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2014.04.29_NAEC Seminar_Closing the loop

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  • 1. CLOSING THE LOOP: HOW INEQUALITY AFFECTS ECONOMIC GROWTH AND SOCIAL COHESION Federico Cingano Directorate for Employment, Labour and Social Affairs Employment Analysis and Policy Division NAEC Seminar 29 April 2014
  • 2. 2/23 The question has a clear policy relevance as inequality has kept increasing in most OECD countries over the last years Does inequality affect economic growth?
  • 3. 3/23 Recent trends in income inequality across OECD countries Mid 80s to 2009/101 0.15 0.2 0.25 0.3 0.35 0.4 0.45 0.5 0.55 0.6 0.65 0.7 Increasing inequality Mid-80s¹ Late 2000s 0.15 0.2 0.25 0.3 0.35 0.4 0.45 0.5 0.55 0.6 0.65 0.7 Little change in inequality 0.15 0.2 0.25 0.3 0.35 0.4 0.45 0.5 0.55 0.6 0.65 0.7 Decreasing inequality Note: Income inequality is measured by the Gini coefficient based on equivalised household disposable income, after taxes and transfers for total population. Data refer to 1992 for Czech Republic, to 1991 for Hungary Sources: OECD Income Distribution Database (via www.oecd.org/social/income-distribution-database.htm) Does inequality affect economic growth?
  • 4. 4/23 The question has a clear policy relevance as inequality has kept increasing in most OECD countries over the last years • Which are consequences for growth (and exit from the crisis)? • Which are the relevant channels? It has revived a long standing, controversial debate in economics • Several (opposing) theoretical mechanisms • Large amount of empirical evidence, but no consensus Does inequality affect economic growth?
  • 5. 5/23 This presentation provides: • A brief review of • The main theoretical channels • The existing empirical evidence • New evidence for OECD countries, assessing: • The strength of the inequality & growth nexus (“Does…?”) • The link between inequality and human capital accumulation (“How does…?”) Does inequality affect economic growth?
  • 6. 6/23 “Incentives” argument: • Inequality as a necessary reward for costly/risky investments • e.g. human and physical capital investment, entrepreneurship etc. • Lowering inequality (Redistribution) distorts incentives→ bad for accumulation and growth • Equity – Efficiency trade-off (Okun 1975) Inequality and Growth: opposing views (1/2)
  • 7. 7/23 “Opportunities” argument: • Inequality induce missed opportunities of investment (by the poor) and resource misallocation. • e.g. human capital under-accumulation, misallocation of talents, etc. • Lowering inequality (Redistribution) generates investment opportunities → good for growth • Inequality and financial market imperfections (Loury, 1981; Galor-Zeira, 1994) Inequality and Growth: opposing views (2/2)
  • 8. 8/23 Huge literature started in 1990s. Mostly focused on reduced-form growth regressions Largely inconclusive: - Early (cross-country) works: mostly negative estimates - Later (panel) analyses: often positive (or non-significant) estimates Possible explanations: • Data quality and their coverage • Estimation approaches and inequality indicators Inequality Inequality stimulates accumulation Growth Incentives: Inequality induces under-investment (by the poor) Opportunities: +/- Inequality and Growth: review of the evidence (1/2)
  • 9. 9/23 “Inequality of incentives” (stimulates accumulation) Growth Incentives: “Inequality of opportunities” (induces under-investment ) Opportunities: Few, recent works try to disentangle the two channels: • Decompose overall inequality in (proxies of) • Inequality of opportunities • Inequality of incentives • Assess their relative strength in growth regressions First results suggest both channels play a role + - Inequality and Growth: review of the evidence (2/2)
  • 10. 10/23 Evidence presented in this work Focus on OECD countries, looking at whether: 1. inequality (& redistribution) affects growth 2. inequality at the top and at the bottom of the distribution play different roles 3. inequality impacts on (Human Capital) accumulation/ the effect depends on socio-economic background Inequality stimulates accumulation Growth Inequality induces under-investment (by the poor) Inequality Incentives: Opportunities: + - Top inequality “Inequality of incentives” Bottom inequality “Inequality of opportunities” +/- + - 1 2 3
  • 11. 11/23 • 1. Inequality and Growth: new estimates for OECD countries
