Capsule: Luxembourg Income Studies Abstract on Causes of Inequality

The following is an excerpt from an abstract of a paper authored by Wen-Hao Chen, Michael Förster and Ana Llena-Nozal and published as a Luxembourg Income Studies working paper. The authors work in the Social Policy Division at OECD.

The study points out that earnings inequality in most of the countries studied resulted from a combination of growing shares at the top of the earnings distribution, and declines in the shares of those at the bottom. The biggest changes, though, came at the top.

The distance between the highest 10% of earners and those in the middle has been growing faster than the distance between the middle and the lowest wage earners. Thus, in most countries wage disparities grew more in the upper half of the distribution than in the bottom half.

In assessing the relative impact of technological change, and of globalization, on the increase in inequality, the study identified technological change as the main driver.

The results suggest that technological progress is a key driver behind the upward trend of earnings inequality; it transmitted inequality mainly through raising wage dispersion. Economic globalisation, in terms of both rapidly rising trade and financial integration, appears overall distributional neutral once other factors, in particular changes in policies and institutions, are also controlled for.

This raises the question whether countries which introduced policies to increase competitiveness in the global economy may have also contributed to inequality of earnings, in essence, by favouring the creation of low-end jobs, holding low-end wages down through liberalization of labor market policies. Yet they also increased training and educational opportunities. The researchers make the following comment:

Regulatory reforms that aimed at promoting growth and productivity appeared to exert contrasting effects: they tended to close the gap between employed and non-employed, by increasing job opportunities but at the same time also contributed to greater wage inequality. Finally, the growth in the supply of skilled workers is an important equalizing factor contributing not only to reduce wage dispersion among workers but also to higher employment rates. Up-skilling provided a sizable counterweight to the increase in earnings inequality resulting from technological progress, pressure from globalisation and institutional changes.

There is also some evidence that lower unemployment benefit replacement rates and lower tax wedges were associated with higher aggregate employment. At the same time, another strand of literature provided strong evidence that many regulatory and institutional reforms also contributed to widening wage disparities, as more low-paid people entered employment and the highly skilled reaped more benefits from a more dynamic economy.

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