KEELEY, Brian. Icome Inequality - TheGap Between Rich and Poor PDF

OECD INSIGHTS OECD INSIGHTS
OECD INSIGHTS
Brian keeley
Income Inequality Income

The Gap Income inequality is rising. A quarter of a Inequality
Brian Keeley
century ago, the average disposable income
between Rich of the richest 10% in OECD countries was
and Poor around seven times higher than that of
the poorest 10%; today, it’s around 9½
times higher. Why does this matter? Many fear
this widening gap is hurting individuals, societies The Gap between Rich and Poor
and even economies. This book explores income
inequality across five main headings. It starts by
explaining some key terms in the inequality debate.
It then examines recent trends and explains why
income inequality varies between countries. Next
it looks at why income gaps are growing and, in
particular, at the rise of the 1%. It then looks at the
consequences, including research that suggests
widening inequality could hurt economic growth.
Finally, it examines policies for addressing inequality
and making economies more inclusive.
Other OECD Insights titles include:
INCOME INEQUALITY
Human Capital (2007)
From Crisis to Recovery (2010)
From Aid to Development (2012)
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series:
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Investment
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01 2015 39 1 P
OECD Insights
Income Inequality
The Gap between Rich and Poor
Brian Keeley
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Please cite this publication as:

Keeley, B. (2015), Income Inequality: The Gap between Rich and Poor, OECD Insights, OECD
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http://dx.doi.org/10.1787/9789264246010-en
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Foreword
Inequality is bad and getting worse. In the 1980s, the richest
10% of the population in OECD countries earned 7 times more than
the poorest 10%. They now earn nearly ten times more. When you
include property and other forms of wealth, the situation is even
worse: in 2012, the richest 10% controlled half of all total household
wealth and the wealthiest 1% held 18%, compared to only 3% for the
poorest 40%.
The poorest members of society suffer immediately from

inequality, but in the longer term, the whole economy is also
damaged. OECD figures show that the rise in inequality observed
between 1985 and 2005 in 19 OECD countries knocked 4.7 percentage
points off cumulative growth between 1990 and 2010.
To reduce inequality, we have to promote inclusive growth.

Create economies where every citizen, regardless of income, wealth,
gender, race or origin is empowered to succeed. Our approach to
doing this rests on four main pillars.
➤ Overcome gender inequalities. The fact that more women have

worked full-time and earned higher wages since 1990 has limited
the rise of inequality, but we cannot be happy with the slow pace
of change, and we cannot afford to waste the potential of the
many women who are excluded from the labour market.
➤ Labour market policies need to address working conditions as

well as wages and their distribution. In 2013, about a third of
total OECD employment was in “non-standard” jobs: temporary
jobs, permanent part-time jobs and self-employment. Youth are
the most affected group: 40% are in non-standard work and about
half of all temporary workers are under 30. Working conditions
are often precarious and poor, and can trap workers at the bottom
of the ladder. Among those on temporary contracts in a given year,
less than half had full-time permanent contracts three years later.
➤ A focus on education in early years is essential to give all

children the best start in life. This investment needs to be
continued throughout life to prevent disadvantage, promote
OECD Insights – INCOME INEQUALITY © OECD 2015 3

FOREWORD
better opportunities and educational attainment. High inequality

makes it harder for lower-middle and working class families to
invest in education and skills.
➤ Governments should not hesitate to use taxes and transfers to

moderate differences in income and wealth. Well-designed,
prudent redistribution need not harm growth. We do not need new
instruments; we simply need to use better the ones we have:
scaling back tax deductions, eliminating tax exemptions, making
tax systems more progressive, using property taxes batter and
above all, ensuring greater tax compliance. And let’s not forget
government transfers. They play an important role in guaranteeing
that low-income households do not fall too far behind.
This new book in the “OECD Insights” series explores how

inequality is rising, why it is rising and the impacts of this rise on
people’s lives. We argue that rising inequality can be avoided if we
take decisive action to promote inclusive growth.
Angel Gurría
OECD Secretary-General
4 OECD Insights – INCOME INEQUALITY © OECD 2015

Acknowledgements
The author thanks Michael Förster of the OECD Centre for Opportunity
and Equality for his assistance as well as Federico Cingano,
B o r i s C o u r n è d e , Vi n c e n t F i n a t - D u c l o s , D a m i a n G a r ny s ,
Audrey Garrigoux, Sue Kendall-Bilicki, Maxime Ladaique,
Frédéric Lamoitte, Kate Lancaster, Horacio Levy, Patrick Love,
Ana Llena Nozal, Julia Stockdale-Otarola and Céline Thevenot.
OECD Insights is a series of primers commissioned by the OECD

Public Affairs and Communications Directorate. They draw on the
Organisation's research and expertise to introduce and explain some
of today's most pressing social and economic issues to non-specialist
readers.
Currency Note
Currency references are in US dollars unless otherwise indicated.

Constant dollar values have been adjusted to account for inflation.
Current dollars are the sums actually given or received.
Follow OECD Insights Blog on:
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http://www.linkedin.com/groups/OECD-Publications-4645871
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Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
1. What are income and wealth? . . . . . . . . . . . . . . . . . . . . . . . . . 17

Key themes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
1.1. Income vs. wealth: Similar but different . . . . . . . . . . . . . 19
1.2. Measuring inequality: A challenge for data . . . . . . . . . . . 21
1.3. Measuring poverty: Relative and absolute . . . . . . . . . . . . 25
2. What’s happening to income inequality? . . . . . . . . . . . . . . . . 31

Key themes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
2.1. Rich countries: Inequality rising since the 1980s . . . . . . 32
2.2. Developing countries: Inequality rises, but a middle
class emerges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
3. Why is income inequality rising?. . . . . . . . . . . . . . . . . . . . . . . 41

Key themes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42
3.1. Globalisation: A key role for technology . . . . . . . . . . . . . . 43
3.2. Labour vs. capital: A shifting balance . . . . . . . . . . . . . . . . 46
3.3. The workplace: Traditional jobs are declining . . . . . . . . . 49
3.4. Societies: Love, life and inequality . . . . . . . . . . . . . . . . . . 51
3.5. The state’s role: Less regulation, less redistribution . . . . 53
3.6. Top incomes: Why did the 1% get so rich? . . . . . . . . . . . . 55
4. How does income inequality affect our lives? . . . . . . . . . . . . 63

Key themes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64
4.1. Theories: How economists think about inequality . . . . . 65
4.2. Economies: Is inequality good or bad for growth? . . . . . 67
4.3. Education: Reducing, reinforcing inequalities . . . . . . . . . 71
4.4. Society: Inequality may hold people down . . . . . . . . . . . 74
5. How can governments respond to income inequality? . . . . 79

Key themes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80
5.1. Policy goals: Growth, well-being or both? . . . . . . . . . . . . . 81
5.2. Education: From pre-school to university. . . . . . . . . . . . . 85
5.3. Skills: Equipping workers for change . . . . . . . . . . . . . . . . 90
5.4. Jobs: Getting more people into work . . . . . . . . . . . . . . . . . 92
5.5. Taxes and transfers: What the state gives and takes… . 98
Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103
Bibliography. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105

Introduction
Income inequality has risen in much of the world, sending

the issue to the top of the policy agenda. The rise of the “top
1%” gains the lion’s share of attention, but there’s also
concern about large numbers of low earners who look to be
slipping further and further behind.
INTRODUCTION
Introduction
In late 2011, a group of protesters set up camp in New York not

far from Wall Street, the heart of global capitalism. The Occupy
protestors represented a diverse set of interests and concerns, but
around one slogan they could unite: “We are the 99%.” The
movement soon spread. According to Britain’s Guardian newspaper,
at least 750 similar protests followed worldwide, mostly in North
America and Europe.
The timing of the protests was significant. It followed a

once-in-a-generation financial crisis that brought in its wake sharp
falls in economic growth and sharp rises in unemployment. The
protests also came at a time when public consciousness was growing
of a longer term trend that predated the economic crisis. In its
campaigning for “the 99%” against “the 1%,” the Occupy movement
arguably represented the strongest statement yet of concern over
one of today’s hottest policy issues – income inequality.
There are few signs that this concern is easing. At the 2015
Davos World Economic Forum – an event one commentator described
as “dominated by the proverbial 1%” – income inequality was “top of
the agenda”. The past few years have also seen a 700-page tome on
inequality, Thomas Piketty’s Capital, rise to the top of the best-seller
list. And they have produced survey findings indicating public
disquiet over the gap between rich and poor – “a big problem,”
according to majorities in 44 countries polled by the Pew Research
Centre.
Rising inequality
Income inequality has been rising in many wealthy countries in

recent decades. In the 1980s, the average disposable income of the
richest 10% in OECD countries was around seven times higher than
that of the poorest 10%; today, it’s around 9½ times higher.
Income gaps are even more striking when it comes to the

highest earners. In the 1980s, the top 1% of earners commanded less

INTRODUCTION
than 10% of total pre-tax income in every OECD country bar one.
Thirty years later, their share was above 10% in at least nine
OECD countries and above 20% in the United States.
Data: The gap between rich and poor is at its highest for 30 years, with
the top 10% now earning 9.6 times more than the poorest 10%
Income ratio between top and bottom deciles in OECD countries

12
10
0
Mid-1980s Mid-1990s Mid-2000s 2013
Source: OECD (2015), In It Together: Why Less Inequality Benefits All,

http://dx.doi.org/10.1787/9789264235120en.
Much of the focus of the inequality debate has been on the

rising incomes of the 1%. But there is also growing concern about the
economic situation of a large swathe of low-earners – perhaps as
much as the bottom 40% in some countries – who have been slipping
behind. As a 2015 OECD report pointed out, “When such a large
group in the population gains so little from economic growth, the
social fabric frays and trust in institutions is weakened.”
It’s not just wealthy countries that are seeing growing gaps
between rich and poor. While developing countries have made
impressive strides in reducing poverty in recent years, many have
also seen a rise in income inequality. In Asia, income inequality has
grown in a number of the region’s economic powerhouses, including
China, India and Indonesia; in China, it rose by about 1.6% a year in
the two decades following 1990. It rose, too, in sub-Saharan Africa
but declined in many South American countries, although it remains
high by global levels.

INTRODUCTION
And in both developed and developing countries, income is only

one aspect of broader economic and social inequalities. These are
often characterised by inequality of opportunity, especially in areas
like access to high-quality education, adequate healthcare and
decent employment. Such inequalities can lock in privilege and
exclusion and prevent people from poorer families from moving up
in society and making the most of their potential.
The causes of these growing income gaps are complex and

reflect both economic and social changes. Globalisation, and in
particular the impact of technology on the workforce, is one
important factor. Social changes, such as shifts in marriage patterns
have also played a role. And, when it comes to the rise of top
incomes, a number of special factors come into play, including the
growing use of performance pay, shifting pay expectations and
changes in tax policy.
Why inequality matters
Some might now ask why rising income inequality matters –

hasn’t there always been a gap between rich and poor? It’s true that,
with the exception of some nomadic and hunter-gatherer groups,
inequality has long been a fixture of human societies. Indeed, some
level of inequality is widely seen as essential to create incentives for
entrepreneurs to take risks.
But there’s growing concern over what happens when the gap
between rich and poor grows too wide and when economic growth
delivers benefits only to the well off. Evidence increasingly suggests
that high inequality slows economic growth and reduces social
mobility. Many also fear that widening divisions threaten the
stability of our societies and could hold back the development of
consensus on meeting common challenges.
In the years since the financial crisis, these concerns have

entered the political and economic mainstream. U.S. President
Barack Obama has described rising inequality and declining mobility
as the “defining challenge of our time”. And Angel Gurría,
Secretary-General of the Organisation for Economic Co-operation

INTRODUCTION
and Development (OECD), has warned that “high levels of inequality

generate high costs for society, dampening social mobility,
undermining the labour market prospects of vulnerable social
groups, and creating social unrest.”
Understanding income inequality
Drawing on the research and analysis of the OECD and other

sources, this OECD Insights introduces and explains some of the key
issues in inequality today. It looks at how income inequality has
developed over time, explains why the gap is growing, examines the
consequences for our societies and economies and, finally, looks at
how governments can shape policies to ensure a more even
distribution of opportunity in our societies. The discussion is
structured around five questions:
1. What are income and wealth?
Getting to grips with the income inequality debate means

understanding certain key terms, such as income and wealth. It also
means understanding how inequality is measured, a complex task
that poses serious data challenges. Of course, income inequality is
only one measure of how economic resources are shared across
societies. To supplement them, it’s essential to draw on measures of
poverty.
2. What’s happening to income inequality?
Income inequality has risen in many developed countries, but

there are striking variations between countries. These reflect two
main factors: the size of the gap between the highest and lowest
salaries in a country and the extent to which the state redistributes
income through taxes and benefits. Income inequality has also risen
in developing economies, even during a period that has seen sharp
falls in extreme poverty and the emergence of a new, albeit fragile,
middle class.

INTRODUCTION
3. Why is income inequality rising?
The causes of rising inequality are complex, but include the

growing role of technology in our economies and the impact of
globalisation. These factors also help to explain a shift in which
groups benefit most from the economy, with the balance shifting
from labour to capital. Inequality is also being fuelled by social
factors, such as changes in marriage patterns, and shifts in the
workplace – more people are now working part-time and on
temporary contracts and fewer are in unions. The state’s role has
evolved, too, with a general tendency towards less redistribution. All
these factors can explain much of the overall rise in income
inequality, but not necessarily why the incomes of the top 1% have
risen so sharply. To understand that, some special factors need to be
considered.
4. How does income inequality affect our lives?
Economists have long theorised over the relationship between

growth and inequality, and vice versa. Today, there appears to be
increasing evidence that excessive inequality is bad for economic
growth. High inequality has other negatives too, such as lowering
social mobility and, in education, reducing people’s opportunities to
learn. And there’s much debate over other social ills that may be
linked to inequality, such as higher rates of crime and ill health.
5. How can governments respond to income inequality?
If the ill-effects of income inequality are to be tackled, ways will

need to be found to promote inclusive growth. Doing that means
examining policy goals – should governments be pursuing growth or
well-being, or a better balance of both? In using policy to address
income inequality, a number of areas stand out. Education and skills
are key – policy must ensure that as many people as possible enjoy
access to high-quality opportunities to learn, especially early in life,
and that people can go on learning throughout their lives. Jobs are also
essential, and key to tackling poverty. And the role of taxes and
transfers in redistributing income and wealth must also be considered.

INTRODUCTION
Throughout this OECD Insights, you can explore income

inequality in even greater detail by following three different sorts of
links:
➤ More from Insights will take you to material aimed at the non-
specialist reader, mostly from the OECD Insights Blog and book
series.
➤ More from the OECD will take you to material that may be more
suitable for the reader with specialist knowledge, mainly from
OECD reports and publications.
➤ Data will take you to data from the OECD, including static charts
as well as interactive data (online only) from the OECD Data Portal.
Users can access the background data to charts and tables, as well
as important notes and disclaimers, by using the StatLink.

1
What are income
and wealth?
A number of key concepts are essential to any discussion of

income inequality. These include the distinction between
income and wealth as well as definitions and measures of
inequality and poverty.
1. WHAT ARE INCOME AND WEALTH?
Key themes
For centuries, the nursery song “Tinker, Tailor” was used by
children to determine who they might marry. Counting out cherry
stones or daisy petals, they would chant a still familiar rhyme:
Tinker, tailor, soldier, sailor,

Rich man, poor man, beggarman, thief.
With origins that can be traced back to at least 1475, the song is
a reminder that, in much of human history, some level of economic
inequality has been a recurring theme. In other words, some people
have usually had more than others. But the extent of this inequality
has varied considerably. Today in northern Europe, for example, the
gap between rich and poor is still relatively narrow compared to
other developed countries. In other countries, such as the
United States and Turkey, China and in Central and South America,
it’s typically much wider.
Why does this matter? Later sections will explore the impacts of
income gaps on our economies and societies. But, for now, it’s
enough to say that we need to understand how economic resources
are spread across society to determine the extent to which people
are in the economic mainstream or on its fringes.
To develop a full picture of people’s economic resources, two

concepts are particularly important – income and wealth. Income is
the flow of money that comes into a household from employers,
owning a business, state benefits, rents on properties, and so on.
Wealth essentially represents people’s savings and it’s typically
higher – and spread out more unevenly – than income. Wealth
matters but, in some ways, income matters more. That’s because
it’s usually a better indicator of people’s day-to-day economic
resources.

