Inequality and Prosperity in the Industrialized World

Addressing a Growing Challenge

On average, income inequality within developing economies is very high, particularly in Africa, and higher than in the industrialized world, which creates its own major development challenges. But, in aggregate, global income inequality has declined from the late 1980s, and particularly rapidly from about 2008, as developing economies have, on average, closed some of the gap with industrialized countries. Previously, at least since the early 19th century, global inequality had increased. The driving factors behind this change have included the very real impact of globalization and technology on trade and employment, and also the transition of the formerly Communist bloc in Eastern Europe. In very simple terms, globalization has been a positive force in leveling inter-country inequality over the past 30 years. At the same time, the share of the world’s population estimated to be below the World Bank’s $1.90/day extreme poverty threshold has fallen drastically, from 35% in 1990 to 11% in 2013. Despite a major expansion in world population, the number of people in extreme poverty has fallen dramatically from 1.85 billion to under 800 million.

However, within-country inequality in the larger developing countries — the same economies that have enjoyed large income growth and narrowed the differences with rich countries, such as China, India, and Indonesia — has actually increased substantially in recent years. As a result, income inequality within countries now accounts for around a third of global inequality, when it was only one-fifth in 1988. The contribution of inter-country inequality has correspondingly shrunk.

Of critical focus to our research, income inequality has increased substantially within many OECD countries over recent decades after a long period of decline. The extent to which income inequality in advanced economies has grown is now widely known, though the relative importance of the range of driving forces producing these trends is less clear, as is their importance to economic growth. Rising inequality is not only a concern from a fairness perspective, in itself and in terms of its impacts on social outcomes such as health, crime, and family structures; it is also now increasingly being seen as a core issue for macroeconomic performance, implicated in the economic crisis and slow recovery from it, and as representing a major threat to long-term growth and prosperity.

A range of factors has been identified contributing to the rise in income inequality across OECD countries, including technological change, globalization, changes in labor market institutions, and weakening redistribution via taxes and transfers, as well as specific factors affecting the very top of the income distribution and the distribution of wealth and income arising from this. There remain substantial differences across studies as to the relative contribution of particular elements. What is more surprising, perhaps, is that the search for effective responses is still at an early stage, although recently international organizations such as the OECD and IMF have advanced some broad recommendations to tackle inequality while promoting growth.

Against this background, our research program will focus on identifying the impacts of inequality on economic growth potential, social cohesion, and the political process. On the back of this, we shall collaboratively suggest a coherent set of responses that would address rising inequality in a manner that promotes inclusive growth.

The Executive Summary of this report summarizes our initial findings and conclusions. Three significant points are worth stressing here. First, it appears increasingly clear to us that if the drivers of inequality are not addressed, then inequality may become an increasing drag on economic growth due to a variety of factors which we assess throughout this report and which we shall investigate further in future research. The drag reflects wasted potential and a skills mismatch within labor forces and also that more unequal societies are less successful at investing productively for the long term. Indeed, we highlight that more unequal countries now seem to be growing less robustly than more equal ones, i.e., growth may be lower and more fragile at higher levels of economic inequality. From an investment perspective, an inequality-driven economic drag could take quite different paths in different countries leading to a consequent impact on longer-term relative asset prices and exchange rates. In other words, and put bluntly, it makes good economic sense to understand and address inequality.

Second, economic inequalities are everywhere, which makes addressing the underlying issues with simple policy responses very challenging. We show in this report that inequalities have grown not just between countries but between regions within countries, between generations, between industries, and between firms. In particular, demographic forces, most notably the aging population in the developed markets, are creating a new set of inter-generational inequality challenges that are likely to get worse. Globally, wealth inequality is significantly higher than income inequality. Putting an inter-generational lens on this sharpens the issue. The debate around inequality thus needs to be related to issues such as youth unemployment, social mobility, and pension funding.

Third, inequality, as well as the impact of other exacerbating factors such as lower social care budgets and the reduced provision of other government-funded services, is now clearly a critical focus in the mainstream political process and in election campaigns in many countries. In aggregate, it appears that inequality is contributing markedly to declining social trust, the erosion of social cohesion, and the fragmentation of the political process. Inequality will likely be an increasing factor in election outcomes, with social media playing a growing role in shaping perceptions. A consensus urgently needs to be reached between government, the public sector, the private sector, and society at large about how to tackle the challenge of inequality in a way that promotes inclusive and necessary economic growth. At the moment, we risk political paralysis, or worse.