive impact of the reform which is, for a given income group, statistically higher, lower, or equal than that on average income. For example, in the case of unemployment benefit replacement rate (summary measure of generosity), household income effects are negative for all income groups and they are more negative for median income, incomes of the lower middle class and incomes of the poor, in each case compared with average income. The symbols (*, **, ***) denote respectively statistical significance at 10, 5 and 1% t level.

Reform to unemployment benefit systems affects households differently, depending on whether they target all jobless workers or the long-term unemployed. The results provide evidence of a negative link between unemployment benefit levels and GDP per capita, suggesting that reductions in benefit generosity have tended to boost output. This finding holds at the level of average household income. But distributional effects are found to depend on whether the reform affects all unemployed workers or is

targeted to the long-term unemployed:

 Untargeted reductions in replacement rates are found to raise GDP per capita and even more so household disposable incomes, by similar amounts across different points of the distribution. This suggests that in the long run, employment gains35 largely offset income losses from reduced transfers and increased wage dispersion, implying that unemployment benefit reforms could help boost incomes without widening inequality.

 Reductions in replacement rates targeted to the long-term unemployed (i.e., benefits for jobseekers in the fourth and fifth year of unemployment) are found to increase disposable incomes for the median household but to reduce disposable incomes for the lower-middle class and, even more, poor households – unambiguously pointing to higher inequality.

 These differential distributional implications imply that targeting unemployment benefit reforms to the long-term unemployed may deliver relatively less employment gains because the long-term unemployed have usually lower chances to find a job relative to the recently unemployed, reflecting compositional effects as well as skills erosion.

The macroeconomic effects of ALMPs are difficult to identify empirically, but these policies have strong distributional consequences.36 In fact, the empirical evidence reported above fail to identify a significant effect on GDP per capita, although there appear to be significant positive effects on average household incomes. This finding holds for household incomes down the distribution and associated income gains are found to be larger for the poor, pointing to equalising effects. This tentatively indicates that stepping up job-search support and programmes for the unemployed can increase jobseekers’ employment chances and wages once in employment and, via this channel, reduce income inequality.

Empirical evidence on selected drivers of globalisation

There is fairly strong empirical evidence of the growth-enhancing consequences of globalisation, especially in mature economies, but this is far less the case about its distributional implications. The empirical evidence reported below shows that globalisation-related inequality effects are mainly driven by the wage dispersion channel, in particular arising from changes in the skill and industry composition of labour demand.37 To shed light on these effects, the joint effects of export intensity, as well as FDI inflows and outflows on GDP per capita, and the four measures of household disposable incomes have been examined, using the same framework as for labour market policies.38 The main results are presented in Table 2.3.

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Note: The entries of this table come from the estimation of the simultaneous effects of policies on long-term levels of GDP and household incomes across the distribution. Since GDP per capita is a determinant of household incomes across the distribution, the total effects of policies on the latter decompose as follows: i) indirect effects, i.e. channelled via reform-driven GDP effects and ii) direct (or additional) effects, i.e. over and above GDP effects. The tables systematically report: i) the effects of structural policies on GDP per capita, which, by construction imply equivalent indirect effects on household incomes; ii) the total (or net) effects of structural policies on household incomes, combining direct and indirect effects; iii) the direct (or additional) effects of structural policies on household incomes. The policy indicators are entered in lagged levels in both the GDP and the household income equations.

The entries can be read as follows. + denotes a positive policy impact while - denotes a negative one. The table also provides (statistical) comparison of estimated policy effects on household income standards at different points of the distribution, respectively the median, the lower-middle class and the poor, with policy effects on average household income. Hence, the cases, and = denote, respectively, a positive impact of the reform which is, for a given income group, statistically higher, lower, or equal than that on average income. For example, in the case of unemployment benefit replacement rate (summary measure of generosity), household income effects are negative for all income groups and they are more negative for median income, incomes of the lower middle class and incomes of the poor, in each case compared with average income. The symbols (*, **, ***) denote respectively statistical significance at 10, 5 and 1% t level.

Stronger export intensity boosts long-run GDP per capita and average household disposable income. Such effects hold across the distribution of household income, but with significantly stronger estimated gains for the poor. The stronger positive effects of export intensity on lower income households are broadly consistent with previous empirical literature (e.g., Jaumotte et al., 2008, and Koske et al., 2012), pointing to the positive effects of international competition on GDP and employment.39

The results on the impact of international financial integration through FDI flows are less clearcut. In particular:

 The influence of inward FDI is qualitatively close to that of export intensity, a likely reflection of

the interplay between trade and FDI, and the resulting difficulty to identify their isolated effects:

there is evidence of positive effects on GDP per capita and positive equalising (both indirect and direct) effects on household disposable incomes. This suggests that policy reforms aimed at easing barriers to entry for foreign firms could both raise efficiency and incomes of the less-well off.

 The impact of outward FDI is insignificant on both GDP per capita and average household income. By contrast, there is some evidence of negative effects on household incomes of the lower-middle class and the poor. These effects are consistent with the outsourcing hypothesis.

Summing up Preliminary empirical evidence on the effects of a set of stylised structural reforms on GDP per capita and household disposable income at different segments of the distribution illustrates the scope for using the Inclusive Growth policy framework to identify policy synergies and trade-offs. Indeed, some pro-growth policies that are associated with higher GDP per capita and/or average household disposable incomes in the long term can have less beneficial impacts on the incomes of households at the lower end of the distribution. This would be the case of reductions of support benefits for the long-term unemployed and of policies that favour FDI outflows. In both cases, the results point to a decline in the income of poorer households, even as the average household income increases. However, the analysis also points to combination of reforms that would mitigate or offset these effects. For instance, reforms of unemployment benefits would be best considered in a context where activation policies are stepped up.

Likewise, the adverse effects of FDI outflows may not materialise if measures are taken to encourage stronger inward investment.

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