The task of measuring income (and wealth) inequality is

challenging. It’s hard, too, to represent the results in a meaningful
way. Today, the most widely used measure is the Gini coefficient. But
the Gini only shows part of the story. While it gives a good overall
sense of income distribution, it doesn’t show us how many people
are lacking even basic resources. For that reason, inequality
measures are usually supplemented with measurements of poverty.
1.1. Income vs. wealth: Similar but different
Income and wealth are often used interchangeably but they’re

not the same. A pensioner living in a house valued at $500,000
might be considered wealthy, but if her pension brings in just $100
a week, most would consider her as having a low income. This is
why it’s important to understand the difference between income
and wealth.
What is income?
People sometimes think of their before-tax salary as their

income, even though it’s rarely the same as what they actually receive
into their hands each month. So, instead, it’s useful to think in terms
of disposable income (or income after taxes and transfers), which gives
a much clearer sense of how much money people actually have
available to them to spend on rent, food, clothes and so on.
In basic terms, disposable income is determined by the flow of

money into a household (usually salaries and payments from the
state) minus what goes out in taxes. Think of it as “incomings” and
“outgoings”:
➤ The incomings side can include salaries or wages, earnings from

investments and rents on properties. It also includes direct
benefits, or transfers, received from the state, such as child
benefits. Some measures of disposable income also include
non-cash benefits from the state, such as education or healthcare
– an important benefit for many families.

➤ The outgoings side typically includes taxes and other charges,

such as social security, that are paid to the state as well as some
payments to other households, such as to divorced spouses.
The difference between market income (i.e. income before taxes

and transfers) and disposable income is substantial in most
OECD countries. Without taxes and transfers, inequality would be
even higher than it currently is (see Section 3.5).
Income is also often discussed in terms of “equivalised

household income” or “household per capita income”. To explain:
Households vary greatly in size – in a wealthy country, an income of
$10,000 might be enough to support someone living on their own but
could pose problems for a family of four. That’s not to say that such
a family needs four times what a single individual needs – one TV
set, one fridge should be enough to meet their needs. But such
economies of scale don’t apply quite so much in other areas, like
clothing and food. The equivalised figure takes account of all this.
It’s computed by dividing household income by the square root of
the household size. So, according to standard economic calculations,
to match that income figure of $10,000 for a single person, a family
of four would actually need an income of $20,000 to reach the same
level of well-being.
More from the OECD: How does your income compare with everyone
else’s? And how well do you understand how income is spread out
across society? Get the answers with the OECD’s Compare Your
Income tool: http://www.oecd.org/statistics/compareyourincome.htm.
What is wealth?
Most people have an instinctive feeling of what wealth means –

money in the bank, property and land, shareholdings, jewellery and
art, pension rights and possibly life assurance, and so on. But wealth
has both a positive and a negative aspect. As well as assets, like our
savings, we may also have liabilities, such as loans and mortgages.
Combine these assets and liabilities and we come up with a picture
of people’s net wealth.

Wealth is important for several reasons: It gives people a cushion

if they lose their job or fall on hard times; it can also provide a source
of income, for example, through interest payments on bank deposits
or dividends on shares; and it allows people to make one-off or
large-scale investments, such as in their education or in property.
Measuring wealth is a complex business, and not all countries

do it the same way – for example, some may include the value of a
pension, others may not. For this reason, it’s important to look at the
fine print of any measure of wealth to see what’s included and
what’s left out.
Comparing wealth and income
Because wealth is accumulated over time, it’s unsurprisingly

typically higher on average than income. For example, in OECD
countries average household disposable income per capita is $25,908
a year but average household net financial wealth per capita is
$67,139.
A second feature of wealth is that it’s typically spread out even

more unequally than income – in other words, wealth inequalities
tend to be more pronounced than income inequalities. Why does
this matter? Wealth can, in itself, generate income, and so as wealth
inequalities widen, they, in turn, fuel income inequalities. And as
wealth is a source of investment, widening inequalities mean a
growing gap between rich and poor in their abilities to take
advantage of investment opportunities.
More from the OECD: Data on income and wealth can be found at the
OECD’s Better Life Index (http://www.oecdbetterlifeindex.org) and at
the OECD Data Portal (https://data.oecd.org).
1.2. Measuring inequality: A challenge

for data
Inequality can be explored in several ways, all of which give a

different sense of how economic resources are spread out across
society and even the world. One approach is to look at global wealth

inequalities, which are extreme. For example, Credit Suisse’s annual

Wealth Report reported in 2014 that “that the lower half of the global
population collectively own less than 1% of global wealth”. By
contrast, the bank calculated that the richest 10% owns 87% of global
assets, while the top 1% accounts for “almost half of all assets in the
world”.
Such wealth studies are eye-catching, but they present

problems. Not the least of these is that data on wealth is extremely
hard to come by, so it’s hard to develop reliable figures. That’s one
reason why inequalities in income have historically been studied
more closely.
More from the OECD: Wealth inequality generally fell in the middle
of the 20th century but has risen in recent years. See “The Distribution
of Wealth”, (Bonesmo Fredriksen, 2012), an OECD working paper,
http://dx.doi.org/10.1787/5k9h28t0bznren.
Representing inequality
Finding a way to represent inequality using just a single number

is challenging, and over the years many approaches have been
taken. But the one that’s probably best known today is the Gini
coefficient, which was defined by the Italian economist and
statistician Corrado Gini in the early 20th century.
The basic idea behind the Gini coefficient is straightforward. It

uses a value of 0 to represent a society where everyone has the
same income and which, therefore, has no inequality; at the other
end of the scale, it uses 1 to represent a society where only one
person has all the income and which, thus, has maximum
inequality. To make them easier to understand, Gini values can also
be represented as Gini points. This is done simply by multiplying
each value by 100, so a Gini coefficient of 0.28 becomes 28 Gini
points. In public debate, a Gini score of 40 points and above is
sometimes considered critical.

Data: In the OECD, income inequality varies from around 25 Gini points in
some Nordic countries to over 40 Gini points in Turkey and Mexico.
Income inequality in OECD countries, 2012

Denmark
Slovak Republic
Slovenia
Norway
Czech Republic
Iceland
Finland
Belgium
Sweden
Austria
Netherlands
Switzerland
Germany
Hungary
Poland
Luxembourg
Ireland
France
Korea
Australia
Italy
New Zealand
Spain
Estonia
Portugal
Greece
United Kingdom
Israel
United States
Turkey
Mexico
0 10 20 30 40 50
Inequality (Gini points)
Source: OECD (2015a), OECD Data Portal, https://data.oecd.org/chart/4lzS.
What are typical Gini values? The average Gini value across
OECD countries is 31.5 points, although there is quite a lot of
variation between countries. The societies with the lowest levels of
inequality, Slovenia and some of the Nordics, score around 24 to 28
Gini points; the most unequal societies, such as Mexico and Chile,
score around 45 points.

Discussions of Gini values can revolve around very small

changes, perhaps around only one or two points. Can these really
matter? It depends. Small fluctuations from one year to the next
may reflect issues with data and calculations rather than underlying
economic realities. However, small changes that are sustained over
time may indeed be significant. “Because the Gini is a sluggish
measure, even 1-2 Gini-point increases annually are a big deal,”
Branko Milanovic, a World Bank expert on inequality, has written.
Gathering the data
For many reasons, measuring inequality is a challenge. One of

the biggest problems lies simply in gathering basic income data.
Statisticians use two main sources – tax data and household
surveys. Both of these have drawbacks, especially when it comes to
estimating the incomes of very low and very high earners.
Household surveys: Better-off people often fail to respond to

surveys and, when they do, may not always be willing to reveal their
full financial situation; at the other end of the scale, the very poorest
people may be so far out on the margins of society that surveys don’t
reach them.
Tax data: Information gathered from tax collection gets around

some of the problems in household surveys. This is demonstrated by
the fact that it tends to report higher earnings among the wealthy
than household surveys do. (Indeed, tax data tends to yield far more
insights into the situation of top earners rather than low earners.)
Still, there are issues. For example, income is often underreported to
tax authorities, which may lead to the income of top earners being
underestimated. Also, in some countries, people who earn too little
to be taxed may not be required to declare their income. And, in
most economies, there’s at least some activity in the “shadow”
economy, where transactions are paid for in cash and not reported to
the tax authorities.

1.3. Measuring poverty: Relative and absolute
Poverty is often thought of narrowly in terms of people’s

economic resources – a lack of money to buy life’s essentials. Indeed
many measures of poverty are based around income levels. But
poverty is about more than not having money in a purse. It can also
be thought of in terms of possessing the basics of life, like shelter or
nutritious food; having access to services that improve people’s lives,
like roads, education and healthcare; being free of the threat of
violence; and being able to contribute to decisions that will shape
you or your community’s future. The impact of these forms of
multidimensional poverty is increasingly recognised.
More from Insights: We need to dig behind the headline figures to

understand what poverty really means, says the OECD Insights Blog,
http://wp.me/p2v6oD1MH.
Absolute poverty
At its most basic, poverty is often discussed in terms of a

poverty line – a fixed daily income, such as a dollar a day, or an
income below which people cannot afford a basic basket of goods
and services. These forms of poverty are referred to as absolute
poverty. One of the most famous measures of absolute or extreme
poverty is indeed the dollar a day. When this level was set by World
Bank economists in 1990, it matched closely to the poverty line in
many poor countries – in other words, the basic income people
needed in order to survive. But the dollar a day was also picked
because it was simple and striking: “We intended to have some
impact with it,” Martin Ravallion, an economist who was formerly at
the World Bank, told the BBC. “Make well-heeled people realise how
poor many people in the world are.”
Despite its apparent simplicity, the dollar a day is more

complicated than it seems. For one thing, it’s not actually a real U.S.
dollar but rather a purchasing power parity dollar (PPP$). This is used
because it makes it possible to take account of differing standards of
living between countries – in a wealthy country like the
United States, a dollar buys very little; in a very poor country, it can

go quite a bit further. The calculations are complicated but, in very

basic terms, the PPP$ represents how much someone would need in
a local currency to buy an item costing $1 in the U.S.
Another complication is that the dollar a day is no longer a

dollar. Some years ago, it was revised up to $1.25 and, in 2015, it was
due to be revised again – to around $1.90. It’s difficult to say how this
change will affect data on global poverty. According to one set of
calculations by World Bank economists, raising the poverty line to
$1.92 would add 148 million to the numbers of people said to be
living in extreme poverty.
The dollar-a-day measure is not without its critics. Some argue

that the concept is misleading and can create a sense that people
living in poverty have a reliable, albeit very small, income. In reality,
they argue, people’s income can be unpredictable and sporadic –
farmers, for instance, may earn all their money just once or twice a
year after harvest time. Also, the idea of a subsistence income risks
painting an overly simplistic portrait of poor people’s lives. As the
work of economists Abhijit Banerjee and Esther Duflo has shown,
the poor – just like the wealthy – take active decisions on how to
spend their incomes, sometimes sacrificing nutrition in order to
save for celebrations, for example. Understanding how people make
these decisions can be important for the design of national and
international aid programmes.
Nevertheless, the idea of measuring absolute poverty in

developing countries in terms of a fixed daily income – whether it’s
$1, $1.25 or around $1.90 – has shown great staying power, especially
by helping to anchor the main Millennium Development Goal for
poverty reduction.
More from Insights: Attitudes to poverty have changed greatly,

explains the OECD Insights Blog, http://wp.me/p2v6oD1zo.
Relative poverty
The concept of dollar-a-day poverty tends to be used in the

context of developing – rather than developed – countries. But many
rich countries also produce absolute poverty measures, typically

based around the idea of a fixed basket of goods and services that
economists estimate are the basic minimum that families need in
order to get by. But there’s no international agreement on what
should be in these baskets, which makes international comparisons
of absolute poverty very challenging. That’s why for wealthier
countries the concept of relative poverty can be more useful. Rather
than measuring people’s economic situation against a fixed bar,
relative poverty gauges where people stand compared to everyone
else in their society.
More from the OECD: Poverty has tended to increase

in OECD countries in recent years. For the latest numbers,
visit the OECD Data Portal, https://data.oecd.org/.
To calculate relative poverty, statisticians fix on a poverty line.

There are many ways of setting this line, but here’s how the OECD
does it: First, statisticians examine the full range of incomes in a
country – from lowest to highest– and identify the point that
separates the top half of earners from the bottom half. This is the
median income. The poverty line is then calculated at 50% of the
median income.
Counting the number of people living below the poverty line

gives the poverty rate. This figure can be refined still further with a
measure called the poverty gap, which represents the average
income of people living below the poverty line. For example, in both
Belgium and the Czech Republic around 9% of people were living
below the poverty line in the early 2010s. But in Belgium, their mean
income was only around 19% below the poverty line while in
the Czech Republic it was around 28%. This means, in effect, that
poor people in the Czech Republic were generally poorer than those
in Belgium.
As well as these overall measures of poverty, specific measures

have also been developed to give a sense of how individual social
groups are faring, especially vulnerable groups like children.

Data: Poverty has risen in some OECD countries since the 1980s; around
11% of people in OECD countries live below the poverty line.
Trend in poverty rates in OECD countries since the mid1980s

2010 or latest available year Mid-1990s
Israel
Mexico
Turkey
Chile
United States
Japan
Spain
Korea
Australia
Greece
Italy
Canada
Estonia
Portugal
OECD
Poland
New Zealand
United Kingdom
Belgium
Switzerland
Slovenia
Sweden
Ireland
Germany
Austria
France
Slovak Republic
Norway
Netherlands
Finland
Luxembourg
Hungary
Iceland
Denmark
Czech Republic
0 5 10 15 20 25
%
Source: OECD (2014), OECD Factbook 2014, http://dx.doi.org/10.1787/888933025062.
More from the OECD: Children in OECD countries are more likely to
live in poverty than any other social group. Explore the OECD Family
Database, http://www.oecd.org/els/soc/oecdfamilydatabase.htm.

Multidimensional poverty
Increasingly, however, income alone is regarded as an insufficient

indicator of poverty and economic inequality, especially in developing
countries. People may lack access to education and healthcare, for
example, in part because of their individual circumstances, such as
gender, ethnicity or place of birth. These deficiencies may greatly
reduce people’s lifetime opportunities every bit as much as low
income, and are far more widespread than traditional measures of
poverty might indicate. The United Nations Development
Programme calculates that in the 104 countries represented on its
Multidimensional Poverty Index (http://hdr.undp.org), at least 1.57 billion
people are living in multidimensional poverty, representing
deprivations in health, education and their standard of living. This is
much higher than the roughly 800 million people worldwide estimated
to be living in absolute – or $1.25 a day – poverty.

2
What’s happening
to income inequality?
Income inequality has risen in many parts of the world,

including in wealthy, emerging and developing countries. In
parallel, many emerging countries have seen the emergence
of a middle class, which, though still fragile, could play a
major role in the future development of economies and
societies.
2. WHAT’S HAPPENING TO INCOME INEQUALITY?
Key themes
For much of the 20th century, the gap in incomes between the
well-off and less well-off is generally thought to have narrowed in
much of the world. In effect, the rich didn’t get much richer while
the poor caught up a bit. According to research based on The World
Top Incomes Database, this decline in inequality began in North
America and much of Europe in around the 1920 and 1930s and a
little later, perhaps the 1950s, in some developing countries. But
then, in the 1970s and 1980s, the pattern began to reverse, and
inequality began to rise again.
In very basic terms, then, the pattern of inequality in the 20th

century and up to today resembles a “U” – a long decline followed by
a slow rise. That shape, incidentally, is the inverse of what some
economists predicted would happen (see Section 4.1).
This rise in inequality over recent decades is evident in most – but

not all – rich economies. It has affected not just economies with a history
of relatively high inequality, but also countries where traditionally there
was less inequality, like Denmark, Germany and Sweden.
Inequality has also grown in emerging and developing economies,

although not always for quite the same reasons. In recent decades,
the economic rise of countries like China, Brazil and India has
reshaped the global economy. Among its most striking effects has
been the sharp fall in the number of people living in absolute – or
dollar-a-day – poverty and the emergence of a new middle class. But
poverty hasn’t gone away. Indeed, in many emerging and developing
countries, relative poverty is proving stubbornly resistant and
inequality, too, is widening.
2.1. Rich countries: Inequality rising

since the 1980s
Since the 1980s, income inequality has risen in most

OECD countries. A quarter of a century ago, disposable income of the
top 10% of earners was on average around 7 times higher than that

of bottom 10%; by 2010, it was around 9½ times higher. Since the

mid-1980s, average inequality in OECD countries has risen by almost
10% to just under 32 Gini points, the standard measure of inequality.
The shift was even more pronounced over roughly the same
period among the top 1% of earners, especially in English-speaking
countries. In the United States, for example, the share of pre-tax
income going to the richest 1% more than doubled, reaching almost
20% in 2012.
Who’s benefiting from growth?
The rise in inequality in many countries since the 1980s (and

even earlier) underlines a significant economic trend. In simple
terms, the benefits of economic growth have tended increasingly to
go to a smaller segment of society. In the United States, for example,
between 1975 and 2012 around 47% of total growth in pre-tax
incomes went to the top 1%. The share was also high in a number of
other (mostly) English-speaking countries: 37% in Canada and over
20% in Australia and the United Kingdom.
But even in countries where the 1% didn’t do quite so well, the

fruits of economic growth have tended to flow more towards the top
10% of earners than towards the bottom 10%. This shift has sparked
increasing discussion of the need for “inclusive growth”, with the
potential to ensure as many people as possible enjoy greater
prosperity, have decent opportunities in areas like work and
education, enjoy access to healthcare and a clean environment and
are able to play a full role in society.
More from Insights: Is the world today more unequal than

it was 200 years ago?, asks the OECD Insights Blog,
http://wp.me/p2v6oD1RQ.
Why is inequality higher in some countries than in others?
The variations in inequality between OECD countries are

striking. Inequality is particularly high in Chile, Israel, Mexico,
Turkey and the United States, and particularly low in Denmark,
Norway, the Slovak Republic and Slovenia. Equally, while inequality
tended to rise in most countries between the mid-1980s and

mid-2000s, there were again striking variations between countries.