  • 12. 12/23 (1) (2) Inequality (Net) Inequality -1.084** -0.956** (0.398) (0.421) (log of) GDP -0.086 -0.024 (0.084) (0.133) Controls (HC and K) N Y Observations 133 133 Number of countries 33 33 Note: the dependent variable is the average 5-year growth rate of per capita GDP (1980-2010). Inequality is measured by before and after tax and transfers Gini indexes (“Gross ” and ”Net” inequality, respectively) at the beginning of the period. System GMM Estimates . *** p<0.01, ** p<0.05, * p<0.1 Lower net income inequality increases economic growth 1. Inequality and Growth: results
  • 13. 13/23 (1) (2) (3) (4) Inequality Ineq. & Redistribution (Net) Inequality -1.084** -0.956** -1.097* -1.107* (0.398) (0.421) (0.563) (0.587) (Gross) Inequality 0.109 (0.647) (Gross - Net) Inequality 0.034 (0.797) (log of) GDP -0.086 -0.024 -0.003 -0.016 (0.084) (0.133) (0.139) (0.136) Controls (HC and K) N Y Y Y Observations 133 133 130 130 Number of countries 33 33 32 32 Note: the dependent variable is the average 5-year growth rate of per capita GDP (1980-2010). Inequality is measured by before and after tax and transfers Gini indexes (“Gross ” and ”Net” inequality, respectively) at the beginning of the period. System GMM Estimates . *** p<0.01, ** p<0.05, * p<0.1 Lower net income inequality increases economic growth Even holding gross inequality constant (redistribution) 1. Inequality and Growth: results
  • 14. 14/23 • Lowering inequality by 1 Gini pt. estimated to raise yearly GDP per capita growth by nearly 0.2 pp. • In 2010, the US-Canada, or UK-Germany inequality gaps was of ~6 pts. • Between 2007-2010 inequality increased by 3 pts. in Spain, 1pt in France and Sweden, nearly 1pt in Italy, Greece and Ireland. Lowered by ~1pt in New Zealand, Poland, Mexico and Chile (~2 in Portugal)  www.oecd.org/social.inequality.htm • Redistribution seems to have helped support faster growth (across Oecd countries) • Finding in line with IMF (2014), looking at broader set of countries 1. Inequality and Growth: implications
  • 15. 15/23 (1) (2) (3) (4) 2nd decile 3rd decile Bottom Inequality -0.100* -0.108** -0.177* -0.166** (0.059) (0.041) (0.102) (0.066) Top Inequality -0.524 -0.317 (0.582) (0.499) Observations 98 98 98 98 Number of countries 32 32 32 32 Note: the dependent variable is the average 5-year growth rate of per capita GDP (1980-2010). Bottom inequality is measured by the ratio between average income in the economy and average income in bottom deciles (cols 2 and 3 focus on the 2nd decile, cols. 3 and 4 on the 3rd). In cols 2 and 4, top inequality is measured by average income of the 8th decile relative to average income. System GMM Estimates . *** p<0.01, ** p<0.05, * p<0.1 Increased dispersion at the bottom of the income distribution negatively impacts on growth. Top inequality seems less relevant 2. Inequality and Growth: the role of bottom and top inequality
  • 16. 16/23 • Assess strength of link, and whether it varies with socio-economic background • Use large OECD survey (PIAAC). Focus on “low” (the poor), “medium” and “high” parental education background (PEB) individuals • Relate their HC attainments (formal education and skills) to inequality levels when aged ~14 • Panel data analysis exploiting within-country variation in inequality and educ. outcomes by different cohorts (t): 3. Inequality and Human Capital accumulation
  • 17. 17/23 The impact of inequality on formal education (1) Inequality lowers the probability of Tertiary education But only of the poor (by 0.7 pp per Gini point) Note: average predicted probability that individuals from poor, medium and high family (educational) background attain Tertiary education as a function of the degree of inequality (Gini points). Low PEB: neither parent has attained upper secondary education; Medium PEB: at least one parent has attained secondary and post-secondary, non-tertiary education; High PEB: at least one parent has attained tertiary education. Dotted lines represent baseline probabilities for each group. The bars indicate 95% confidence intervals.
  • 18. 18/23 The impact of inequality on formal education (2) Inequality increases the probability of lower sec education But only of the poor (by 0.8 pp per Gini point) Note: average predicted probability that individuals from poor, medium and high family (educational) background do not reach Upper secondary education, as a function of the degree of inequality (Gini points). Low PEB: neither parent has attained upper secondary education; Medium PEB: at least one parent has attained secondary and post-secondary, non-tertiary education; High PEB: at least one parent has attained tertiary education. The bars indicate 95% confidence intervals.
