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Policies to counteract growing wage inequality

By Catherine Ramos | Tuesday, 15 September 2015

Income inequality is rising and we should be concerned. European countries including the Commonwealth of Independent States (CIS) region, and the Asia-Pacific region experienced income inequality increases on average by 35%, and 13%, respectively, from the early 1990s to late 2000s[1]. The gap between rich and poor now is at its highest compared to 30 years ago with the richest 10% in the OECD countries earns 9.6 times the income of 10% poorest[2].

Increasing or high inequality is a serious concern as it threatens social cohesion and political stability as people at the bottom become more dissatisfied with their economic situation. The poor may find it difficult to benefit from opportunities thereby suppressing social mobility as those who have ‘more’ also have greater resources and better positional goods. High inequality may also weaken trust and commitment in the government and society, and may cause an increase in prejudice and resentment when inequality is seen as  unfairly creating winners and losers. High inequality also derails economic growth which OECD estimated to be about 4.7 percentage points off economic growth between 1990 and 2010 on average across OECD countries[3]. The key driver impacting growth with reference to inequality is the income gap between the bottom 40% and the rest of the population (in 2012, only 3% of total wealth was owned by the bottom 40% households in OECD countries)[4], thus, as OECD has argued, policies on poverty alone are not enough to address inequality as there is also the need to address low incomes directly.

Factors affecting income inequality, as well as policies to counteract rising inequality have been studied and explored by international bodies such as OECD, UNDP, and ILO. The factors identified as driving income inequality include trade globalisation, financial globalisation, and technical change (exogenous factors, i.e, outside of the domestic policy arena), as well as  macroeconomic policies such as labour market policies and fiscal policies[5] (endogenous factors, i.e., within the control of domestic policy).

Research shows that the policies that countered the negative effect of exogenous and endogenous factors on income gaps include promotion of equity in education, integration of immigrants, anti-discrimination initiatives, increased female labour participation, cash transfers, and the reduction of the employment protection gap between temporary and permanent work[6].  Other policies such as increases in tertiary graduation rates and taxes need to be implemented more cautiously as the effects on inequality can go in either direction. For example, bad fiscal policies such as value-added taxes and inefficient public expenditure that dilutes the benefits to the poor have caused increases in income inequality in the lower-middle and low-income countries by as much as 19% and 31%, respectively[7]. On the other hand, high expenditures on social services that are regularly used by the poor such as basic education and health care have a distributive effect that reduced inequality by one-fifth in OECD countries[8]. A policy to increase the skills supply through increasing graduate numbers may increase income inequality as skill-biased technical change tends to increase demand for skilled labour thereby raising wages while leaving unskilled labour wages stagnant.

Examples of strong and effective policy in mitigating or reversing income equality include equitable provision of education opportunities and education reforms that make educational outcomes less and less dependent on personal and social circumstances. Specific education policies that have been cited in mitigating income inequality include, early childhood care and education, good quality basic schooling for all and postponing of early tracking, and initiatives for disadvantaged children[9]. Policies promoting education equity is an example of a double-dividend policy since it both reduces income inequality and increases long-run economic growth. Other identified double-divided policies include promoting female labour participation, integration of immigrants, and reduction in labour market dualism[10].

In terms of labour policy, the minimum wage initiative has been controversial. For some countries, this law has been meaningless as the wage set is so low that it did not help alleviate poverty nor mitigate income inequality. But countries such as those in Latin America that increased and even doubled the minimum wage have seen a reduction in inequality[11]. So what kind of principle needs to be applied in determining the value of socio-economic policies, such as the minimum wage. The Constitutions of countries that are known for their wage compression policies as well as philosophical arguments by prominent figures offer some direction. For example Article 2 Paragraph 2 of the Swedish Constitution states that “The personal, economic and cultural welfare of the individual shall be the fundamental aim of public activity…” which implies that the individual’s welfare is the ‘end’, the goal of society and economy.  John Paul II in his encyclical Laborem Exercens made the point that labour has a priority over capital– “all the means of production, from the most primitive to the ultramodern ones – it is man that has gradually developed them: man’s experience and intellect…everything that is at the service of work, everything that in the present state of technology constitutes its ever more highly perfected ‘instrument’, is the result of work.”[12] In short, capital if not developed by man is created by man, thus, principle of labour over capital. If societies apply the principles of (a)  individual as the ‘end’ goal of society and economy, and the (b) ‘labour over capital’ in wage determination, these could possibly mean that one’s wage (whether through minimum wage or in some form of social benefits), should be able to cover one’s personal needs, and high enough to enable family formation (in fact, a single salary that can support a family could also help in increasing fertility rate, as it will take out the stress of needing two incomes just to form a family). The United Nations Conference on Trade and Development (UNCTAD) also recommends that wage levels for similar qualifications should be the same throughout the economy and not be left to the discretion of individual firms[13].  These principles or recommendations also serve as a reminder that societies cannot leave the wage level determination and adequacy to the play of supply and demand.

Addressing the growing income inequality issue is obviously not a walk in the park. Counteracting the negative effects of exogenous and endogenous factors on income inequality requires strong political will, guiding principles in policymaking that puts the individual as the ‘end’ and not a ‘means’, as well as well-thought of mix of social, fiscal, labour and education policies to reverse, if not mitigate growing income inequality despite the onslaught of trade and financial globalisation and technical change.

 

[1] UNDP (2013). Humanity Divided: Confronting Inequality in Developing Countries, http://www.undp.org/content/undp/en/home/librarypage/poverty-reduction/humanity-divided–confronting-inequality-in-developing-countries.html

[2] OECD. (2015). In it together: Why less inequality benefits all – Summary, http://www.oecd.org/social/in-it-together-why-less-inequality-benefits-all-9789264235120-en.htm

[3]  OECD, 2015

[4] OECD. (2014). Focus on inequality and growth, http://www.oecd.org/social/inequality-and-poverty.htm

[5] UNDP, 2013

[6] Ibid

[7] Ibid

[8] UNDP, 2013.

[9] OECD, 2014

[10] OECD. (2012). Reducing income inequality while boosting economic growth: Can it done? In OECD’s Economic Policy Reforms: Going for growth. Retrieved from http://www.oecd.org/economy/monetary/economicpolicyreformsgoingforgrowth2012.htm

[11] UNDP, 2013

[12] John Paul II. (1981). Laborem Exercens. Retrieved from http://w2.vatican.va/content/john-paul-ii/en/encyclicals/documents/hf_jp-ii_enc_14091981_laborem-exercens.pdf

[13] United Nations (2012). Chapter VI The Economics and Politics of Inequality Reconsidered, UNCTAD, p. 166.

 

Catherine Ramos is Research Manager at the HEAD Foundation. Her research area focuses on skills and employability.

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