To be sure, it rose in most, notably the United States, New Zealand
and – perhaps surprisingly – Finland and Sweden. But in some
others, such as France, it barely budged.
Data: Income inequality has increased in most OECD countries since the
mid1980s.
Gini measure of income inequality, mid1980s and 2013

1985 2013 or latest year available
Gini points Increase Little change Decrease

50
45
40
35
30
25
20
15
N E
R
2
N
H E
N
EU
N
S
ZL
N
R
R
EL
LD
R
A
M A
A
X
EX
K
Z
SW
IT
U
R
LU
TU
B
N
IS
S
FR
FI
JP
A
B
N
C
N
D
D
A
G
G
D
EC
O

http://dx.doi.org/10.1787/888933207711.
What accounts for these variations? A number of factors play a

role, but two are of particular importance. The first is the wage gap
(or “wage dispersion”) – that’s the gap between the wages of high and
low-income workers. In some countries, this gap is much wider than
in others. The second is the role of the state, which takes income in
the form of taxes and hands it back in the form of transfers. Taxes
and transfers reduce income inequality in all OECD countries (see
Section 3.5), but far more in some than in others.
These factors can be seen at work by comparing the inequality

record of different countries. At the low end, the Nordic countries
(Denmark, Iceland, Norway, and Sweden) and Switzerland all have
below-average inequality and below-average poverty. Unemployment
is low and the wage range is relatively narrow – very high wages are

relatively rare. Most people receive cash transfers from the state, and
income taxes are strongly progressive – in other words, higher
earners lose a bigger share of their income in tax.
More from the OECD: Inequality patterns across OECD countries

are examined in “Mapping Income Inequality Across the OECD”,
(Hoeller, P. et al 2012), an OECD working paper,
http://dx.doi.org/10.1787/5k9h297wxbnren.
At the other end of the scale are a group of countries such as

Chile, Israel, Mexico, Portugal, Turkey and the United States, which
have relatively high income inequality. Several factors are at work –
the wage range is relatively wide, with some people on very high
wages, and the state often provides less in the way of cash transfers.
2.2. Developing countries: Inequality rises,

but a middle class emerges
Since the late 1990s, the engine of the world economy has
moved from the traditionally wealthy OECD countries to developing
and emerging economies – a phenomenon sometimes called
“shifting wealth”. China and India are the most famous examples,
but they’re not alone: In the 1990s, only 12 developing economies
saw their GDP per capita grow at more than double the rate of
OECD countries; in the 2000s that number soared to 83.
More from the OECD: The OECD’s Development Centre explores

“shifting wealth” in its annual Perspectives on Global Development,
http://dx.doi.org/10.1787/22224475.
Lately, economies in many emerging economies have slowed,

reducing the pace of this shift in global wealth – as The Economist has
noted, “its most tumultuous phase seems to have more or less reached
its end”. Nevertheless, the impact of this shift has been profound. Many
developing countries are seeing huge numbers of people escaping
poverty and the emergence of a new middle class – even if many of its
members are still on a very fragile financial footing. But, many also, are
seeing widening income inequality, although the factors behind this
are not always quite the same as in developed countries.

Falling poverty, rising inequality
A striking statistic: Compared to 1981, worldwide there are now

around 650 million fewer people living in extreme poverty – i.e. on
less than $1.25 a day – even though, over that same period, the global
population rose by about 2 billion. Many factors have contributed to
that decline, but the most important is the rise of China – it alone
accounted for around half a billion people moving out of extreme
poverty.
Data: Poverty rates in developing countries have fallen sharply since the
early 1980s, although much of the decline reflects China’s economic
resurgence.
Poverty rates for the developing world, 19812008

% below poverty line
% of population
60
$1.25 per day
40
$1.25 per day (less China)
20
0
1981 1984 1987 1990 1993 1996 1999 2002 2005 2008
Source: OECD (2013), Perspectives on Global Development 2013,

http://dx.doi.org/10.1787/888932812908.
But while $1.25-a-day poverty has been falling in much of the

developing world, the same is not always true of relative poverty,
which in many cases is at best stagnating. In addition, many of the
countries that have made the biggest contributions to reducing
poverty also have very high levels of inequality. In Brazil and much of
South America, these often exceed 50 Gini points while in South Africa
inequality touches 70 Gini points. It’s high, too, in India (around 34 Gini
points) Indonesia (around 40 points) and China (around 45 points).

Although high, these figures are, in some cases, actually lower

than they used to be, especially in parts of Latin America. On the
other hand, South Africa, Indonesia and China all saw increases in
inequality, although, in the case of China, it may now be stabilising.
One consequence of these trends is that most of the world’s

poorest people no longer live in the world’s poorest countries.
According to the British researcher Andy Sumner, about three-
quarters of the world’s 1.3 billion poorest people now live in what the
World Bank classes as middle-income countries (MICs), most notably
India. That raises the question of whether or not growth is inclusive –
is it simply enriching an educated elite or is it bringing broad benefits?
The answer to that isn’t always clear. As the development expert
Owen Barder has noted, “The figures suggest that the biggest causes
of poverty are not lack of development in the country as a whole, but
political, economic and social marginalisation of particular groups in
countries that are otherwise doing quite well.”
More from Insights: “… if we focus on the poorest countries,

we’ll actually miss most of the world’s poor.” OECD Insights Blog,
http://wp.me/p2v6oDBu.
What’s driving inequality in developing countries?
In many developing countries, travelling from the bustle of a

busy city to the quiet of a country village can feel like a journey
through time. In some ways, it is. While cities have become
increasingly plugged into the globalising economy, life in many rural
areas has often changed little. These differences between urban and
rural areas, or between different provinces and regions, reflect what
are called spatial inequalities, and they can be a significant
contributor to overall inequality in many developing countries.
Income explains only some of these regional inequalities,

although in some emerging economies – notably China and India –
it’s significant, with urban incomes rising faster than rural. But there
are also inequalities of opportunity – notably access to healthcare,
education and jobs – that are perhaps more important. For example,
in some emerging economies, enrolment in secondary education is
much lower in rural areas than in urban, especially for girls. Access

to basic healthcare can also vary greatly depending on where people

live. In Asia, for example, infant mortality is typically much higher in
the countryside than in the cities. And, in many parts of the world
women still face many barriers that deprive their families and
communities of valuable economic contributions.
Other factors are also at work. One, for example, is the extent to
which people in many poorer countries work informally, with no
written contracts and little in the way of terms and conditions of
employment. In Mexico and Brazil, around half of jobs are in the
informal sector, a level that rises to around 80% in India and
Indonesia. Such jobs contribute to inequality in a number of ways –
for one thing, they pay less than formal jobs. They also rarely offer
workers opportunities for training and promotion. And they are
unpredictable, meaning workers may find themselves without an
income at very short notice.
More from the OECD: The role of informal work in developing

countries is explored in Is Informal Normal? (Jütting and de Laiglesia,
2009), http://dx.doi.org/10.1787/9789264059245en.
Finally, in developed countries, taxes and transfers do much to

reduce income inequality, but in many developing countries these
systems are rarely well developed. There are exceptions: In Brazil,
for example, the Bolsa Familia, or family allowance programme,
makes payments to more than 13.3 million families, representing
nearly a quarter of the population, on condition that they enrol
children in school and take part in health programmes. That has
helped to reduce rates of both child poverty as well as inequality.
Emerging middle class?
One of the most closely watched aspects of “shifting wealth” is the

emergence of a new middle class, even if in many cases its members
don’t yet enjoy the prosperity and economic security that has
traditionally been associated with the middle class in many wealthy
countries. Nevertheless, this middle class may have the potential to
play a transformative role in both the economy and society.
More from Insights: Who are the middle classes?,

asks the OECD Insights Blog, http://wp.me/p2v6oD1zP.

By definition, “middle class” is a relative term – it’s somewhere

above poor but below rich, but where? Answers vary widely. Some
economists, such as Brazil’s Eduardo Giannetti da Fonseca, prefer a
descriptive approach: “People who are not resigned to a life of
poverty, who are prepared to make sacrifices to create a better life for
themselves but who have not started with life’s material problems
solved ….” Others define it numerically, but even here there are
different ways of thinking. One approach is to come up with a
relative figure based on income levels in each country: For example,
anyone earning between 50% and 150% of the median income. Other
approaches are more global, and define middle class simply as
households with a certain level of income. In 2008, Goldman Sachs
put that figure at between $6,000 a $30,000 a year; by contrast,
experts working in development tend to use a much lower figure,
such as between $10 and $100 a day.
However it’s measured, the key point is that even though this
new middle class remains economically vulnerable, it has at least
risen above day-to-day subsistence living and can plan for, and
invest in, the future. And that, historically, has been one of the most
significant attributes of the middle classes. In the words of the
development expert Homi Kharas, “the middle class has been
thought of as the source of entrepreneurship and innovation – the
small businesses that make a modern economy thrive. Middle class
values also emphasise education, hard work and thrift. Thus, the
middle class is the source of all the needed inputs for growth in a
neoclassical economy – new ideas, physical capital accumulation
and human capital accumulation.” It’s also traditionally seen as an
important political player, both as a source of stability and a force for
policies like investment in education.
More from the OECD: Shifting social patterns are examined

in The Emerging Middle Class in Developing Countries (Kharas, 2010),
a study for the OECD Development Centre,
http://dx.doi.org/10.1787/5kmmp8lncrnsen.
The role of these middle classes is likely to grow: Homi Kharas

projects the middle class could expand from around 1.8 billion
people today to 3.2 billion by 2020 and 4.9 billion by 2030, with the
bulk of this growth – about 85% – coming from Asia.

3
Why is income
inequality rising?
Many factors explain the rise of income inequality. Some are

economic, such as the role of technology in the globalising
economy; others are social, such as shifts in who people
marry; and some relate mainly to the rising incomes of top
earners.
3. WHY IS INCOME INEQUALITY RISING?
Key themes
The rise of the 1% is the most visible face of income inequality,

but fissures have opened up elsewhere, such as between a large
group of low earners – as much as 40% in some countries – and
everyone else. It’s important to understand that the factors driving
rising inequality in one part of the population, say between the 1%
and the 99%, don’t always fully explain why inequalities are rising
elsewhere. It’s important, also, to realise that a whole range of
factors – economic, social and the role of the state – are contributing
to rising inequality.
One of the most important of these is the impact of

globalisation, or the process through which the global economy has
become more integrated through a complex series of “flows”,
including technology and information, trade and investment. Just as
it has in the past, technology is destroying old jobs and creating new
ones. This is making high-skilled workers even more valuable and
killing off the jobs of some middle and low-skilled workers. It’s also
helping to shift the balance between labour vs. capital, delivering a
larg er share of income to the owners of capital, such as
entrepreneurs, and a smaller share to the people who work for them.
Inequality has also been affected by changes in our societies,

such as the growing tendency for people to marry people from very
similar social and education backgrounds, and by changes in the
workplace, such as the rise in part-time working and the decline in
union membership.
Through the taxes it collects and the benefits it pays out, the
state plays a major role in reducing inequality. But the state’s role has
been evolving, with a general trend towards policies that redistribute
less. Other economic policies, such as a move to reduce regulation,
have also probably helped to increase inequality.
Some of these factors have also contributed to the rise of “the

1%”. But a range of special factors have also been involved in
boosting top incomes. These include the emergence of a “superstar”
labour market, the growing use of stock options and performance
pay and the “financialisation” of economies.

3.1. Globalisation: A key role for technology
“Globalisation” means different things to different people. For

some, the spread of Western-style lifestyle and culture – embracing
everything from American coffee chain Starbucks to Korean K-Pop
music – is its most visible face. But in the context of income
inequality, it’s economic globalisation that matters – or the way in
which the world economy has become increasingly integrated and
interconnected through five global “flows”:
➤ Technology and information

➤ Trade
➤ Finance and investment (or the ability of capital to flow across
borders)
➤ Production (or the ability of businesses to move operations around

the world)
➤ International migration
Data: The pace of globalisation – represented here by rising trade, the

opening of financial markets and technological progress – sped up in the
mid1990s.
Developments in trade integration, financial openness

and technological change, OECD average, 19802008
Trade integration Financial openness (right axis)
R&D expenditures
225 600
200 500
175 400
150 300
125 200
100 100
75 1980 = 100 0
50 -100
0
8
8
9
8
0
8
0
19
19
19
19
19
19
19
19
19
19
0
0
0
2
2
2
Source: OECD (2011), Divided We Stand: Why Inequality Keeps Rising,

http://dx.doi.org/10.1787/888932535223.

Globalisation can be a divisive issue, and polls suggest that in

many parts of the world there’s a perception that its benefits are not
being enjoyed equally across societies. In many developed countries,
there’s also a perception that aspects of globalisation, such as
outsourcing by businesses, are costing jobs and driving down
incomes.
More from Insights: The causes and consequences of globalisation

are examined in OECD Insights: Economic Globalisation (OECD, 2013),
http://dx.doi.org/10.1787/9789264111905en.
The impact of technology
All of the flows that constitute globalisation can have some

impact on income inequality, but perhaps none more so than
technology and information flows. That’s not so surprising –
technology has long had an impact on people’s livelihoods. Take the
Luddites, textile workers in 19th century England who smashed up
newly installed machinery. The Luddites are sometimes portrayed as
having been almost irrationally fearful of technology. In fact, they
had good reasons to oppose it. They were craftsmen who had
invested time in developing their skills. As the Industrial Revolution
dawned, they didn’t want to see those skills thrown into the dustbin
of progress. As the economist Paul Krugman has written,
“Mechanization eventually – that is, after a couple of generations –
led to a broad rise in British living standards. But it’s far from clear
whether typical workers reaped any benefits during the early stages
of the Industrial Revolution; many workers were clearly hurt.”
More from Insights: Some experts argue that technological change is

destroying jobs faster than creating them, says the OECD Insights Blog,
http://wp.me/p2v6oD1xZ.
The Luddites illustrate the reality that almost every wave of

technological change brings losers as well as winners. Today is no
exception. Over just the past few decades, the number of people
employed as telephone operators and shorthand typists has dwindled
markedly. Other jobs will go in the future; including some “knowledge
work” that today might seem to be immune to technology. Indeed,
there are already signs that this is happening: As The New York Times

reported, in the late 1970s, a small army of lawyers worked for

months to analyse 6 million documents in an antitrust lawsuit at a
cost of $2.2 million; 33 years later, specialised software conducted
similar analysis on 1.5 million documents at a cost of just $100,000.
So, technological change affects the world of work, devaluing and

revaluing skills and, of course, creating whole new skills and jobs –
think of app developers and social media strategists. This relationship
between skills and technology is regarded by many as an important,
perhaps the most important, factor behind rising income inequality.
It was characterised by the Dutch economist Jan Tinbergen as “the
race between technology and education”. The authors of a book that
took Tinbergen’s phrase as their title, Claudia Goldin and Lawrence
Katz, explained his thinking thus: “When technological advance
vaults ahead of educational change, inequality generally rises. By
the same token, when increases in educational attainment speed
up, economic inequality often declines.”
Looking at the current state of the race between technology and

education, it’s often argued that technology is now in the lead and
that education is failing to keep up. The result is that people with
lower levels of education are in growing danger of seeing their jobs
replaced by technology. On the other hand, people with high-level
skills are well positioned to put new technologies to good use and
are enjoying increasing returns to their education.
The impact of trade and investment
After technology, the two globalisation flows with the greatest

potential to affect incomes are probably trade and investment.
Trade: According to standard trade theory, increases in global

trade should widen the wage gap in developed countries and narrow
it in developing countries. In practice, it’s not clear that this has
actually happened; if it has, the impact looks to have been, at most,
extremely modest. Indeed, some studies suggest wage gaps have
risen in both developed and developing countries.
More from Insights: The impact of trade in our societies and

economies is examined in OECD Insights: International Trade – Fair, Free
and Open? (OECD, 2009), http://dx.doi.org/10.1787/9789264060265en.

