Inclusive growth has been defined as output growth that is sustained over decades, is broad-based across economic sectors, creates productive employment opportunities for a great majority of the country’s working age population, and reduces poverty.1 Inclusive growth is about both the pace and pattern of economic growth.2
However one defines it, there is no bigger policy challenge preoccupying political leaders around the world than expanding social participation in the process and benefits of economic growth and integration. A central lesson of the recent financial crisis is the need for a rebalancing of the emphasis placed by policymakers on drivers of what could be considered the “top-line” measure of national economic performance, GDP per capita growth, on the one hand, and factors that influence its “bottom-line” performance in achieving broad-based progress in living standards, on the other. In advanced and developing countries alike, it is increasingly recognized that GDP per capita growth is a necessary but not sufficient condition for the satisfaction of societal expectations.
Even if the precise nature and relative importance of the causes of rising inequality remain in debate,3 a geographically and ideologically diverse consensus has emerged that a new, or at least significantly improved, model of economic growth and development is required. G20 leaders have committed themselves a number of times since the financial crisis to this goal. For example, in London during the heat of the crisis in 2009, G20 heads of government stated: “We are determined not only to restore growth but to lay the foundation for a fair and sustainable world economy. We have pledged to do whatever is necessary to… build an inclusive, green, and sustainable recovery.” Leaders of major international economic organizations, including the International Monetary Fund (IMF), World Bank, Organization for Economic Co-operation and Development (OECD), and International Labour Organization (ILO), as well as Pope Francis have also repeatedly expressed concern about rising inequality and called for new strategies to address it.4 Many national leaders have placed improvements in social inclusion at the heart of their economic programs.5 Most recently, the draft UN Sustainable Development Goals and the G20 Presidency under Turkey have each identified inclusive growth as a priority agenda item.6
This new political consensus about inclusive growth is rooted in a significant widening of inequality, affecting economies at various levels of development.7 Across the OECD, for example, the average income of the richest 10% of the population is about nine times that of the poorest 10%, up from seven times 25 years ago.8 More important than growing shares at the top are the cases where the benefits of growth have not been shared widely and low- and median-income households have fallen further behind.9 Over the last decade, median household income has stagnated in several advanced economies (such as Germany) and even declined in the United States, resulting in a more vulnerable middle class at risk of falling into poverty.10Part of this trend can be traced back to the slowdown following the financial crisis, and a structural decline in the share of national income accruing to labor.11
In developing economies, sustained strong growth has lifted many out of absolute poverty but improvements in living standards have not kept pace with GDP growth, or been evenly distributed.12This is most apparent in Eastern Europe and many fast-growing emerging Asian economies such as China, India, and Vietnam, and some African economies such as Zambia and Kenya.13Yet, there are some exceptions to the trend of widening inequality, mainly in Latin America, but these tend to be in places where inequality was very large to begin with – in Chile and Mexico, for example, the incomes of the richest 10% are still more than 25 times those of the poorest 10%, while in Brazil the gap in income between the top and bottom deciles is still about five times that of advanced economies.14
The political consensus on inclusive growth has been reinforced by a growing body of empirical economic research about the relationship between inequality and economic growth.15As described in Box 1, there is mounting evidence that inequality has a statistically significant negative impact on growth, and that reducing inequality can enhance and strengthen the resilience of growth. According to research by the IMF, for example, a decrease in the GINI by 3 points (about the difference in Gini between the United States and Morocco) can raise economic growth by about one half of one percent per annum; growth, moreover, is not only higher, but also more sustainable, i.e., less fragile and less likely to end in crisis. Other research by the IMF suggests that, if the income share of the top 20 percent increases, GDP growth tends to decline over the medium term; one explanation is that wealthier households spend a lower fraction of their incomes, which could reduce aggregate demand and undermine growth.16In contrast, an increase in the income share of the bottom 20 percent is associated with higher GDP growth. If the income share of the rich is lifted by 1 percentage point, GDP growth decreases by 0.08 percentage points.17If the income share of the poor and the middle class is increased by 1 percentage point, GDP growth increases by as much as 0.38 percentage points over five years.18
Similarly, OECD research finds that an increase in inequality by 3 Gini points is correlated with a decrease in economic growth by 0.35 percentage points per year for 25 years – a cumulative loss of 8.5%.19 This is primarily because higher levels of inequality are associated with poorer households finding it harder to invest in health and educational opportunities, thereby lowering human capital accumulation and social mobility.20 The economic threat of income inequality to a nation’s well-being lies primarily in the large bottom segment of society not advancing. In response to these findings, the OECD is working on a new metric of multidimensional living standards (see Box 2), in a bid to capture the well-being of societies more accurately. With its Human Opportunity Index (see Box 3), the World Bank is another influential organization increasingly turning its attention to what is needed in addition to economic growth to reduce poverty and share prosperity more widely.
