OECD Strikes Out in Explanation of the Causes of Inequality

The rise in inequality around the world is a hot topic of political debate in the United States and other wealthy nations. Responding to this rise, the OECD recently published a book examining trends in inequality. But while the OECD work contains a great deal of useful data and analysis, a new report from the Center for Economic and Policy Research (CEPR) demonstrates that the OECD fell short of accurately describing the causes of inequality.

The report, "Missing the Story: The OECD's Study of Inequality", shows that the OECD analysis does little to explain the rise in inequality, in part, because it focuses on the growth in the gap of wages between workers at the 90th percentile and the 10th percentile. As well, the study misrepresents the statistical significance and economic importance of some of its findings - particularly with respect to technology -- and fails to note the importance of other factors behind increasing inequality, such as the growth of the financial sector compensation.

"By only examining the growing gap between the 90th percentile and the 10th percentile, the OECD study overlooks the fact that vast majority of the gains from rising inequality went to workers at the 99th and .99th percentiles while workers at the 90th percentile and lower barely saw their share of productivity gains," said David Rosnick, a CEPR economist and co-author of the study.

Another shortcoming of the study centers on its analysis of the role of technology. According to the OECD findings, the development of technology had a significant impact on increasing inequality. However, the CEPR report points out that only a cyclical technology variable had a significant impact on inequality. The OECD's trend technology variable was not close to being significant, meaning that the trend in technology had no measurable impact on inequality over the period examined.

"Though the OECD draws particular attention to the part played by technology in the rise in inequality, closer examination of the data show that the cyclical effect of technology only makes sense in the short run, but over the course of the business cycle, this impact is cancelled out and has no measurable effect over the long-term." said Dean Baker, a co-director of the Center for Economic and Policy Research and a co-author of the report.

The OECD results also understate the impact of financial intermediation. When the share of GDP going to financial sector compensation is included as a variable in the OECD's regression, the coefficient is highly significant. It appears to explain a substantial portion of the increase in inequality across countries. This finding would be consistent with the view that financial sector pulls away more resources than it contributes to the economies in the study, therefore earnings in the sector come at the expense of the rest of the economy, contributing to the relative decline in income for less highly paid workers.

The authors do note that the OECD does accurately find that labor market institutions such as employment protection legislation and higher unionization rates decrease inequality. Increased secondary education and female employment also serve to reduce inequality, as does increased control of foreign investment. In neglecting to show the gains to the top 1 percent and 0.1 percent, however, their analysis does little else to accurately depict the factors driving inequality. The full report can be found here.