There are countries, however, where rising trade does seem to

have had more of an impact, most notably where employment-
protection legislation is relatively loose. In effect, in countries where
it’s easier to hire and fire workers, increasing imports do appear to
have more of an impact on the income gap, especially if they come
from low-income countries.
Investment: For much of the 20th century, money rarely crossed

borders. True, some funds were sent abroad to pay for imports and
as remittances, but this formed a very small slice of most countries’
economic activity. Equally, businesses tended to invest mainly at
home, and spent very little on foreign direct investment (FDI) –
buying foreign businesses or setting up operations abroad. As
recently as the early 1980s, FDI accounted for no more than a
twentieth of economic activity in OECD countries.
More from the OECD: The impacts of globalisation on income

inequality are discussed in Chapter 2 of Divided We Stand: Why
Inequality Keeps Rising (OECD, 2011),
http://dx.doi.org/10.1787/9789264119536en.
Today, it typically accounts for around half, ensuring that FDI is

one of the most visible faces of globalisation – examples abound:
American chipmaker Intel designs silicon chips in India; Indian
conglomerate Tata employs 20,000 workers in the U.S. in its
information technology division. It’s also one of the most
controversial. Offshoring is widely blamed for taking away jobs in
developed countries, especially among low-skilled workers, and
there is some truth to this. How much, though, is hard to say. FDI,
trade and the rising use of technology are so intertwined that it’s
very difficult from an analytical perspective to state the relative
importance of one versus the other.
3.2. Labour vs. capital: A shifting balance
The impact of technology is also evident in another economic

trend that is going hand-in-hand with – and arguably contributing to
– the increase in income inequality, namely a shift in the share of

national income from labour and towards capital. In other words,

less of the income generated by the economy now goes to workers
and more goes to the people who own businesses.
The factors of production
Societies call on a vast range of resources to produce goods and

services. Take something as basic as a T-shirt: Somebody needs to
take the initiative to produce the garment and to buy the weaving
machinery; cotton needs to be grown; cloth needs to be woven; the
T-shirt needs to be designed, and so on… Despite this complexity,
economists usually boil down all these separate elements into just
four “factors of production” – land, labour, capital and enterprise (or
entrepreneurship).
For income inequality, the relationship between two of these

factors is especially important. The first is labour, the workers paid
to carry out certain duties – such as operating a T-shirt production
line. The second is capital, or financial resources and assets that are
put to economic use – such as the entrepreneur who buys the
equipment for the production line. Ultimately, capital is owned by
somebody somewhere – it might be an individual, a family or, more
usually these days, shareholders.
All these economic activities generate income but, historically,

economists have believed that the proportion of this income that
goes to labour and the proportion that goes to capital don’t really
change. Yes, it might rise or fall a little but, over time, it looked to be
stable. Indeed, so fixed was this idea that it formed one of six
“stylised facts” – or generalisations that are basically true – of
long-term economic growth set down by the economist Nicholas
Kaldor in the 1950s.
Balance shifts to capital
The past few decades have increasingly challenged Kaldor’s

finding. There is increasing evidence that the share of national
income going to capital is rising and that the share going to labour is
falling, and that this is now a global phenomenon. In the early 1990s,
the share going to labour across all OECD countries was about
two-thirds, or 66.1%; by the late 2000s, it had fallen to 61.7%.

Data: Labour’s share of national income fell in almost all OECD countries
in recent decades.
Labour share of national income in OECD countries, 1990 and 2009

Level in 2009 Level in 1990
%
85
80
75
70
65
60
55
50
45
40
.
d
y
ga
ep
an
te
pa
an
tu
R
ta
el
Ja
or
ak
er
Ic
S
P
d
G
ov
te
Sl
ni
U
Source: OECD (2012), OECD Employment Outlook 2012,

http://dx.doi.org/10.1787/888932651503.
A range of factors have fuelled this decline in the “labour

share”, for example competition from exports from developing
countries and loosening in the rules covering jobs and employment.
But the biggest factor looks to be technology, accounting for perhaps
80% of the shift, according to OECD estimates (although others argue
that financial globalisation is the main factor). This represents the
increased use of robots and automation as well as the growing
sophistication of information processing. The implications are clear:
Income that once went to workers now goes to the owners of capital
who financed the machines or software that – to a greater or lesser
extent – have replaced those workers.
But is this shift in income share from labour to capital fuelling

income inequality? It’s difficult to say for sure. The two processes
have certainly moved in parallel with each other in recent decades,
but establishing a causal link between the two is challenging. One
obstacle, among many, is that the lines between labour and capital
are not as clear as they once were. In the early industrial age, when

workers manned assembly lines and factories were owned by

individuals or families, it was easy to see who represented labour
and capital. But today, it’s not so rare for workers to also have a foot
in the capital camp through shareholdings and investments in unit
trusts. Nevertheless, some research does show that the decline in
labour’s share of income is fuelling inequality: For example, a report
by the International Labour Organisation on G20 countries suggests
that a 1% decrease in the labour share increases inequality in market
income (i.e. income before taxes and transfers) by between 0.1%
and 0.2%.
More from the OECD: The shifting balance between capital

and labour’s share of national income is examined in the
OECD Employment Outlook 2012 (OECD, 2012),
http://dx.doi.org/10.1787/empl_outlook2012en.
3.3. The workplace: Traditional jobs

are declining
The past few decades have brought substantial changes to the

way we work, with a decline in the traditional 9-to-5 job and a fall in
the number of union members. Both these trends can affect income
inequality.
The changing world of work
Non-traditional jobs – including part-time and short-term work

as well as self-employment – are becoming more widespread. Since
the mid-1990s, more than half of all new jobs in OECD countries
were non-traditional. Whatever about the merits or otherwise of this
sort of work – it’s a welcome choice for some workers, an imposition
for others – there are clear signs that its growth is linked to income
inequality in a number of ways.
More from the OECD: The rise of nonstandard work and its impact on
inequality is examined in In It Together: Why Less Inequality Benefits All
(OECD, 2015), http://dx.doi.org/10.1787/9789264235120en.

First, it’s associated with a “hollowing out” of the workforce. In

effect, the proportion of people in the traditional “middle” of the
workforce – permanent staffers, such as accountants, who have
mid-level skills and perform routine tasks – has declined.
Between 1995 and 2010, the share fell from 53% to 41% of the
workforce in OECD countries. But the share of people working at the
two ends of the skills spectrum – high-skill workers like designers
and lower-skill workers like drivers – has increased, and they’re
increasingly likely to be part-timers, temps or self-employed. This
trend towards a more U-shaped workforce is in itself likely to
increase income inequality.
The second important link between non-traditional work and

income inequality concerns the pay and conditions of such workers.
At the low-end of the skills spectrum, especially, such workers
typically have both lower annual earnings (because they’re working
shorter hours or enduring periods of unemployment between
contracts) and lower hourly earnings than permanent workers. Such
jobs are often associated with poorer working conditions and less
stability, a combination that has led some to describe this class of
workers as the “precariat”.
So, why is non-traditional work growing? Numerous factors

help to explain it. One is technology, which both increases demand
for part-timers and temps and makes it easier to employ them.
Another factor is the changing face of the workforce itself, notably
the rising number of women going out to work. Either by choice or
because they have no options, large numbers of women choose
part-time work to help balance their career and family demands. A
third factor is a weakening in the laws protecting temporary
workers, especially in countries where protection of permanent
workers remains strict. In labour forces split between strongly
protected permanent “insiders” and weakly protected temporary
“outsiders”, employers may prefer to recruit temps, who can be hired
and fired more easily in response to changing business conditions.
More from the OECD: How can policy respond to the rise of the
nontraditional job? The options are examined in OECD Policy Brief:
Adapting to the changing face of work,
www.oecd.org/policybriefs/Adaptingtothechangingfaceofwork.pdf.

Declining union membership
The past few decades have seen a g eneral decline in

membership of labour unions, which have traditionally worked to
counter inequality among workers – “a fair day’s wages for a fair
day’s work”. In New Zealand, for example, union membership fell
from about 70% of workers in 1980 to just 17% in the late-2000s.
Declines in many OECD countries reflect a number of social and
economic changes, including the loss of traditionally unionised
businesses, like heavy manufacturing. They also reflect changes in
labour laws in some countries that have weakened unions’
bargaining power.
Has the decline in union membership fuelled income inequality

in OECD countries? Probably, although the picture is not black and
white. Firstly, declining membership doesn’t automatically imply
that unions’ negotiating power is fading. In many countries, the pay
and conditions of non-union workers may still be covered in
union-led negotiations. Secondly, the cause-and-effect relationship
may run both ways. Some economists argue that workers may
interpret rising inequality as a sign that unions can’t represent their
interests and so are not worth supporting. In that sense, declining
union membership could be both a result and a cause of rising
inequality.
3.4. Societies: Love, life and inequality
Changes in our societies are contributing to some extent in the

rise in inequality. Possibly the most significant trends concern our
relationships – are we married or single and, if we’re married, is our
partner earning a similar income?
Marrying people like us
People are now increasingly likely to marry or live with

someone from a similar social background – a phenomenon that
economists romantically refer to as “assortative mating”. Today, in
about 40% of working couples, both partners have very similar
earnings; in the early 1990s, the proportion was about 33%.

Data: The proportion of people marrying partners with similar incomes

has been rising in most OECD countries.
Percentage of workers in earnings decile with a spouse

in the same decile, mid1980s and mid2000s
Early year Recent year
% of working couples
14
12
10
0
d
ce
um
3
k
ar
an
ic
2
an
D
ex
gi
m
nl
EC
Fr
el
M
en
Fi
O
D

http://dx.doi.org/10.1787/888932536515.
This trend is, in part, a consequence of the welcome fact that

women are now far more likely to have qualifications and careers
that match or exceed men’s. For example, not so long ago, a male
doctor might have married a nurse; today, he’s more likely to marry
another doctor. The result is that a household that would once have
brought in a doctor’s earnings and a nurse’s lower earnings today
brings in two doctors’ incomes, so concentrating higher incomes in
fewer households.
Singleparent families
Another potentially significant social change is the rise in the

number of single-parent families. In several of the Nordic countries
and the United States, more than a quarter of families are led by
single parents, and the average for OECD countries is around 20%; in
the 1980s and early 1990s it was closer to 15%.
Media coverage tends to focus on families led either by

low-income single-mothers or wealthy singletons but generalisations

are hard to make. Nevertheless, it’s clear that – compared with

two-parent families – single-parent families are more likely to rely
on just one paycheque. And, in some countries, there’s evidence that
the proportion of single-parent families among low earners has been
rising much faster than among higher-income groups. This puts
such families at a double disadvantage: Not only are they relying on
just one paycheque but that paycheque is not, relatively speaking, all
that big.
More from the OECD: Statistics on the size and shape of families can
be found at the OECD Family Database,
http://www.oecd.org/els/soc/oecdfamilydatabase.htm.
3.5. The state’s role: Less regulation,

less redistribution
Policy decisions by governments play a big role in determining

families’ spending power. Some of these relate directly to our
disposable income, such as the taxes we pay and the transfers, like
unemployment benefits, that we receive. Some are only indirectly
related to our incomes, such as the rules that regulate how markets
work. These, for example, may increase competition in the
marketplace but also reduce workers’ job security and wage-bargaining
powers.
Taxes and transfers
The wages we earn from our employers are only one factor –
albeit an important one – in determining how much we have to
spend on ourselves and our families. What really matters is what’s
left after we pay our taxes and receive state transfers – a total that
economists refer to as disposable income. Taxes and transfers do
much to reduce income inequality for two main reasons. Firstly,
higher-wage workers tend to pay higher taxes than their lower-wage
counterparts; secondly, lower-wage workers tend to receive more
support from the state. Combined, these systems of taxes and
transfers play a big role in narrowing income gaps.

Data: The taxes that workers pay to the state, and the transfers they
receive, do much to narrow the earnings gap in OECD countries.
Inequality of market income (before taxes and transfers)

and disposable income (after taxes and transfers)
in OECD countries, late 2000s
Gini points of market income
Gini points of disposable income
60
55
50
45
40
35
30
25
20
15
10
5
0
a
.
en
ea
le
9
ep
ad
2
hi
ed
or
D
R
C
an
EC
K
w
ak
C
S
O
ov
Sl

http://dx.doi.org/10.1787/888932536515.
Up to the mid-1990s, taxes and transfers were tending to play a

growing role in reducing inequality. But in the middle of that decade
the pattern began to reverse. What happened? A key change seems to
have come on the transfers side, especially a decline in spending on
unemployment benefits. Unemployment fell, so fewer people were
claiming benefits, while rules for claiming benefits were tightened.
What about taxes? In general they tended to fall, which

typically would increase income inequality. However the picture is
not as simple as that. On the one hand, some of the impact of this
fall was cushioned by the fact that income taxes also became more
progressive – if taxes fell on better-paid workers, they fell even more
on lower-wage workers. On the other hand, very high earners (“the
1%”) seem to have bucked this trend towards increasingly
progressive taxation, enjoying a very considerable fall in their tax
burden (see Section 3.6).

Regulation
Up to the 1980s, OECD economies were generally more regulated

than they are today. It wasn’t unusual for a single national airline to
have a monopoly on certain routes. In the decades since, most
OECD countries have reformed the rules covering products, services
and employment, with the aim of making their economies more
dynamic.
Governments have also tended to take a more passive role in

the labour market. In the past, wage rises were sometimes negotiated
at a national level and there was relatively tighter regulation of how
and when companies could let workers go. Today, market forces are
generally allowed freer rein.
These reforms have not been universally welcomed but, by and

large, they have helped boost the numbers of people in work.
However, they have also tended to widen the wage gap, pushing
down the wages of low-skill workers and pushing up the wages of
high-skill workers. This happened for two main reasons. Firstly, the
influx of new workers into the workforce included some very
low-earners. Many of these – particularly part-time and temporary
workers – are now covered by weaker employment protection laws
than in the past. Secondly, in an increasingly competitive economy,
skilled workers are increasingly in demand and can command
higher wages.
Other policy areas
Governments can also influence income inequality through

their policies in a wide range of other areas (see Section 4.4),
including through their approaches to migration, the rules covering
jobs and employment and, in particular, education.
3.6. Top incomes: Why did the 1% get so rich?
Across much of the OECD, but especially in English-speaking

countries, the share of national income taken by the top 1% of
earners has risen, sometimes sharply, in recent decades. The rise

has been particularly striking in the United States: In 1980, the top
1% of income recipients in the U.S. earned 8% of all pre-tax income;
by 2012, their share had risen to over 19%. Other OECD countries also
saw big rises, including the United Kingdom and Australia.
Data: Top earners have increased their share of total earnings in most
OECD countries since the 1980s.
Share of top 1% incomes in total pretax income,

19812012 (or latest year available)
2012 1981
%
20
15
10
0
ia
s
n
om
ce
d
en
ds
y
y
ay
k
ga
an
al
ar
te
ad
an
an
an
an
pa
ai
al
w
an
an
ed
It
Sp
tu
gd
ta
m
m
tr
an
al
rl
el
nl
Ja
or
Fr
rl
w
or
en
ze
er
Ir
Ze
Fi
us
S
in
he
S
K
P
it
d
D
A
ew
te
et
w
d
S
te
ni
N
N
U
ni
U
Source: OECD (2014), “Focus on Top Incomes and Taxation in OECD Countries: Was
the crisis a game changer?”, http://dx.doi.org/10.1787/888932965953.
The rising income share of the 1% has become a hot issue, but
some observers believe this focus actually misses much of the story
of rising income inequality. As well as looking at the top 1% of
earners, they argue, we should also look at an even smaller segment
– the top 0.1% of earners (1 in 1,000), and even the top 0.01% of
earners (1 in 10,000). As the Nobel laureate Paul Krugman has noted,
data from the U.S. Congressional Budget Office shows that
between 1979 and 2005, the after-tax income of Americans in the
middle of the income distribution rose by 21%; among the 0.1% it
was up 400%.