Nevertheless, despite widespread dissatisfaction with the standard growth model – whether its relatively laissez-faire Anglo-Saxon variant or developmental-state counterparts – and accumulating evidence that reducing inequality can actually strengthen economic growth, the new inclusive-growth consensus is still essentially an aspiration rather than a prescription. No internationally-recognized policy framework and corresponding set of indicators or measurable milestones has emerged to guide the construction and implementation of a more socially inclusive model of economic growth and development.
The so-called Washington Consensus offers a roadmap for countries seeking to generate strong growth in national income in part through integration into the global economy.21But its near-exclusive focus on drivers of GDP growth and relative inattention to structural and institutional features of policy that influence the extent to which growth translates into broad-based progress in living standards has rendered it incomplete and unbalanced. The international community’s post-crisis search for a new growth and development model is, in effect, an attempt to rectify this imbalance. This Report is intended as a contribution to that thought process.
Box 1: The International Monetary Fund’s Examination of Inequality, Redistribution, and Growth
Economists are increasingly focusing on the links between rising inequality, the role of redistribution, and the fragility of growth. The emerging consensus is that inequality leads both to lower and more fragile—less sustainable—growth.1-1 That equality seems to drive higher and more sustainable economic growth does not however in itself support efforts to redistribute. In particular, inequality may impede growth at least in part because it calls for efforts to redistribute that themselves undercut growth.
While considerable controversy surrounds these issues, policymakers should not jump to the conclusion that the treatment for inequality is worse for growth than the disease itself. Equality-enhancing interventions could actually help growth: think of taxes on activities with negative externalities paid mostly by the rich, or cash transfers aimed at encouraging better attendance at primary schools in developing countries. The macroeconomic effects of redistributive policies will reflect a balance between the components of the fiscal package, and it is an empirical question whether redistribution is pro- or anti-growth in practice.
Looking at the best available macroeconomic data, the answer seems clear: inequality is bad for growth, and redistribution is not.2-1 (Figure 1): Lower net inequality is robustly correlated with faster and more durable levels of growth, controlling for the extent of redistribution. Redistribution itself appears generally benign in terms of its impact on growth – for the average country, it reduces inequality, which has protective effects both for the level and the sustainability of economic growth. Only in extreme cases is there some evidence that redistribution is harmful to growth.3-1 In fact, for the average country, redistribution has direct benign effects on growth – and, through its effect of reducing inequality, has further positive effects overall. Redistribution, on average, is a pro-growth policy.
The data also confirm that more unequal societies tend to redistribute more. This is not necessarily an obvious result: if political power were as unequally distributed as economic power, with the rich controlling the political process, more unequal societies might not try to lessen their inequalities. The correlation between inequality and redistributive efforts is stronger for advanced economies, but holds in developing countries too.
There are, of course, inherent limitations of empirical analysis and of cross-country data on inequality more generally. But the message from Ostry et al. (2014) is that the extreme caution against efforts to redistribute is probably not warranted if the reason is an assumed large trade-off between redistribution and growth. The best available macroeconomic data do not support this conclusion.
Box 2: The OECD’s Approach to Inclusive Growth
The OECD launched its Inclusive Growth Initiative in 2012 to help governments analyze and address rising inequalities. It starts from the premise that GDP per capita may not be sufficient to generate sustained improvements in societal welfare. Promoting across-the-board improvements in well-being calls for a broader conception of living standards than that contained in traditional measures. Beyond income and wealth, people’s well-being is shaped by a range of non-income dimensions – such as their health, educational, and employment status – that are not adequately captured in a measure like GDP per capita. Likewise, well-being at the societal level cannot be gauged solely by looking at averages. Only by looking at the evolution of living standards for different segments of the population, such as the median or the poorest, can it be seen whether economic growth benefits all groups in society or just the lucky few.
