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Income inequality slows GDP

Jasper SkyDecember 10, 2014

Growing income inequality has reduced GDP growth in many industrialized countries, a new OECD report has revealed. Today's economy would be bigger if the richest 10 percent hadn't increased their share of total income.

Symbolbild Bettler
Image: Fotolia/Gina Sanders

The Organization for Economic Cooperation and Development (OECD) has found that the divide between the richest 10 percent and poorest 10 percent in many of the world's wealthiest countries - including Germany - has been growing. In a report released Monday, OECD said that this, in turn, had caused growth to slow.

In Germany in the mid-1980s, for example, the richest 10 percent of the population earned on average five times more per month than the poorest ten percent. Now, the richest decile earn seven times as much as the poorest decile.

One result of the growing divide between rich and poor, the OECD report showed, was that gross domestic product (GDP) - measuring the general level of economic activity - was smaller than it would be if inequality had not increased.

"In Germany, real inflation-adjusted GDP growth between 1990 and 2010 was 26 percent. We estimate that had inequality remained stable, and not increased, during those two decades, GDP would have grown by about 31 percent. So the German economy would be five percent bigger now had inequality not increased," said OECD economist Michael Förster, a co-author of the OECD study.

Germany is a country whose "social market economy" is set up to maintain a broad middle class. The situation is more extreme in many other OECD countries, according to the report, entitled "Trends in income inequality and its impact on economic growth".

Government interventions to decrease inequality would increase GDP growth

Strong and sustainable GDP growth was only possible if governments take energetic and decisive measures against further increases in inequality, the OECD said. Suitable measures could include income or wealth redistribution through tax measures, and transfers of money and benefits to the poor.

"The OECD recommends three types of policy intervention to reduce inequality, which can be implemented in different mixes depending on the socioeconomic conditions and policy preferences in different countries," Förster said.

OECD - Michael Förster
Michael Förster says his findings complement those reported in economist Thomas Piketty's book, "Capital in the 21st Century"Image: OECD

"The three pillars are: an inclusive labor market - e.g. structuring labor markets to ensure low unemployment. [Secondly] investments in human capital - which means good skills training and education programs. And finally, redistribution of some of society's wealth or income toward the relatively poor through various transfer programs," he explained.

Förster said that the results reported in the new OECD study provide further statistical evidence of negative effects of growing inequality, complementing - using different sets of data - the results found by French economist Thomas Piketty, whose 2013 book "Capital in the 21st Century" has become one of the most talked-about economics books in decades.

The poor spend all their income - the rich often sit on their savings

Poorer citizens tend to spend every extra euro or dollar of income. In economists' jargon, poor people's "propensity to spend" any extra income is much higher than that of the rich, who tend to save extra income.

On average, much of the extra money taken in by the wealthy tends to sit unspent in the form of financial savings, rather than being spent into circulation in the real working economy. That directly translates into a reduction in GDP compared to an economy with a less unequal distribution of wealth or income.

The impact of inequality on growth stems from the gap between the bottom 40 percent and the rest of society, not just the poorest 10 percent, the OECD report said. Improvements and increasing access to public services like good education, training and healthcare, as well as cash transfers, are essential to generate greater equality of opportunities in the long run.

The report also found no evidence that redistributive policies such as taxes and social benefits harm economic growth, provided the policies are well designed and implemented.