Understanding these figures is important if we want to develop a

better picture of who’s benefiting from economic growth. For example,
in the decade to 2007, real household income increased by an average
of 1.2% a year in the United States. But when the top 1% of earners is
excluded, that figure falls to 0.6%. In effect, the 1% took 58% of the gain
in real incomes. So, what looked to be an overall improvement in the
population’s economic well-being actually benefited a much smaller
group than the broad figures seem to suggest.
And the winners are…
Some of the top earners are household names – sports stars like
Serena Williams and entertainers like Jackie Chan and Taylor Swift –
but most are not. In the United States in 2010, the largest group,
about 41%, was made up of executives in non-financial businesses,
like Apple and Walmart. Around 18% were employees – and not
necessarily executives – in banks and finance houses. In the
United Kingdom, the finance crowd accounted for about 21% of top
earners and in France about 15%.
The fact that so many of the top earners work for a living is
striking. Back in the early 20th century, when income inequality last
reached the levels we’re seeing today, much of the income of top
earners came from rents on land and property as well as income
from investments in government bonds. By contrast, today’s top
earners are more likely to be either a salaried employee, for example
an executive like Morgan Stanley chairman James Gorman, or a
company founder, like Facebook’s Mark Zuckerberg.
More from Insights: Rich Man, Poor Man: Are “the 1%” worth it?,
asks the OECD Insights Blog, http://wp.me/p2v6oD1AR.
Why do the 1% earn so much?
There’s no single answer to why the 1% earn so much. Multiple

factors have contributed to the rise of top incomes, and the
significance of each of these is not the same in every country:
“Superstars” in a global economy: The labour market for

high-skilled workers has gone global, especially in sectors like
finance, where firms in financial centres like London and Singapore

may be competing to attract the same people. In this competitive

labour market, employers seek to attract not just good employees
but the very best. That helps explain why there can be a wide pay
gap between those seen as being at the very top of their game and
those just behind.
Technology has played a role in this process, in part by helping

to build a global labour market for skilled workers. Technology also
tends to serve as a complement for high-skilled workers, making
them potentially even more valuable – think of financial traders who
can carry out transactions worth billions of dollars at the touch of a
button. But there are limits to how much of the rise of the 1% can be
explained by technology. Many in the top 10% are also highly skilled,
but have not enjoyed the gains of the 1%.
Changes in the way top earners are paid: The heavy presence
of top executives and finance professionals among top earners is
significant. In recent decades, and especially in English-speaking
countries, a growing slice of their income has come not in the form
of a monthly salary payment but as valuable stock options.
The idea of paying managers in stock options arose as a

response to “the agency problem” – when you hire someone to run
your business, how can you ensure they act in your interests and not
their own? Most shareholders have a tenuous relationship, at best,
with the firms in which they hold shares, so it can be almost
impossible for them to oversee management and ensure it’s working
in their interest. Giving managers a stake in a rising share price, it’s
argued, helps align their interests with those of shareholders. Since
the financial crisis, this line of thinking has come under fire. Many
now argue that stock options can promote short-term thinking
among managers, who may try to boost the firm’s share price in the
short run to make a quick killing, even if it hurts the firm’s long-term
prospects.
“Financialisation”: Stock options are also widely used in the

financial sector, which plays a growing role in modern economies –
albeit, not always a positive one, say critics. And these days, finance
is not short of critics. In part that’s a response to financial crisis
of 2008, which was preceded by decades of rapid growth in financial

services. For example, since the 1960s, credit by financial

institutions, including banks, has grown at three times the pace of
economic activity. Over the same period, stock markets also grew at
a fast pace.
The rapid expansion of finance has contributed to income

inequality in a number of ways, the most obvious being that
financial sector workers tend to be very highly paid. In Europe, they
account for 1 in 5 of the top 1% of earners even though, overall, they
account for only 1 in 25 of the total workforce. These high salaries
might be justified if such workers had very high levels of
productivity. However, comparisons with similarly skilled workers in
other sectors suggest this is not the case. Financial workers –
particularly the highest earners – thus seem to enjoy a wage
premium over other comparable workers.
More from the OECD: The impact of finance on inequality is examined

in “Finance and Inclusive Growth”, an OECD Economic Policy Paper,
http://dx.doi.org/10.1787/5js06pbhf28sen.
“Too much finance” fuels income inequality in other ways, too.

The wide availability of credit allows high earners to increase their
borrowings, allowing them to gain more from investment
opportunities than people on lower incomes. In addition, higher
earners also benefit from the expansion of stock markets. That’s
because they are always more likely to hold shares than lower
earners. As markets expand, they benefit more from share dividends
and capital market gains.
To be sure, financial sectors are essential to ensuring that

capital and resources flow from those that have them to those who
need them and to help balance risk with reward. But there is
increasing evidence that their usefulness diminishes at a certain
point or when they favour certain activities over others – for
example, providing credit rather than facilitating financing through
stock markets. Not only are such financial sectors bad for inequality,
they’re also bad for growth – in effect, they deliver a larger slice of
the benefits of economic growth to a small number of high earners,
many of whom work in finance itself.

More from Insights: Too much money is bad for you, says the OECD
Insights Blog as it looks at the impact of finance on growth,
http://wp.me/p2v6oD28k.
Many now wonder about the size of the financial sector as it

currently exists, its potential to destabilise the “real economy” – the
manufacturing and services in which most people work – and the
fact that it attracts too many of the “brightest and best” graduates,
who might better serve humanity in professions like medicine or
engineering. The economics commentator John Cassidy has
summed up criticisms of those who work in financial centres like
the City of London and on Wall Street with the observation that “if
they retired to their beach houses en masse, the rest of the economy
would be fine, or perhaps even healthier.”
Changing pay norms: Societies differ in the extent to which

they accept large income differentials. Implicit in these social norms
is a trade-off: Stick to society’s expectations and you preserve your
reputation; breach the expectations and you’ll earn more but hurt
your image. But these norms can change over time and their
influence can vary markedly. In much of the post-war period, there
was an expectation that income differentials would be – by today’s
standards – relatively narrow. But in the 1980s these norms began
fading, especially in English-speaking countries. By contrast, they
still remain relatively strong in much of continental Europe, which
has certainly played a role in limiting top incomes there.
Tax and pay: The past few decades have also seen substantial
falls in top tax rates in many developed countries. Across
OECD countries, the average top statutory tax rate fell from 66%
in 1981 to 41% in 2008. High earners have benefited from other
changes in tax regimes, too. Tax on property and on inheritances has
tended to fall, allowing high earners to build up wealth.
As The Economist has noted, the usual justification for lower rates
of tax on top earners is that it encourages growth: “Stop penalising
success, goes the argument, and the economy will soar.” But, as it has
also noted, this link is not always supported by the evidence:
“America’s economy grew strongly in the 1920s and 1960s, when top
rates were high. It fared better in the 1990s, when top rates increased

Data: Tax rates on top incomes fell substantially between the 1980s and
the financial crisis.
Maximum, minimum and average statutory tax rates on top incomes

in OECD countries, 19812013 (or latest)
%
100
OECD maximum: 93%
90
80
70 OECD average: 66%
60
51
50 47
43 41 43
40
30
20
10 OECD minimum: 15%
0
1981 1990 2000 2005 2008 2013
a bit, than in the 2000s, when they declined.” Against that, many
economists argue that there are limits to the amount of extra revenue
that higher taxes can bring in. Higher taxes do inhibit growth, they
argue, and they also increase the incentives for high earners to engage
in aggressive tax planning, which allows them to reduce the share of
income and wealth exposed to tax. (see Section 5.5).

4
How does income
inequality affect our lives?
Inequality affects economies and societies, with growing

evidence that excessive inequality may be bad for growth.
There are also concerns that inequality may dampen
educational opportunities and social mobility.
4. HOW DOES INCOME INEQUALITY AFFECT OUR LIVES?
Key themes
In 2012, Facebook founder Mark Zuckerberg exercised some of

his stock options in the social-networking company. That decision
cemented his position among the super-rich and prompted this
rhetorical question: “How would the typical American end up better
off if […] Zuckerberg could not exercise his options?” asked Scott
Winship, then a Fellow at the Brookings Institution.
That question goes to the heart of a key issue in economic

inequality: If a few people get wealthy, does that hurt – or help – the
economic prospects of everyone else and does it make our societies
worse places to live? These questions aren’t new: In Plato’s Republic,
written more than 2,300 years ago, discussion turns to what happens
when a society is ruled by its elites: “… such a city should of necessity
be not one, but two, a city of the rich and a city of the poor, dwelling
together, and always plotting against one another.”
The relationship between growth and inequality has long been

an important question for economists, and a number of influential
theories have emerged over the years. But for most people, the issue
boils down to this: is rising inequality good or bad for growth? Those
who believe it’s good, or at least necessary, argue that it provides
incentives to entrepreneurs and a source of overall investment for
the economy. Those who believe it’s bad argue that it can prevent
poorer people from investing in their education and encourage the
rich to grab a bigger slice of the economic pie without making the pie
any bigger.
The impact of rising inequality on societies is also drawing

concern: “The social compact is starting to unravel in many
countries”, OECD Secretary-General Angel Gurría has said.
“Uncertainty and fears of social decline and exclusion have reached
the middle classes in many societies.”
Inequality is also a key issue in education. Education can play a

powerful role in providing opportunities for people from all sorts of
backgrounds, but it can also reinforce existing economic divisions in
society. The OECD’s PISA programme has shown that some
countries’ education systems do a much better job than others in

helping students from poorer families achieve excellence. Inequality

has other impacts on societies, too, including reducing mobility and,
some argue, fostering crime and harming people’s health.
4.1. Theories: How economists think

about inequality
Economists have long been interested in the idea that a

country’s level of development might help determine its level of
inequality. One of the most famous theorists was Simon Kuznets, a
Russian-American economist born at the start of the 20th century,
who argued that inequality follows a natural trajectory as economies
move further away from their agricultural roots.
Kuznets’ hypothesis
According to Kuznets, inequality is low in pre-industrial

societies, where most people live at subsistence levels. As
industrialisation begins, however, gaps start to widen thanks to the
rising earnings of factory workers compared to those of farmers, and
they continue to grow with the emerg ence of increasing
specialisation among industrial workers. But then, argued Kuznets,
gaps start to narrow as the state begins collecting more taxes and
distributing them as benefits.
Kuznets’ hypothesis, as it became known, was influential in the

th
20 century, and the shape of inequality that it traced – an inverted-U
– seemed to match the facts reasonably well. However, it’s fared less
well in recent years – rather than rising and then falling, the
trajectory of inequality now appears to be more U-shaped: It was
high at the start of the 20th century, fell in the middle of the century,
but has been rising since the 1970s.
The apparent failure of Kuznets’ hypothesis reflects another

problem economists face in determining the link between inequality
and growth – namely, if there is a link it doesn’t appear to be direct.
If it were, it would be possible – in theory at least – to figure out a
country’s growth rate from its level of inequality.

A complex and dynamic relationship
It’s also possible to look at the relationship between inequality

and growth from the opposite direction: Does inequality affect
growth and, if so, how? The Harvard economist Richard B. Freeman
is one of those who believe it does. He argues that inequality is good
for growth – up to a point. But after that point, rising inequality
means falling growth: “The few people with the skills or background
to compete for the top jobs work hard”, according to Prof Freeman,
“while everyone else coasts because they have little or no chance of
reaching the top.” This argument makes a case for “optimal”
inequality or, what some have called, “just-right inequality” – not too
little, not too much.
Arguments like this underline the complexity of the link

between inequality and growth. Not only is it a dynamic
relationship, it’s also – according to many economists – determined
by the particular “shape” of inequality in each society. To explain,
inequality can take different forms. Some societies may be divided
between a rich elite and everyone else. Others may have relatively
small numbers of rich and poor and a large middle class. These
variations may determine the relationship between inequality and
growth for two main reasons, according to researcher Sarah
Voitchovsky. First, inequality may affect how different income
groups behave. Second, it may affect how different social groups
interact. Some examples:
If inequality affects how income groups behave…
➤ The poor: If there are large numbers of poor people, economic

growth may be affected by their inability to invest in education
and their lower health levels, among other factors.
➤ The middle classes: If inequality “squeezes” the middle class, it

may reduce its demand for goods and services.
➤ The rich: If inequality means rising incomes among the rich, it

could see them accumulate savings, which banks can then lend
out, so increasing investment in the economy. Or, the rich may use
their economic power to lobby against policies that don’t serve their
needs, for example investment in public health and education.

If inequality affects how different income groups interact…
➤ Trust: Higher inequality is probably associated with reduced trust,

which may hurt business by imposing higher “transaction costs”. For
example, if a business trusts a customer, and vice versa, they may be
able to agree a deal without expensive legal advice and contracts.
➤ Social capital: In an unequal society, people’s network of social

relationships – their social capital – may not extend beyond their
own income group and so may not be useful in helping them to
find work. Equally, elite groups may use their social networks to
exclude “outsiders” from economic opportunities.
➤ Social unrest: Large wealth gaps can be associated with social

conflicts, and with higher security costs, for both businesses and
governments.
➤ Volatility: High levels of inequality may make it hard for societies

to come to a political consensus, resulting in sudden policy shifts
or governments serving the interests of their own supporters at
the expense of the greater good.
This framework can be helpful when it comes to understanding

how the link between inequality and growth is debated in the “real”
world, where discussion typically boils down to this question: Is
inequality good or bad for growth?
4.2. Economies: Is inequality good or bad

for growth?
Rising income inequality has focused increasing attention on to
whether it’s helping or hurting growth. Is it, as some contend, a
necessary evil that must be tolerated in the interests of economic
growth? Or is it in itself an obstacle to growth? Here are some of the
main arguments from both camps:
Inequality is good for growth…
Perhaps the most obvious way in which inequality drives

growth is that it allows for entrepreneurs – like Apple’s Steve Jobs or
HTC’s Cher Wang – to enjoy the rewards of their risk-taking.

“Imagine a society with perfect economic equality”, the Harvard

economist Greg Mankiw has written. One day, an entrepreneur
comes up with a new product. “Everyone in society wants to buy it.
They each part with, say, $100. The transaction is a voluntary
exchange, so it must make both the buyer and the seller better off.
But because there are many buyers and only one seller, the
distribution of economic well-being is now vastly unequal. The new
product makes the entrepreneur much richer than everyone else.”
As Prof Mankiw goes on to point out, the society in this scenario

is then faced with a set of choices, as much political as economic:
Does it tax the entrepreneur heavily to curb income inequality but
possibly also reduce her incentives to innovate. Or, does it leave
things alone, so encouraging other entrepreneurs to take similar
risks, with potential benefits for anyone who can make use of the
resulting new products and services.
Proponents of the second option – light tax and relatively little

redistribution – support their case with two arguments. The first is that
allowing people to accumulate wealth means they become sources of
investment for the economy. Writing about the build-up of inequality in
Europe before World War I, J.M. Keynes stated that if the wealthy had
frittered their money away on pleasure, “the world would long ago have
found such a regime intolerable. But like bees they saved and
accumulated, not less to the advantage of the whole community …”.
The second argument, promoted most famously in the 1970s by

the American economist Arthur Okun, is that there may be a
trade-off between inequality and economic efficiency – in other
words, attempting to reduce inequality beyond a certain level may
lead a society to use its economic resources less efficiently than it
could do. In a famous phrase, Okun theorised that money taken from
the rich in taxes would be carried to the “the poor in a leaky bucket.
Some of it will simply disappear in transit, so the poor will not
receive all the money that is taken from the rich.”
Inequality is bad for growth…
However the idea that there is a trade-off between inequality and

efficiency is increasingly criticised, and there is rising evidence – from
the OECD, IMF and others – that excessive inequality is bad for growth.

Recent OECD research indicates that this impact can be substantial. In

OECD countries, the average increase in inequality of 3 Gini points over
the past couple of decades is estimated to have cut GDP by around 8.5%.
More from Insights: “If a large swathe of the population is unable

to invest in its skills, that’s bad news for the economy”,
says the OECD Insights Blog, http://wp.me/p2v6oD1VR.
So, what’s happening? Numerous theories have been put

forward to explain why inequality might be bad for growth (see
below), but the OECD research centres in on one in particular –
namely, that a widening wealth gap leads low-earning families to
invest less in education and skills. This probably hurts growth by
reducing the number of skilled – and more highly productive –
workers available for hire in the economy.
The effect of inequality on people’s human capital can be seen

in the graphic below, which compares the numeracy skills of people
from three backgrounds – families where the parents have high,
medium and low levels of education. Here, parental education
Data: As inequality rises, numeracy skills of poorer people decline.
Average numeracy score by parental educational background (PEB)

Low Medium High
Probability of tertiary education

0.50
0.45
0.40
0.35
0.30
0.25
0.20
0.15
0.10
18 20 22 24 26 28 30 32 34 36 38
Inequality (Gini coefficient)

http://dx.doi.org/10.1787/888933207742.

