New ILO Publication

Inequality is not inevitable

A new ILO book shows that the growing gap between rich and poor is only partially associated with technological change. The divide is mostly the result of economic and institutional policies that preceded the global economic and social crisis and were exacerbated by it.

Comment | 10 February 2014
By Sangheon Lee, ILO senior economist

When more than 2,500 of the world’s business and political leaders met in Davos in January, many saw the growing gap between rich and poor as the biggest threat to the global economy.

Over the last 20 years, income distribution has shifted in favour of the rich, while the relative income position of the poor and of much of the middle class was deteriorating in most countries, including global economic powers such as the United States, Germany and China.

According to the new ILO book, “Wage-led growth: An equitable strategy for economic recovery”, this trend is only partially associated with technological change.

The main reason workers are getting a smaller share of national income are policies over the last 30 years that have distributed income in favour of capital and against labour. What is called the labour income share began to fall around the 1980s in many advanced economies, including the United States and Japan, and a similar trend has been observed in recent years in emerging countries, notably China.

In addition, this smaller share of labour income was distributed more and more unequally between workers – with striking results.

The new book portrays a rather depressing but familiar picture. For the advanced countries, the labour income share on average has decreased by about 10 percentage points from the peak level of the late 1970s. Yet this significant reduction hides even wider income inequality, as the top 1 per cent of earners are included in the labour income share. If the top 1 per cent were not taken into account, the share the ordinary workers get would fall by another 2 to 6 percentage points.

Rebalancing economic policies

This timely publication challenges the widespread view that ‘growth should be in the driver’s seat and distribution in the backseat’. It also questions the common assumption that wage moderation can boost economic growth and hence reduce poverty.

The book analyses the dual function of wages in market economies - the fact that they are not only a cost of production but also a source of demand and productivity. It argues that if a critical mass of countries pursue pro-labour distributional policies simultaneously, there will be significant improvements in aggregate demand and growth, as well as reduction of inequality.

The book estimates that if the labour income share was increased by one percentage point in all G20 countries simultaneously, overall gross domestic product (GDP) would increase by 0.36 of a percentage point. As G20 economies account for more than 80 per cent of world GDP, a ‘wage-led growth’ strategy could be seriously considered as a global policy alternative.

We therefore need a “rebalancing” of policies in order to bring about more equitable growth. But this will require strong policy coordination at the global level.

Crisis brought positive changes

The book calls for new thinking around the role of wages in macroeconomic and growth policies, and we can certainly see significant policy shifts in some countries.

The US government recognized the damaging economic effects of inequality and has taken active policy measures, including a proposal by the federal government for a substantial increase in minimum wages. Many cities in that country are not waiting for the Congress to act, but have raised their local minimum wages.

The Chinese government has introduced a more radical policy reform which intends to shift the economy from an export-driven model to a more balanced one, which boosts the economy through higher wages and active redistributive policies.

Most recently, Germany has decided to introduce a statutory minimum wage in order to provide an effective wage floor for low-paid workers. Such active policy intervention is also observed in Japan, where the government has been encouraging the social partners to increase wages as a way of boosting domestic demand.

These policy changes present a first step in tackling inequality, but they are still too small to reverse the trend. More comprehensive action at the national and global level is needed.