  • 19. 19/23 The impact of inequality on formal education (3) Inequality lowers years of schooling of the poor (by 0.1 yr. per Gini point) Note: average predicted Years of Schooling for individuals from poor, medium and high family (educational) background as a function of the degree of inequality (Gini points). Low PEB: neither parent has attained upper secondary education; Medium PEB: at least one parent has attained secondary and post-secondary, non-tertiary education; High PEB: at least one parent has attained tertiary education. The bars indicate 95% confidence intervals.
  • 20. 20/23 The impact of inequality on skills proficiency (1) Inequality lowers (literacy and numeracy) skills among the poor (by 1.1 score point per Gini point) Note: average predicted Numeracy score for individuals from poor, medium and high family (educational) background as a function of the degree of inequality (Gini points). Low PEB: neither parent has attained upper secondary education; Medium PEB: at least one parent has attained secondary and post-secondary, non-tertiary education; High PEB: at least one parent has attained tertiary education. The bars indicate 95% confidence intervals.
  • 21. 21/23 The impact of inequality on skills proficiency (2) Inequality lowers (literacy and numeracy) skills among the poor (even conditioning on level of formal education) Note: average predicted Numeracy score, conditional on the actual level of education, for individuals from poor, medium and high family (educational) background as a function of the degree of inequality (Gini points). Low PEB: neither parent has attained upper secondary education; Medium PEB: at least one parent has attained secondary and post-secondary, non-tertiary education; High PEB: at least one parent has attained tertiary education. The bars indicate 95% confidence intervals.
  • 22. 22/23 Evidence points to: • Negative effects of inequality on growth • Seem driven by income disparities at the bottom of the distribution • Redistributive policies as captured by the data have not led to bad growth outcomes • Negative effects of inequality on Human Capital accumulation, but only among the poor  lowering opportunities ? increasing incentives Closing the loop? Summary of the evidence
  • 23. 23/23 THANK YOU
  • 24. 24/23 Additional material
  • 25. 25/23 Trends in income inequality prior and since the Great Recession
  • 26. 26/23 Growth consequences of recent (2007-10) changes in inequality across OECD countries -0.7 -0.6 -0.5 -0.4 -0.3 -0.2 -0.1 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 ESP SVK FRA SWE IRL ITA GRC EST JPN DNK SVN ISR AUT TUR USA CAN FIN CZE HUN GBR DEU NOR KOR AUS LUX NLD BEL CHL MEX POL NZL PRT ISL Percenatgepoints Note: based on the change in the Gini coefficient of household disposable incomes between 2007 and 2010, as reported in OECD (2013), “Crisis squeezes income and puts pressure on inequality and poverty” via www.oecd.org/social.inequality.htm 1. Inequality and Growth: implications (2)
  • 27. 27/23 Additional effects: inequality and employment Inequality raises the probability of not being employed of the poor Note: average predicted probability that individuals from poor, medium and high family (educational) background are not employed over the working life (obtained as (1-experience/potential experience)). Low PEB: neither parent has attained upper secondary education; Medium PEB: at least one parent has attained secondary and post-secondary, non-tertiary education; High PEB: at least one parent has attained tertiary education. Dotted lines represent baseline probabilities for each group. The bars indicate 95% confidence intervals.
  • 28. 28/23 Implied aggregate effects of inequality on Human Capital (flows) Impact on low PEB individuals Aggregate impact if share of PEB = 0.4 Aggregate impact if share of PEB = 0.2 Aggregate impact if share of PEB = 0.1 Prob. of Tertiary Education -4 -1.6 -0.8 -0.4 (percentage points) Average Years of Schooling -0.5 -0.2 -0.1 -0.05 (years) Average PIAAC score -6.5 -2.6 -1.3 -0.6 (Numeracy) Average PIAAC score -6.6 -2.7 -1.3 -0.7 (Literacy) Effects on Long run Productivity -2.1% -1.0% -0.5% Based on Coulombe and Tremblay (2006) Inequality increasing by ~6 (Gini) points implies: Note: the increase corresponds to the interquartile (25th – 75th) differential in the underlying distribution of inequality in the sample. In 2010, it corresponds to the differential between the US and Canada, or, in Europe, between the UK and Germany. Over time, it corresponds to the increase observed since the 1980s in countries as the US, the UK, New Zealand, Sweden and Finland.

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