background (or PEB) represents socioeconomic status, so in effect

these three groups correspond to familiar social groups – well-off,
middle-income and poorer people. The chart shows that as
inequality rises, there is little change in the numeracy skills of
people from well-off and middle-income backgrounds. However,
there is a substantial decline among poorer people.
This effect is visible not just in maths skills. It can also be seen in
the length of time people spend in education and employment – rising
inequality has little impact on the numbers of people from better-off
and middle-income families who graduate from university or on how
they do in the job market. The same is not true for people from poorer
backgrounds. As inequality rises, they become less likely to graduate
from university and more likely to endure periods of unemployment.
Other research also supports the idea that there need be no

trade-off between equality and a strong economy. According to
economists Andrew Berg and Jonathan Ostry of the IMF, over the long
term “equality appears to be an important ingredient in promoting
and sustaining growth”. They offer a number of reasons for why a
growing gap between rich and poor could impede growth, including
the possibility that it may create political and social instability, which,
in turn, may deter investment. Social divisions fuelled by inequality
may also make it more difficult for governments to find the necessary
consensus in society to meet economic and financial crises.
More from the OECD: The impact of inequality on growth is

investigated in Chapter 2 of In It Together: Why less Inequality Benefits
All (OECD, 2015), http://dx.doi.org/10.1787/97892642351205en.
Critics have also linked high levels of inequality to rent seeking,

which the economist Joseph Stiglitz has defined as “efforts that people
take to get a larger share of the pie rather than to increase the size of
the pie”. This can happen in the political arena in both democratic and
authoritarian systems. In democracies, wealthy individuals may use
their ability to, say, fund political parties to influence policies in a way
that benefits them; in authoritarian systems, says former IMF
economist Simon Johnson, “governments and their private-sector
allies commonly form a tight-knit – and, most of the time, genteel –
oligarchy, running the country rather like a profit-seeking company in

which they are the controlling shareholders.” Such tensions have long
been recognised. Almost a century ago, the jurist Louis D. Brandeis
declared, “We may have democracy, or we may have wealth
concentrated in the hands of a few, but we can’t have both.”
Rent-seeking can also show up in the corporate sector: One

example is the huge increase in pay and bonuses of top executives in
big corporations and financial institutions (see Section 3.6),
especially in English-speaking countries, which, some critics argue,
have become increasingly detached from firms’ actual performance.
Rising inequality may also skew an economy in ways that

reduce overall middle-class demand for consumer goods or even fuel
debt crises. For example, high earners may have a lot of surplus
wealth that they need to find ways to invest. After all, says World
Bank economist Branko Milanovic, “there is a limit to the number of
Dom Perignons and Armani suits one can drink or wear”. He argues
that this is exactly what happened in the run up to the financial
crisis: “Overwhelmed with such an amount of funds, the financial
sector became more and more reckless, throwing money at anyone
who would take it.” On the other side of the coin, he argues, lower
earners took advantage of banks’ largesse to borrow money they
couldn’t afford to repay, thus fuelling a debt crisis.
4.3. Education: Reducing, reinforcing

inequalities
Most OECD societies offer substantial educational opportunities
to all citizens regardless of income. But in practice, while education
systems can be a force for social mobility (see Section 4.4) they can
also reproduce and reinforce a society’s existing pattern of wealth
distribution. On average in most countries, children from middle-
class and wealthy families do better in school, are more likely to go
to university and, eventually, earn more as adults.
Richer families can invest more
Some of these differences in learning opportunities come from

outside the formal education system and, arguably, are becoming

more pronounced amidst rising income inequality. Some may even

emerge before the child is born, when the health of the mother and
availability of good nutrition can affect foetal development. And
many of these advantages continue throughout the child’s life. For
instance, there’s some evidence of a growing gap in investment in
“enrichment” – spending on books, childcare, non-school activities –
between rich and poor parents.
More from Insights: Find out why it’s “never too early to join
the rat race” at the OECD Insights Blog, http://wp.me/p2v6oD1ws.
According to Miles Corak, an academic, spending per child in

this area among American families in the bottom fifth of the income
distribution rose by just over 55% between the mid-1970s to around
$1,300 in the mid-2000s. Among the top fifth, however, it rose by over
155% to $9,000 per child. Coupled with other advantages of coming
from a well-off family – such as the likelihood that they can invest
more in formal education and provide valuable social connections
later in life – this early investment in enrichment is considered by
many to be widening the education gap between rich and poor.
Social divisions in the classroom
Education systems, too, can reinforce social distinctions by

offering a lower quality of education or a narrower range of options to
children from disadvantaged families. For example, schools with large
numbers of disadvantaged students tend to find it harder to attract
qualified teachers, even though – or, perhaps, because – the challenges
of teaching children from disadvantaged families may be greater.
And in many countries, children from differing social

backgrounds are essentially taught separately. That’s despite
evidence from the OECD’s Programme for International Student
Assessment (PISA) that combining children from different social
backgrounds, and of different abilities, tends to raise overall
performance without bringing down the performance of the
strongest students. This segregation can happen because most
schools tend to serve a particular area. But it can also happen if
students are streamed into different classes by ability – weaker
students are more likely to come from disadvantaged backgrounds.

Whatever the causes, the impact of social background on

students is clearly evident in results from PISA, which surveys the
performance of 15-year-old students worldwide in more than
Data: Young people whose parents didn’t finish secondary education are
themselves underrepresented in universitylevel education, indicating that
inequalities in access to education persist from one generation to the next.
Participation in tertiary education of students whose parents

have below upper secondary education (2012)
Proportion of parents with below upper secondary education in the total parent
population
Proportion of young students (20-34 year-olds) in tertiary education whose
parents have below upper secondary education
Spain
Italy
Ireland
Netherlands
Australia
Korea
France
Average
Flanders (Belgium)
Denmark
England/N. Ireland (UK)
Sweden
Austria
Slovak Republic
Finland
Russian Federation
United States
Norway
Canada
Poland
Estonia
Germany
Japan
Czech Republic
0 20 40 60
%
Source: OECD (2014), OECD Education at a Glance 2014,

http://dx.doi.org/10.1787/888933115654.

65 countries. Across OECD countries, students from better-off

families are almost a year ahead on average in maths compared to
students from poorer families, according to PISA 2012.
More from the OECD: PISA’s findings on the inequality and equity in
education are explored in PISA 2012 Results: Excellence through Equity
(OECD, 2012), http://dx.doi.org/10.1787/9789264201132en.
Who goes to university?
Social background also has a clear impact on who goes on to

higher education. For example, in all OECD countries, the children of
parents who did not attend university are themselves less likely to
study at tertiary level. On average in OECD countries, the proportion
of young people from families with low levels of education who are
studying in university is only around half what it would be if social
groups were proportionally represented in tertiary education.
Overcoming inequalities
It’s striking, however, that some countries and some education

systems do a much better job of minimising the impact of social
differences in education (see Section 5.2). In PISA 2012, around 6% of
disadvantaged students were “resilient” – in other words, they
overcame social disadvantage to perform well in PISA. But in some
countries, notably in East Asia, the proportion of resilient students
was at least double this. These findings suggest that the right
policies can do much to reduce the impact of social background in
education.
4.4. Society: Inequality may hold people down
Many people fear that inequality has a corrosive effect on

societies, making them worse places to live in, not just for the poor
but also the rich. There are several different strands to this line of
thinking. One is that inequality reduces social mobility – it’s harder
to climb the economic ladder if the rungs are growing further apart.
Another strand is the possible impact of inequality on people’s
well-being – everything from health to happiness.

Back to The Great Gatsby
It’s no surprise to learn that economic advantage passes down

through generations. But, thanks to recent research, it’s become clearer
just how long these advantages can linger – perhaps for at least half a
millennium. Researchers at the London School of Economics, for
example, found that students with surnames like Baskerville and
Mandeville, which can be traced back to the Norman invaders who took
control of England in the 11th century, had attended the country’s most
exclusive universities, Oxford and Cambridge, continuously for around
eight centuries. By contrast, students with “lower status” surnames
were enrolled with much less consistency. The phenomenon is not
restricted to the United Kingdom. Economist Gregory Clark has found
evidence of the persistence of rigid class structures in societies as
diverse as Japan, the United States and even China.
Do these intergenerational advantages linger longer in more

unequal societies? Some researchers argue that they do, and for
evidence they point to a piece of research that draws its title from an
earlier period of soaring inequalities, the 1920s. “The Great Gatsby
curve”, named after the eponymous hero of F. Scott Fitzgerald’s 1925
novel, compares inequality with social mobility in a number of
wealthy countries. It suggests that in more unequal societies, people
are less likely to rise – or fall – out of their slot in the income scale,
especially if they are among the top or bottom fifths of earners. In
effect, if you’re born really rich or really poor you’re likely to stay that
way. The result of this, according to an OECD report, is that it “can
stifle upward social mobility, making it harder for talented and
hard-working people to get the rewards they deserve”.
However, this research is not without its critics. For one thing,
there are major data issues at the national level in pulling together
statistics on mobility, and at the international level in producing
numbers that can be compared between countries. And, as with so
much in this area, correlation does not necessarily imply causation.
For example, the relatively high rates of social mobility in many
Nordic countries may partly reflect the fact that their societies have
historically been relatively homogenous, reducing the potential
impact of barriers like ethnicity that may restrict social mobility in
other countries.

Data: Charts like this – similar to “the Great Gatsby curve” – suggest that
countries with higher levels of inequality have lower rates of social
mobility.
Inequality and mobility (intergenerational earnings elasticity)

across OECD countries
Intergenerational earnings elasticity
90
DNK
85 NOR
FIN
CAN
80 JPN
KOR
75 SWE
AUS NZL
70
DEU
65
CHE
ESP
60
55 FRA
ITA
USA
GBR
50
45
20 255 30 30 40
Inequality (Gini points)

http://dx.doi.org/10.1787/888933207806.
How’s life?
What about the impact of inequality on other aspects of our

lives? The OECD has explored some of these issues in its How’s Life?
project, which explores well-being and quality of life issues. It has
identified specific ways in which inequality can reduce people’s
well-being, for example by fuelling crime: As How’s Life 2013 noted,
“…socio-economic inequality seems to play a central role in the
occurrence of criminal victimisation as disadvantaged people are
more likely to perpetrate and to be victims of crimes.” And there may
be a general correlation, too, between overall well-being and
inequality: “Overall well-being is positively associated with low
socio-economic differences in well-being measured by income or
educational inequality.”

Fierce debate
But linking inequality to specific social issues can be

challenging, in part because it can be hard to distinguish the impact
of inequality from that of poverty. For example, for a range of
reasons, including weaker nutrition and lack of access to adequate
healthcare, poorer people tend to suffer more health problems. But
in a highly unequal society, might there also be special factors at
work? The answers to these questions are important. Policies that
target poverty, such as special payments to low-income families,
may not be the same as those that target inequality, such as much
higher taxes on high earners.
At the moment, the idea that inequality causes a range of social

and medical problems is hotly debated. For example, the British
epidemiologists Kate Pickett and Richard Wilkinson, have argued
that there is indeed a special link between inequality and what The
Economist described as “all manner of social ills … more crime,
higher infant mortality, fatter citizens, shorter lives, more teenage
pregnancies, more discrimination against women and so on.” They
argue that when humans perceive themselves to be socially inferior
it leads to the release of the hormone cortisol. This, in turn, elevates
blood pressure and blood sugar levels, which can cause a number of
medical conditions. The social consequences of stress, it’s argued,
may lie in cortisol’s tendency to override other socially useful
hormones, such as oxytocin, which plays a key role in the formation
of trust relationships. However, this research has been attacked,
both for data reasons but also, say critics, because the cross-country
comparisons fail to take a range of unrelated factors into account,
like national diet and genetics.
An independent review of the research, commissioned by the

Joseph Rowntree Foundation in the United Kingdom, probably gives
the best summary of current thinking. It concludes that there is a
consensus around the idea that inequality and health and social
problems are correlated. However, it adds, “There is less agreement
about whether income inequality causes health and social problems
independently of other factors, but some rigorous studies have
found evidence of this.” Given the general rise of inequality, it seems
likely that research in this area will continue.

5
How can governments
respond to income
inequality?
Government policy can respond to rising income inequality

in many different areas, with a particular focus on three
policy areas – education, jobs and taxes and transfers.
5. HOW CAN GOVERNMENTS RESPOND TO INCOME INEQUALITY?
Key themes
At the heart of the inequality debate lies a deeper question:

Who benefits from economic growth? It’s become clear in many
OECD countries that the benefits of economic growth are
increasingly not being evenly shared. To some extent, this trend
reflects fundamental changes in the global economy. But this is not
to say that our societies can’t – or shouldn’t – respond by trying to
make growth more inclusive.
An important way of achieving this is through government

action. This may mean rethinking policy goals to better balance the
pursuit of prosperity with broader social and environmental
progress and to ensure opportunity is widely spread. This sort of
approach asks us some fundamental questions about how we
measure progress. It can also confront us with some difficult choices
between policies that may be good for growth but not for well-being.
In seeking to make growth more inclusive, governments must

work across a wide range of policy areas. One of the most important
is education, which is key to determining each individual’s life
chances. That’s why education policy needs to address the needs of
young people from pre-school to university, ensuring they get the best
start in life and the support they need throughout their education.
Education is closely tied to skills and training, and these, in turn,

increasingly determine people’s ability to earn a decent living. That’s
why policy must work to ensure workers have the training they need
and that workers can make the best use of their talents in the
workforce.
Work is also key to reducing inequality and to ensuring that

families don’t get trapped in poverty – an issue that has become a
focus of serious concern in many OECD countries since the financial
crisis. As well as building the economic conditions for job creation,
policy needs to aim to get people into the workforce, especially women
and young people.
A final area of policy focus is taxes and transfers, or the money

that the state gives and takes. In developed economies, taxes and

transfers do much to reduce inequality, although there is room in

many countries to improve their performance. That may mean better
focusing assistance on those who need it most and limiting tax breaks
and allowances that disproportionately benefit high earners.
5.1. Policy goals: Growth, wellbeing or both?
In recent decades, a rising share of the benefits of economic

growth in many countries has flowed to people who are already at
the top of the economic pile. This trend has led many to question the
focus of economic policy – should it aim for growth for its own sake,
and hope that it “lifts all boats”? Or should it aim explicitly for more
inclusive growth – ensuring the fruits of growth are spread more
evenly and that economic goals are balanced with a wide range of
social and environmental objectives?
More than growth
Economic growth is, naturally enough, usually a key policy goal.

It’s essential if societies are to pay for things like healthcare,
education, public parks and so on. But a rise in GDP – the most
widely used measure of economic progress – is not necessarily a sign
that all is going well. For example, it can disguise underlying
problems – such as build-ups of unsustainable debt – that may
eventually trigger a painful reversal.
Single-minded pursuit of growth also risks eroding the resources

necessary to sustain growth. This issue is especially evident in one of
the world’s economic powerhouses, China. Less than 1% of China’s
500 biggest cities meet the World Health Organisation’s air-quality
guidelines, according to the Asian Development Bank. The tensions
inherent in China’s rapid growth have been recognised by the
government, with Premier Li Keqiang stating that “we shouldn’t
pursue economic growth at the expense of the environment.”
Less obviously, unbalanced economic growth can fuel income

instabilities that threaten social stability and undermine future
growth by curbing the ability of poorer families to invest in skills and
education (see Section 4.2).

Measuring our societies’ wellbeing
If rising GDP isn’t an automatic indicator of progress, then what

is? That question has been asked increasingly in recent years amid
rising concern that our societies aren’t always very good at
measuring what really matters. “What we measure affects what we
do”, a report by the distinguished economists Joseph Stiglitz,
Amartya Sen and Jean Paul Fitoussi stated in 2009, “and if our
measurements are flawed, decisions may be distorted.”
GDP – or “gross domestic product”, a very widely used measure

of economic activity – has borne the brunt of the criticism, albeit not
always fairly. After all, it was never designed as a measure of
well-being. And even as an economic measure, it offers only a very
limited sense of whether people are managing to make ends meet.
That’s true too of measures derived from GDP, such as GDP per capita
(which divides the size of an economy by the size of the population):
“If inequality increases enough relative to the increase in average per
capital GDP, most people can be worse off even though average
income is increasing”, the Stiglitz-Sen-Fitoussi commission noted.
That’s why we need to dig beneath the data to determine if

growth – rising GDP – really is inclusive, or bringing wide benefits.
Data on inequality and poverty can help us do that (see Chapter 1).
But we can also look beyond pure income and inequality data to
develop a broader sense of how people’s lives are evolving.
Over the years, various measures have emerged that aim to

provide this broad sense of the state of our societies. Among them is
the Human Development Index, produced by the United Nations
Development Programme. It uses a single number to indicate the
level of a country’s development, based on three separate indicators:
income; life expectancy, which reflects the state of people’s health;
and years spent in education. In 2012, the index scored Norway –
where life expectancy exceeds 81 years – as first in the world for
human development; by contrast, Niger, where life expectancy is
just 55 years, was ranked 186th.
The OECD also examines broader issues of well-being in its

Better Life Index, which rates a wide range of developed and emerging
economies for their performance in 11 areas, including housing,

income, education and life satisfaction. Some countries score well

for average household disposable income (see Section 1.2), such as
the United States, Luxembourg and Switzerland, but do less well on
the Better Life Index’s broader measures of well-being. Others, such
as Australia, Sweden and Canada, may have lower income rankings
but rank higher on “happiness” issues like work-life balance and life
satisfaction.
More from the OECD: The OECD’s Better Life Index lets users compare
wellbeing across countries based on 11 topics identified as essential in
terms of meeting people’s material needs and ensuring a decent quality
of life, http://www.oecdbetterlifeindex.org/.
Inequalities that go beyond income
But looking at national figures only takes us so far. Broad

measures of “well-being” may not shine a light on significant
inequalities within societies in areas like health and access to
healthcare and education. These inequalities can be striking. In
Scotland, for example, the life expectancy of a boy in Lenzie, a fairly
affluent town on the outskirts of Glasgow, is about 82 years,
according to data quoted by the World Health Organisation. Twelve
kilometres away, in the deprived Calton area, a boy can expect to live
to just 54.
As well as such health inequalities, most countries have

inequalities in access to public services like healthcare and
education. Across OECD countries for which there is data,
low-income adults are always less likely to have seen a dentist in the
previous 12 months. Similarly, low-income adults are less likely to
undergo screening for breast, colorectal and cervical cancers. Access
to education can also show sharp divergences depending on people’s
family background (see Section 4.4).
All this highlights the reality that policies targeting inequality

and inclusive growth need to go beyond just supplementing people’s
incomes. For example, policy may need to focus more on supporting
young people from poorer families in education and on creating
health and lifestyle programmes specifically targeted at low-income
groups.

