This document summarizes research on how inequality affects economic growth and human capital accumulation. The key points are: 1. Analysis of OECD countries finds that lower net income inequality is linked to higher economic growth rates. Reducing inequality by 1 Gini point could increase annual GDP growth by 0.2 percentage points. 2. Inequality at the bottom of the income distribution, not the top, appears to negatively impact growth. 3. Inequality reduces human capital accumulation, but only for those from poorer socioeconomic backgrounds. It lowers their education levels and skills proficiency even when controlling for education. This suggests inequality decreases opportunities for the poor.

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.