The OECD’s Inclusive Growth Framework includes a measure of “multidimensional living standards” designed to track societal welfare and analyze the extent to which growth – in a given country and over a given period – translates into improvements across the range of outcomes that matter most to people’s lives.
It includes an income dimension, measured as average household real disposable income adjusted for inequality between the income of the average household and that of a household at a different decile (e.g. median or bottom 10%). It also includes the non-income dimensions of health and unemployment, chosen based on empirical work on the most significant determinants of subjective well-being. According to the most recent data, in 2012, losses in living standards related to longevity and unemployment in the OECD equated to as much as 29% of household average income.
Multidimensional living standards are a useful tool for policymakers as the monetization of non-income dimensions allows for the impact of policies on jobs, health, and income to be expressed on a common scale. The effects may operate in the same direction, creating positive synergies, or may be partly offsetting, leading to trade-offs which might require compensatory action. For instance, it may be found that proposed environmental regulations are likely to reduce income by lowering economic growth, but more than offset this through better health due to reduced pollution.
Similarly, the introduction or extension of health services financed by additional contributions from employers or households may be detrimental to the average and median household income and employment, but may benefit the poor in the form of higher longevity and higher in-kind transfers related to health services.
The OECD is continuing its methodological work in order to refine the multidimensional living standards measure, incorporating other non-income dimensions that matter for well-being, such as health inequality and education. Work is also underway to extend the analysis beyond the OECD to include emerging and middle-income countries, and to test the robustness of the framework. The policy mapping work will pursue the analysis of the main drivers of the key dimensions – based on a production function approach – and the identification of robust empirical relationships.
Sources: “All on Board: Making Inclusive Growth Happen,” OECD, 2014; “Report on the OECD Framework for Inclusive Growth,” OECD, 2014.
Box 3: The World Bank’s Focus on Inclusive Growth and Inequality
The World Bank recently adopted the “twin goals” of reducing extreme poverty to 3 percent or less globally by 2030, and boosting “shared prosperity” – defined as growth in the income of the bottom 40% in every country. Economic growth will be fundamental to achieving these goals, but growth alone will not be enough. If growth over the last 10 years is extrapolated to 2030, without changes in inequality, extreme poverty would decline to only 5.6% from 14.5% today.1-3 Analysis of growth in developing countries over the second half of the last decade shows that the bottom 40% grew faster than the country average in more than 70% of the cases for which data is available – but this growth was very low in a significant minority of these countries. In some high-growth countries, shared prosperity was often spurred by social transfers, which may not be sustainable going forward. This analysis provides support to the view that, despite widespread perceptions of rising income inequality, the reality is much more complex.2-3
While acknowledging the importance of reducing inequality of income, the World Bank concentrates on reducing inequality of opportunity.3-3 Characteristics such as gender, parental income, ethnicity, and geography can curb a child’s potential from the beginning of life, perpetuating poverty across generations and restricting economic mobility. The Human Opportunity Index measures these overlapping disadvantages and tracks progress in narrowing inequality of opportunity.4-3
It is imperative to provide opportunities for the poor and vulnerable to access education, health, and other basic services which can improve their human capital. Among redistributive policies that can contribute to this are conditional cash transfers. Pioneered in Latin America, these involve public cash transfers targeted at the poor and vulnerable, and are linked to their enrollment in education or health services. The importance of well-targeted transfers and of effective fiscal mechanisms that guarantee that transfers and public services are adequately funded yet fiscally sustainable, cannot be overestimated.
Improving the human capital of those at the bottom is fundamental to ultimately ensuring that they can access jobs and earn a livelihood. In fact, research shows that more and better-paying jobs are the main channel through which poverty and income inequality can be reduced.5-3 Enabling the conditions for the private sector to create jobs for those at the bottom, while ensuring that the latter have the skills to access them, will be key for sustainable inclusive growth going forward.