Data: People on lower incomes are more likely than those on higher
incomes to report that they have not been able to meet their care needs.
Cost is the most commonly cited obstacle.
Unmet care needs for medical examination by income level,

European countries, 2011
Highest income Lowest income
%
16
14
12
10
0
ds
nd
4
ly
ep
ai
2
Ita
an
la
Sp
D
R
Po
EC
rl
h
he
ec
O
et
Cz
N
Source: OECD (2013), Health at a Glance 2013,

http://dx.doi.org/10.1787/888932918643.
Policy tradeoffs – hard choices
So, the policy response to inequality and to making growth

more inclusive is complex and multidimensional, and can involve
initiatives across a range of fronts – taxation, health and education
policy, labour markets and so on. But it can also involve some tough
choices. Some policies may be good for growth and good for reducing
inequality – a win-win. That’s usually the case for policies that
improve people’s access to education and, especially, that improve
the quality of early childhood care and education (see Section 5.2).
By contrast, certain forms of taxation may be good for growth

but bad for inequality. For example, economists typically argue that
indirect taxes – such as consumption taxes like VAT – have a much
smaller impact on economic activity than direct taxes, like income
tax. However, from the perspective of income inequality, indirect
taxes tend to hit lower earners proportionately harder than higher
earners, and so typically add to inequality (see Section 5.4).

More from the OECD: Potential tradeoffs between growth and

equality are examined in Economic Policies 2012: Going for Growth,
http://dx.doi.org/10.1787/growth2012en.
These examples help underline an important point about

inequality: Many of the key policy decisions have less to do with
economic decisions and more to do with politics – or, the way in
which power is exercised in societies and collective decisions made.
The choices societies take often reflect the extent of their “taste” for
inequality. Some may favour a policy mix that seeks to narrow the
income gap as much as possible; others may prefer policies that
incentivise economic “winners” to push for growth.
5.2. Education: From preschool to university
Social background is strongly linked to how well children and

young people do in education (see Section 4.3). But, as the OECD’s
PISA studies show, this “rule” can be broken. Every country has
examples of children from disadvantaged families who excel in their
schooling. Equally, some countries are much better than others at
reducing the impact of social background in education. But for this
to happen, care and education policies need to be effective across
young people’s lives, starting in their very earliest years.
There are a couple of “big ideas” that can help frame any
discussion of the role of education in countering inequality. One is the
idea of equity, which, in turn, is built on two key principles: Fairness,
or ensuring that a person’s own background or circumstances – such
as gender, ethnicity or family situation – are not allowed to limit their
success in education; and inclusion, a broad concept that boils down
to the idea that everybody – regardless of background – should develop
certain basic skills through education (see below). The second big idea
is quality. That means good schools, but it also means overall
education systems that meet the needs of students and that provide
them with a full range of options to meet their individual capacities
and aptitudes.

Preschool care and education
In recent decades, there’s been growing recognition of the

importance of children’s very earliest years in determining their
lifelong development. The advantage that children from better-off
families enjoy in these early years can be substantial, but some of
this gap can be bridged by providing children from less-advantaged
families with high-quality day-care and pre-school.
In countries with higher levels of enrolment in day-care and

pre-school and higher levels of spending, social background appears
to play a smaller role in influencing how well students do in
secondary school. There are other benefits, too. Where high-quality
and affordable childcare is available, parents – and especially
mothers – may find it easier to go out to work, which can help reduce
poverty and raise employment rates.
Such programmes are not always universally popular, in part

because returns from investment in the care and education of very
young children can take a long time to materialise. But, when they
do, they can be greater than almost any form of investment in young
people. As the economist James Heckman has argued, young people
who benefit from early childhood care and education have a whole
lifetime to reap the benefits. In addition, learning at a very young age
makes it easier to go on learning throughout life, enabling people to
go improving their skills and education.
More from the OECD: Volume III of Starting Strong examines

the challenges of providing highquality preschool care and education,
http://dx.doi.org/10.1787/9789264123564en.
Quality, however, is key, and needs to underpin the regulation of

pre-school care and the design of curricula and learning goals. It also
needs to be evident in the staffing of care and education centres –
research shows that children do better in the care of well-qualified
staff, who have the knowledge and skills needed to create a
stimulating environment in which children learn and develop
through play.

Equity in education
Some of the most important insights into equity in education –

ensuring fairness and opportunity for all young people – have come
from the OECD’s PISA programme. These three-yearly assessments
of 15-year-old students in more than 60 countries show clearly that
some educational systems do much better than others in lowering
socio-economic barriers to success. One marker of this is the
proportion of “resilient” students – young people who “beat the
odds” and perform better than their family background might
predict. In a number of East Asian economies and countries, more
than 15% of students are resilient, according to PISA 2012; by
contrast, the average for OECD countries is just over 6%.
Data: The proportion of resilient children – or children who do better in

PISA than their social background might indicate – varies greatly.
Percentage of resilient students among all students, PISA 2012

20
15
10
0
na
om
u
ag
ec
an
er
hi
gd
P
re
nl
er
-C
Fi
in
G
av
ai
K
gh
d
an
EC
te
ni
Sh
Source: OECD (2013), PISA 2012 Results: Excellence Through Equity (Volume II): Giving
Every Student the Chance to Succeed, http://dx.doi.org/10.1787/888932964813.
Over the years, PISA has highlighted several factors that

promote equity in education. Chief among these are teachers.
“Nowhere does the quality of a school system exceed the quality of
its teachers”, says Andreas Schleicher, who runs the OECD’s PISA
programme. Many of the most successful school systems have

figured out how to attract the most talented teachers to work in

disadvantaged schools. They also understand that, while it’s
important to set ambitious learning goals for students, it’s also
important to train teachers so that they can understand each child’s
needs, and then personalise their teaching in ways that meet these
needs. It’s also essential to support teachers throughout their
careers by encouraging collaboration and mutual learning among
teachers in schools as well as continuous professional training and
development.
More from the OECD: Find out what teachers themselves think
of their working conditions and schools with the OECD’s Teaching
and Learning International Survey (TALIS),
http://www.oecd.org/edu/school/talis.htm.
PISA has also highlighted a number of other factors that are

associated with successful school systems. One of these is
inclusiveness, an idea that covers a lot of ground. Encouraging
inclusiveness can mean educating children with disabilities in
regular classrooms; it can also mean educating children from poorer
and better-off families together; and it can mean delaying the
“streaming” of children into different programmes. In some
countries, social background has traditionally been as important a
factor as aptitude in determining whether a child is directed towards
an academic or a vocational education. That sort of approach risks
devaluing vocational education, which should be an attractive
option in every country’s education mix, and unfairly limits the
choices of young people.
More from the OECD: Findings from PISA on equity in education

are presented in PISA 2012 Results: Excellence through Equity,
http://dx.doi.org/10.1787/9789264201132en.
Who’s represented in education?
Young people from poorer backgrounds are underrepresented

in tertiary education. One indicator of this can be seen in the student
make-up of universities and colleges. If enrolment in tertiary
education accurately reflected the general population, there would
be almost twice as many young people from families with parents

who have low levels of education (i.e. who didn’t complete

secondary education). Of course, many young people from poorer
families do make it to university, but even here the influence of
social background is apparent. There is evidence that many attend
low-status, rather than elite institutions; enrol in short programmes
leading to vocational degrees, such as vocational therapy, rather
than long programmes, like medicine; and are particularly
underrepresented in advanced tertiary education, such as doctoral
programmes.
Many of the barriers to disadvantaged young people entering

tertiary education have their roots not in financial constraints –
although these can certainly be a factor – but in the fact that they
don’t have the right qualifications. This only underlines the
importance of moving early to support young people throughout
pre-school and compulsory education; delaying until they are at the
age to enter university is likely to represent a lost opportunity.
Career guidance is also important during secondary schooling to
ensure parents with low levels of education and their children
understand the potential benefits of tertiary education.
More from Insights: Education’s power to drive social mobility

is weakening, says the OECD Insights Blog, http://wp.me/p2v6oD1Pj.
Education systems also shouldn’t limit future student’s future

options early on in their school careers by putting them on an
exclusively vocational education track. The benefits of offering
opportunities for vocational education are increasingly recognised,
especially for students who might otherwise drop out of school.
However, entry into vocation education is all too often determined
solely by social background. Children, especially from disadvantaged
families, may be put on a vocational track when they’re as young as
10 or 12, effectively closing off academic options at an age when
their interests and aptitudes are still not fully developed. That’s why
there should be plenty of doors in the walls separating academic and
vocational secondary education to ensure students aren’t overly
restricted in their choices.

5.3. Skills: Equipping workers for change
One of the significant drivers of income inequality is the

expanding pay gap between high and low-skilled workers (see
Section 3.3). It’s clear that workers with relatively weak skills will
continue to face increasing challenges in the modern economy.
According to economists Carl Benedikt Frey and Michael Osborne,
47% of existing jobs in the United States are under threat from
computerisation. Many of these will be routine office jobs, but, as
artificial intelligence advances, even high-level tasks will face
increasing competition from computers.
More from Insights: Will a robot take your job?,

asks the OECD Insights Blog, http://wp.me/p2v6oD1NQ.
But you don’t need to look into the future to see the cost of
insufficient or outdated skills, both for national economies and
individuals. Nationally, the wage gap between high and low-paid
workers tends to be narrower in countries where skills are more
evenly distributed across the workforce. For individuals, low skill
levels are linked to higher rates of unemployment and lower
incomes. They are also linked to other unwelcome outcomes,
including a greater likelihood of health problems and lower levels of
social engagement (although the cause-and-effect relationship is
not necessarily straightforward).
Ensuring that people are equipped to thrive in the economies

and societies of tomorrow is a process that needs to start in the
earliest years of life and then continue throughout young people’s
formal education. But the task doesn’t end once young people leave
education. Throughout people’s working lives, government policies
need to encourage continuous investment in training, ensure that
people who want to work can work, and ensure a better match
between people’s abilities and the jobs they actually do.
Developing skills
Even at the height of the Great Recession, some employers had

problems hiring. In Greece in 2010, for example, the unemployment
rate of almost 18% was exceeded by the percentage of businesses

reporting recruitment difficulties, 41%. The reasons for such

mismatches are complex. Potential hires may be living in the wrong
part of the country or may be deterred by low pay or poor conditions
on offer. Or they may lack the qualifications businesses are looking
for.
These complexities underline the need to develop a clear

picture of who can do what in the workforce, which, in turn, can
guide the design of policies that boost people’s job prospects. Some
policy approaches are fairly obvious. For example, young people are
likely to benefit from high-quality training that takes them out of the
classroom and into the workplace. This can help ensure that they
develop not just “hard” skills on real equipment but also “soft” skills
like teamwork. Less obviously, tax systems can be designed to
provide businesses and individuals with incentives to invest in
training.
More from the OECD: The OECD Skills Strategy aims to help
countries create and make the best use of highquality skills,
http://dx.doi.org/10.1787/9789264177338en.
Putting skills to use
For a variety of reasons, many people with useful skills are

deterred from working. That’s a particular issue for women but also
for other groups, such as workers reaching the ends of their careers.
In Iceland and New Zealand, more than three-quarters older people
(55 to 64) are still in the workforce; in a dozen other OECD countries,
the proportion is below half.
In many cases, people decide that it just doesn’t pay to work.

Costly childcare is a particular obstacle for many women (see
Section 5.5), but so is the lack of job flexibility, such as part-time
working. For older workers, pension systems may effectively
encourage them to retire early by limiting the financial benefits of
working beyond their mid-50s. As populations age, governments
have been increasingly tightening rules that encourage workers to
retire early. In New Zealand, for example, the proportion of older
people still at work rose from 44% in 1990 to 76% in 2010.

Matching skills with jobs
Young people may find it particularly difficult to make effective

use of skills and training. As well as suffering higher rates of
unemployment, they frequently find themselves in unstable jobs
that don’t match their qualifications and offer little job security.
Long-term unemployment at an early age risks “scarring” young
people, resulting in a lifetime of weakened job prospects.
More from the OECD: Find out how young people can get
their working lives off to a good start in the OECD’s Jobs
for Youth project, http://dx.doi.org/10.1787/9789264096127en.
Government policies can work to discourage hiring-and-firing

rules that penalise young people compared with other groups. They
can also provide financial incentives to help overcome employers’
resistance to hiring relatively inexperienced young people. Policies
can also work to encourage entrepreneurship and innovative
start-ups, which have a strong record in job creation and may offer
work that’s well-matched to young people’s abilities.
5.4. Jobs: Getting more people into work
It’s by no means the only answer to inequality and poverty, but

work can go a long way to securing people’s economic fortunes and
putting them on a firm footing. “Employment can provide not just a
salary but an opportunity for people to grow, to develop new skills
and ambitions and to feel useful in society”, according to an OECD
How’s Life report.
The role of work is brought into even sharper focus when it’s in
short supply, as it has been since in recent years. The impact of the
jobs crisis can be seen in the rise in many OECD countries in the
percentage of people living in “workless” households. In a number of
Eurozone economies – Greece, Ireland and Spain – the percentage of
people living in families where no one is working has doubled
since 2007, while in several other countries it’s up by at least 20%.

Data: After the financial crisis struck, some countries saw rises in the
numbers of people living in households where no one is working.
Percentage shares of adults living in workless households

2012 2007
20
15
10
0
a
e
y
ly
an
ec
vi
ni
ai
Ita
t
Sp
to
m
re
La
Es
er
G
G
Source: OECD (2014), OECD Society at a Glance 2014,

http://dx.doi.org/10.1787/888932965953.
Families where no one is working are more likely to fall below

the poverty line, and children living in such families may face a
lifetime of disadvantage. To combat these ill-effects, it’s important
not just to get laid-off workers back into jobs but also to encourage
employment among certain groups that are underrepresented in the
workforce, most notably young people, people with long-term
disabilities and – especially – women.
Inwork poverty
But while work is probably the single most effective response to

poverty, in recent years there’s been concern that its power may be
waning. There are several reasons for this. One is the existence of
“in-work poverty”, where workers earn too little to lift themselves
above the poverty line.
What causes in-work poverty? Low wages and insufficient

working hours are obvious factors. It’s also linked to job instability,
where people may move frequently between low-paid jobs and
unemployment. Indeed, recent decades have seen the emergence of

a growing division in many workforces between workers with highly

stable contracts and those on temporary contracts, who often have
little job security and are at risk of repeated bouts of unemployment
between jobs. The number of adults working in the household is also
a factor. Typically, in-work poverty is lower where two or more adults
work rather than one.
Policies for more and better jobs
What can governments do to get more people into the

workforce? Creating the right economic conditions for job creation is
clearly essential to ensure that there’s a strong demand for workers.
But policy can also help to ensure there are strong incentives for
people to find work. In the area of unemployment benefits, this can
mean shifting from “passive” state support, which may focus solely
on the payment of benefits, to more “active” support. With this sort
of approach, the state provides services like job-search support and
training while making benefits payments contingent on people
demonstrating that they’re committed to finding work.
Specific policies can also help tackle the needs of groups that
are underrepresented in the workforce, including women and young
people, as well as particular groups of workers, like part-timers and
temporary staffers.
Women: Women are a growing presence in the workforce and

are steadily narrowing the gap with men in terms both of
employment and earnings. For example, over the past 20 years, the
employment gap between men and women – that’s the percentage
of working men minus the percentage of working women – has
narrowed by 7 percentage points. However, the gap still stands at 16
points. And that doesn’t take account of the fact that more women
work part-time than men. When that difference is factored in, the
employment gap widens to close to 24 points.
Gaps also persist in pay, although these, too, have narrowed.

