Inequality, Labor Market Policies and Economic Growth : Is There a Relation? Empirical Evidence for the OECD Countries

This paper tries to analyze whether pursuing economic growth and setting up labor market policies affect inequality. Therefore a simple testable model along the lines of the Kuznets and Neoclassical literature is fit to the data. The explanatory power of the regressions is high. On average the model explains about three quarters of the variation in inequality measures for the OECD countries. The theoretical ignorance about the sources of inequality translates into sharp disagreements in evaluating policy options. The results here indicate that inequality is negatively affected by factors related to the engines of economic growth: the accumulation of physical capital and technological know-how. As for aggregate investment in physical capital and inequality in the OECD countries, the results in this paper reconcile with earlier findings on this topic. However the relation between R&D and inequality had not been tested yet.The gains for the upper part of the distribution from investments in capital outweigh the losses at the bottom quintile significantly. Moreover, the impact of accumulating either kind of capital differs: investment in physical capital has a larger negative impact on the bottom part than investment in knowledge, and the income gains of accumulating technological know-how are smaller for the richest quintile compared to the gains of investment in physical capital. Investment in R&D thus seems the least harmful for inequality: accumulating technological know-how widens the gap between rich and poor less serious than accumulating physical capital. Changes in the tax-wedge turn out to be a significant instrument for lowering inequality: it increases the income share at the bottom part of the distribution at the cost of a lower income share higher up the distribution. The effect of changes in the labor force growth could not be estimated precisely, but higher labor force growth seems to widen the gap between the top and bottom quintile, via a decrease in the income at the lower and an increase at the top part of the distribution. The impact of active labor market policies is significant and effective to reduce inequality. The reduction in the income share at the top part of the distribution due to this type of policy (presumably financed by redistributive taxes) can be ignored compared to the gains at the bottom part of the distribution. As opposed to the active labor market policies, passive labor market policies, however, have only a small impact which could not be estimated precisely. As for the Gini-coefficient this kind of labor market policy moreover is rather a source of increases in inequality. However, the sum of the labor market policy and the tax wedge effects seems not offset the effects of investment in physical capital and knowledge. The causality tests confirm the causal relation in this model as well as the causal direction implied in the political economy literature, but rejects the causality suggested in the consumption theory