Much of the debate on inequality focuses on its deleterious social and political effects and its impact on growth. But an equally important question is which policies play a clear role in reducing income inequality.
The results of our new study suggest that improvements in education – even more than factors such as government expenditure or financial-sector development – have contributed in an important way to reducing income inequality within countries.
In our study, we first explore whether a country’s income distribution becomes more equal as it grows richer – a question that has intrigued economists as far back as Simon Kuznets. Is income inequality reduced as countries grow more prosperous? Does this relationship depend on the country’s stage of economic development? Which factors affect it?
Examining historical data, we found that increased prosperity, on average, leads to lower inequality. A 1% increase in GDP per capita reduces the Gini coefficient – a measure of income inequality that ranges from 0 for perfect equality to 1 for absolute inequality – by around 0.08 percentage points.
Further, we found that growth in a country’s GDP boosts the relative income share of the poor and the middle class at the expense of the richest 20%. In other words, not only do the poor and the middle class benefit from growth, they actually benefit proportionately more than the rich. These results hold true across regions and across different stages of development.
We tried to pinpoint exactly how increased prosperity helps reduce inequality, and discovered that education plays a key role. Indeed, our results suggest that education policies – particularly those that concentrate on equity and skills – can be among the most potent levers that countries possess to reduce income disparities over the longer term.
Role of technology
If growth reduces inequality, how does this square with the increase in labour income and earnings inequality that has been observed in many countries over the past few decades?
Technology and globalization are two possible ways to explain this phenomenon. Technological change has conferred an advantage to those adept at working with computers and information technology. And global supply chains have moved low-skilled jobs out of advanced economies, depressing prospects of workers who previously held these jobs. Even in countries to which these jobs relocate, the initial beneficiaries are often the more skilled workers.
Education matters because educated individuals are better able to cope with technological and environmental changes that directly influence productivity levels. Indeed, better education is the best policy to help countries avoid the increase in income inequality that often results from technological change and globalization.
So what can be done? For many advanced economies, including the United States, bringing down inequality in the future means increasing the supply of highly educated workers. Too many young people drop out of high school; too many high-school graduates are not college-ready. Then there is the cost of higher education, which in the US is prohibitively expensive for many families. These are problems that could be solved by better government policies.
In many developing countries, levels of educational attainment still remain uncomfortably low, with access to even basic education constrained by market failures and inefficient policies.
While the precise focus of policies necessarily varies across countries, a number of broad areas can sketched out. Education policies that help students achieve strong academic outcomes, continue on to higher levels of education and acquire the skills to succeed in a globally competitive economy can foster greater inter-generational earnings mobility and help reduce income inequality over time.
In developing countries, policies that promote equal access to basic education, such as cash transfers aimed at encouraging better attendance at primary schools or spending on public education that benefits the poor, could reduce inequality by helping build human capital and making educational opportunities less dependent on socio-economic circumstances.
Published in collaboration with IMF
Author: Era Dabla-Norris is a deputy chief in the IMF’s Strategy, Policy and Review department.
Image: A group of students walk home from school along a road currently being constructed in the Bumi Serpong Damai housing complex, on the outskirts of Jakarta, January 28, 2014. REUTERS/Beawiharta