Since 2000, the pay gap between full-time male and female
employees has narrowed from around 18 points in OECD countries
to around 15 points. However, this average conceals very big
differences between countries, ranging from above 36 points in

Data: The pay gap between women and men is narrowing, but still stands
at around 15 percentage points on average, and is around double that in
some countries.
Wage gap between male and female fulltime employees,

OECD average, 2013 or most recent year.
Korea
Estonia
Japan
Israel
Netherlands
Turkey
Canada
Finland
Switzerland
Austria
Australia
United States
United Kingdom
Germany
Portugal
Chile
Czech Republic
Mexico
Sweden
Slovak Republic
Iceland
France
Latvia
Ireland
Slovenia
Italy
Poland
Hungary
Spain
Denmark
Norway
Lithuania
Greece
Luxembourg
Belgium
New Zealand
0 5 10 15 20 25 30 35 40
%
Source: OECD Gender Data Portal,

http://www.oecd.org/gender/data/genderwagegap.htm.
Korea to below 6 points in New Zealand. Other gaps persist, too:

Around 83% of women work in the services sector compared with
just 34% of men. Women are also much less likely to be in senior
roles – in 2013, only just over a third of managers were women in
OECD countries. There are gaps, too, when it comes to childcare – a
significant factor for many women in determining whether they

work full-time, part-time or at all. Women still carry the heaviest

burden of childcare: On average in OECD countries, women spend
just over 4½ hours a day on unpaid work – chiefly childcare and
housework – around double the average for men.
More from the OECD: The OECD Gender Data Portal is a source
for data on gender inequalities in education, employment and
entrepreneurship, http://www.oecd.org/gender/data.
As well as the social and equality arguments for encouraging

female employment, there are also many economic justifications. Not
the least of these is that, broadly speaking, rising female employment
has acted as a brake on rising income inequality. True, it hasn’t halted
the rise, but it has tended to slow it. If the proportion of households
with working women had remained at the levels of the early 1990s,
income inequality in the OECD would have increased by almost 1 Gini
point more on average, i.e. by 4 rather than 3 points. In addition, the
impact of more women working full time and narrowing the pay gap
with men added another brake of 1 point.
To ensure even more women can enter the workforce and make
the most of their career options, continued efforts to combat
discrimination and remove barriers to female employment and
career progression will be needed.
More from the OECD: The OECD Gender Recommendations set

out policy principles to level the playing field between women and men
in education, employment and entrepreneurship,
http://www.oecd.org/gender/CMIN(2013)5ENG.pdf.
Because of the burden of childcare that traditionally falls on

women’s shoulders, support for parents is also key to encouraging
more women to enter the workforce. The OECD’s Babies and Bosses
project identifies the Nordic countries, which have very high rates of
women in work, as a model. Traditionally, they’ve offered a
continuum of support to families, from when children are very
young and still at home, and then on to childcare and into
pre-school, school and after-school activities. But other countries
have also taken important strides in supporting parents to better
share childcare duties. For example, Germany, Italy and France now

all offer “use it or lose it” leave to new fathers. Businesses, too, can
play a role by offering greater flexibility in when – and where –
workers carry out their duties and a more understanding attitude
when parents need to take time off to care for children.
Young people: Compared to the rest of the population, young

people are about twice as likely to be unemployed. Young people
who experience prolonged unemployment can face a lifetime of
reduced earnings and career possibilities. The needs of the young
are looked at in the OECD’s Jobs for Youth project, which
recommends a range of policy approaches. These include moving
quickly to provide young people with job-search assistance;
strengthening apprenticeship and vocational programmes for young
people with low skill levels; and providing financial incentives for
businesses hiring young and low-skilled workers. Second-chance
programmes for school dropouts are also important to ensure young
people develop the skills they need to avoid dead-end work.
More from the OECD: The state of vocational education and training
is examined in Skills Beyond School,
http://dx.doi.org/10.1787/9789264214682en.
Supporting temps and part-timers: The traditional permanent

9-to-5 job is declining in OECD countries. Since the mid-1990s, more
than half of all jobs created in OECD countries were in temporary and
part-time work and in self-employment – what’s sometimes called
“non-traditional” employment. For a variety of reasons, this trend is
tending to increase income inequality (see Section 3.3). Because
relatively high numbers of women and young people are in
non-traditional jobs, policies targeted at these groups are likely to have
a significant impact on a large share of the non-traditional workforce.
But additional policies may also be needed, for example targeted social
spending, such as in-work benefits, to reduce the numbers of working
poor. Policies should also work to help ensure that temporary contracts
become stepping stones to career progression rather than dead ends.
More from the OECD: The impacts of rising female employment

and nonstandard employment on income inequality are examined
in In It Together: Why Less Inequality Benefits All (OECD, 2015),
http://dx.doi.org/10.1787/9789264235120en.

5.5. Taxes and transfers: What the state gives

and takes…
Even if the term may not be in everyday use, tax and transfer
systems are familiar to most people. The “tax” part needs little
explanation, for now; the “transfer” part essentially covers payments
made by the state, such as unemployment and family benefits.
These days, complex tax and transfer systems are a feature of life in
developed – and, increasingly, in developing – countries. They have
many different social and economic objectives, but, from the
perspective of income inequality, the main concern is over how
much they redistribute across society. The extent to which this
happens is determined by three main factors:
➤ Size: Simply, the amount the state takes in taxes and distributes
in transfers.
➤ Mix: Some tax and transfer systems rely more on income taxes
rather than consumption taxes, say, or pay out more in family
benefits than in pensions. This “mix” helps determine overall
redistribution.
➤ Progressivity: “Progressivity” is most easily explained in relation

to taxes. A tax is progressive when it means that higher earners
pay out a bigger share of their income than lower earners. By
contrast, it’s regressive when it hits lower earners proportionately
harder than higher earners.
How transfers contribute to redistribution
Most – but not all – transfers are made through welfare systems,
the roots of which can be traced back to Otto von Bismarck, the 19th
century Prussian statesman. In a speech in 1884, he outlined his
vision of state support: “Give the working man the right to work as
long as he is healthy; assure him care when he is sick; assure him
maintenance when he is old.” The Iron Chancellor was not acting
solely out of benevolence. In that same speech, Bismarck made it
clear that he was mainly interested in curbing the appeal of
socialism. Today’s welfare systems have a broader scope than in
Bismarck’s day, thanks in part to the influence of the “Beveridge
Plan”, a programme designed by Lord Beveridge in the United Kingdom

in 1942 that led to the creation of the first unified social security
system. These days, they can be said to have the following broad
objectives:
➤ Smoothing out people’s incomes across their lives: Welfare systems

often provide people with pensions, funded – at least in part – by
the taxes or social contributions they paid during their working
lives.
➤ Helping people cope with the unexpected: Welfare systems provide

support to people during crises such as job loss or sickness and
disability.
➤ Limiting the impact of poverty or reducing income inequality:

Welfare systems use a mix of two main approaches: Means-tested
support to people on very low incomes and universal benefits,
regardless of family income, such as child support.
As well as direct transfers, like unemployment benefits, states

also make non-cash transfers through public services. For example,
in most OECD countries, education is free or heavily subsidised until
at least the age of 15. These public services have an important
impact on families’ finances: If the value of these services were
translated into cash, the average annual household income in
OECD countries in the late 2000s would have risen from around
$22,000 a year to $28,000. Public services also play a major role in
reducing income inequality, reducing it by between a fifth and a
third, depending on the measure of inequality used.
Since the mid-1990s, tax and transfers systems have tended to

become less redistributive in OECD countries, largely because of
changes on the benefits side. Benefits have become less generous,
eligibility rules have been tightened and transfers to the lowest
income groups haven’t kept up with earnings.
Go deeper: OECD economists look at the role of taxes and transfers

in reducing income inequality,
http://dx.doi.org/10.1787/eco_studies20125k95xd6l65lt.

Some transfers redistribute more than others
When it comes to redistribution, not all transfers are the same.

Some significant transfers, such as pensions, can play only a fairly
small role in redistribution (although the impact can vary depending
on how it’s measured). In part that’s because, in many countries, a
large slice of workers’ pension payments are funded by money they
themselves paid to the state during their working lives – in that
sense, some pension systems may be regarded as delivering deferred
earnings rather than redistributing income across society. Other
factors also play a role. For example, lower-paid workers typically
live shorter lives than their higher-paid peers. As a result, they may
not draw down pension payments for as long as their better-paid and
longer-lived peers and so, essentially, subsidise the pensions of
higher-paid workers. Other transfers are typically more redistributive,
for example family cash benefits. But as with so much in this area, a
lot can depend on the benefit is designed – for example, whether it’s
means-tested or universal.
How taxes contribute to redistribution
Just as with transfers, the reasons why governments impose

taxes go well beyond just redistributing income. Taxes help fund all
the operations of government, including building schools and
hospitals, paying for a bureaucracy and providing defence. They can
also be used to guide certain behaviours: For example, cigarette and
alcohol taxes aim to encourage healthier lifestyles.
While people generally think of transfers as the main means for

redistributing income, the tax system itself can also play an
important role. In the United States, for example, tax credits provide
significant support for lower-paid workers. Typically, they allow
taxpayers to directly cut their tax bill if they meet certain conditions,
such as being a parent. In some countries, low earners can even
receive a tax refund if their tax credits exceed their tax bill. Along
with allowances and tax breaks, tax credits are a form of tax
expenditure. This is another way of saying that governments
sacrifice some of their potential tax take in return for pursuing social
and economic goals, such as expanded home ownership, regional
investment or support for specific business sectors.

Some taxes are more progressive than others
Overall, personal income taxes tend to be among the most

progressive forms of taxation in OECD countries. And even though
top rates of tax have been falling, they’ve become more progressive
in recent years. That’s been driven not by higher taxes at the top but
by increases in tax credits and cuts in social security contributions
for lower paid workers. But, equally, some tax credits – and tax
expenditures more broadly – are moving against this trend towards
greater progressivity. This happens especially when higher earners
get substantial tax breaks on things like health and child care and
retirement savings.
Other taxes can be less progressive and, in some cases, even

regressive. One example is consumption taxes, such as value-added
tax, or VAT. Because poorer households tend to consume a bigger
slice of their income than wealthier households, who save more,
they tend to be hit disproportionately by consumption taxes. Many
countries try to address this by limiting consumption taxes on
essentials like food. While this does help poorer families, it also
benefits their wealthier counterparts.
Policy approaches
Few areas of policy pose quite so many challenges as the design

of tax and transfers systems, in part because of their complexity and
the fact that they serve a very wide range of social and economic
goals, not just redistribution. As a result, they are often the subject of
intense political debate, and reaching a consensus can be a challenge.
Nevertheless, from the point of view of income inequality, a

number of ideas have emerged in recent years that seek to improve
the performance of tax and transfer systems. On the transfers side,
the budget squeeze facing many OECD governments makes it more
important than ever to ensure that public spending delivers
maximum benefits. This may strengthen the case for increasingly
targeting payments on low-income families.
Similarly, recognition of the role of work in lifting families out of

poverty and in building valuable social connections has shifted
attention to in-work benefits. These can encourage people to take up

work and help reduce levels of in-work poverty. And the role of
non-cash transfers – such as spending on education and healthcare
– should not be forgotten. Education spending needs to be targeted
in ways to ensure that as many people as possible can access a
high-quality education.
Data: Taxes that affect mainly top earners have gone down.
Dividend income and corporate income statutory tax rates,

OECD average, 19812013
Dividend income (domestic profits) tax Corporate income tax
%
80
70
60
50
40
30
20
10
0
1981 1990 2000 2013
On the taxes side, there has been growing discussion around

the idea of changing the tax treatment of top earners, which has
tended to become more generous since the 1980s. Even without
increases to top rates of tax, there is room in many countries for
scaling back some tax deductions and credits that tend to benefit
higher earners disproportionately. There may also be room for
taxing benefits like stock options as ordinary income. Again, these
sorts of benefits tend to be enjoyed disproportionately by high
earners. Other approaches include making greater use of property
and wealth taxes, such as inheritance taxes, and harmonising the
way tax systems treat regular income and income from capital,
which tends to be taxed less heavily.

Conclusions
Income inequality is a complex subject that is sometimes

reduced to overly simple explanations. The reality, as this OECD
Insights has attempted to show, is that its causes are diverse. They
can vary depending on whether we’re looking at the rising incomes
of “the 1%” or the growing gaps between, say, very low earners and
the rest of the population. Equally, the consequences of rising
inequality are multifaceted, and may be reflected in the pace of
economic growth, reduced social mobility and, perhaps, even our
health. Clearly, there is no single solution to harmful impacts of
income inequality. A comprehensive response may require action
across a broad swathe of policy areas, including in education,
employment policy and taxes and transfers.
What is the future for income inequality? On the face of it, the
outlook is not encouraging. Some of the most important drivers of
inequality look increasingly to be embedded in our economies and
societies. As one OECD paper recently noted, “the growing
importance of skill-biased technological progress for growth and
rising demand for higher skills will lead to continued polarisation of
the wage distribution”. It forecast that by 2060, and without a change
in policy approaches, inequality in the average OECD country will
match that found today in the most unequal countries.
But, of course, policy approaches can, and do, change. We take

for granted much of the social and economic infrastructure that
surrounds us – mass education, basic healthcare, social security. But
there was a time when little of this existed. It came about because
societies recognised the need to respond to changing circumstances.
Rising inequality is certainly a changing circumstance, and there’s
no shortage of signs that more and more of us feel the need to
respond. As Chrystia Freeland, a journalist and Canadian politician,
has written, “Not so long ago, inequality was a dirty word. [Now]
inequality hasn’t merely become a subject fit for polite company, it
has become de rigueur.” But talking about a problem is one thing,
finding solutions is another. Again, however, the examples of how
societies have repeatedly acted to improve people’s lives should give
us reasons to be optimistic. As the economist Anthony Atkinson has

written, “The world faces great problems, but collectively we are not
helpless in the face of forces outside our control.”
Ultimately, the question for our societies is this: How much

inequality are we prepared to accept? This goes to the heart of our
attitudes to wealth and poverty, to inclusion and exclusion, to social
mobility and immobility. Economics will no doubt play a part in how
our societies formulate a response. But, fundamentally, these
questions are political. Not in the sense of party politics, but in the
sense of how our societies work collectively to make decisions that
affect the lives of everybody, be they rich or poor.

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(01 2015 39 1 P) ISBN 978-92-64-24600-3 – 2015
OECD INSIGHTS OECD INSIGHTS
OECD INSIGHTS
Brian keeley
Income Inequality Income

The Gap Income inequality is rising. A quarter of a Inequality
Brian Keeley
century ago, the average disposable income
between Rich of the richest 10% in OECD countries was
and Poor around seven times higher than that of
the poorest 10%; today, it’s around 9½
times higher. Why does this matter? Many fear
this widening gap is hurting individuals, societies The Gap between Rich and Poor
and even economies. This book explores income
inequality across five main headings. It starts by
explaining some key terms in the inequality debate.
It then examines recent trends and explains why
income inequality varies between countries. Next
it looks at why income gaps are growing and, in
particular, at the rise of the 1%. It then looks at the
consequences, including research that suggests
widening inequality could hurt economic growth.
Finally, it examines policies for addressing inequality
and making economies more inclusive.
Other OECD Insights titles include:
INCOME INEQUALITY
Human Capital (2007)
From Crisis to Recovery (2010)
From Aid to Development (2012)
Forthcoming in the new OECD Insights Debates

series:
Ageing
Investment
V isit the Insights blog at w w w.oecdinsights.org
isbn 978-92-64-24600-3
01 2015 39 1 P

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OECD INSIGHTS OECD INSIGHTS

Income Inequality Income

Other OECD Insights titles include:

Forthcoming in the new OECD Insights Debates

V isit the Insights blog at w w w.oecdinsights.org

Please cite this publication as:

ISBN 978-92-64-24600-3 (print)

Series: OECD Insights

Photo credits: Cover © AuntSpray/Shutterstock.com; Introduction © iStockphoto.com/lindscars;

Corrigenda to OECD publications may be found on line at: www.oecd.org/about/publishing/

The poorest members of society suffer immediately from

To reduce inequality, we have to promote inclusive growth.

➤ Overcome gender inequalities. The fact that more women have

➤ Labour market policies need to address working conditions as

➤ A focus on education in early years is essential to give all

OECD Insights – INCOME INEQUALITY © OECD 2015 3

better opportunities and educational attainment. High inequality

➤ Governments should not hesitate to use taxes and transfers to

This new book in the “OECD Insights” series explores how

4 OECD Insights – INCOME INEQUALITY © OECD 2015

OECD Insights is a series of primers commissioned by the OECD

Currency references are in US dollars unless otherwise indicated.

Follow OECD Insights Blog on:

This book has... StatLinks2

OECD Insights – INCOME INEQUALITY © OECD 2015 5

1. What are income and wealth? . . . . . . . . . . . . . . . . . . . . . . . . . 17

2. What’s happening to income inequality? . . . . . . . . . . . . . . . . 31

3. Why is income inequality rising?. . . . . . . . . . . . . . . . . . . . . . . 41

4. How does income inequality affect our lives? . . . . . . . . . . . . 63

5. How can governments respond to income inequality? . . . . 79

OECD Insights – INCOME INEQUALITY © OECD 2015 7

Income inequality has risen in much of the world, sending

In late 2011, a group of protesters set up camp in New York not

The timing of the protests was significant. It followed a

Income inequality has been rising in many wealthy countries in

Income gaps are even more striking when it comes to the

10 OECD Insights – INCOME INEQUALITY © OECD 2015

Income ratio between top and bottom deciles in OECD countries

Source: OECD (2015), In It Together: Why Less Inequality Benefits All,

Much of the focus of the inequality debate has been on the

OECD Insights – INCOME INEQUALITY © OECD 2015 11

And in both developed and developing countries, income is only

The causes of these growing income gaps are complex and

Why inequality matters

Some might now ask why rising income inequality matters –

In the years since the financial crisis, these concerns have

12 OECD Insights – INCOME INEQUALITY © OECD 2015

and Development (OECD), has warned that “high levels of inequality

Understanding income inequality

Drawing on the research and analysis of the OECD and other

1. What are income and wealth?

Getting to grips with the income inequality debate means

2. What’s happening to income inequality?

Income inequality has risen in many developed countries, but

OECD Insights – INCOME INEQUALITY © OECD 2015 13

3. Why is income inequality rising?

The causes of rising inequality are complex, but include the

4. How does income inequality affect our lives?

Economists have long theorised over the relationship between

Trend in poverty rates in OECD countries since the mid1980s