Rising Income Inequality Undermines GDP Growth: OECD

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The Organization for Economic Cooperation and Development (OECD) says that rising economic inequality has been holding back economic growth for decades and that it will continue to do so unless Western governments implement policies that bolster the lower middle class.

“Income inequality has a negative and statistically significant impact on medium-term growth,” says the OECD report. “Rising inequality by 3 Gini points, that is the average increase recorded in the OECD over the past two decades, would drag down economic growth by 0.35 percentage point per year for 25 years: a cumulated loss in GDP at the end of the period of 8.5 per cent.”

US level of income inequality nestled between Russia, China

The Gini coefficient is a widely used measure of income inequality that rates countries between 0 and 100 (or 0 and 1, depending on how you normalize). Scoring a 0 would mean that the society is perfectly equal, and a 100 would mean that a single person owns the nation’s entire wealth. Obviously those are extremes, but most countries are somewhere between 20 and 60.

For context, the US scores a 41, which is worse than Egypt (31), Sudan (35), Iran (38) and Russia (40), but not quite as bad as China (42), according to World Bank statistics. That’s a big jump since the 1980s, but then nearly every OECD country has been on the same path.

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OECD says that weak skills development is the real problem

The OECD report isn’t the first to tie income inequality to slow growth (it doesn’t take the extra step of blaming the tepid recovery on the weak middle class, though many others have), but the usual explanation is that the middle class spends virtually everything that it earns, while wealthy people don’t. Shifting income upwards means less consumption overall and slower growth. But the OECD says that thhe real culprit is the lack of skill development.

“The evidence is strongly in favour of one particular theory for how inequality affects growth: by hindering human capital accumulation income inequality undermines education opportunities for disadvantaged individuals, lowering social mobility and hampering skills development,” says the report.

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The OECD says that, not only do policymakers not have to balance economic growth against populist measures, actively helping the bottom 40% is better for everyone in the long run. It recommends targeted cash transfers, better access to public services, education, training, and healthcare as important ways to invest in the working class and long-term GDP growth.

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