Productivity and inequality – a nexus for policymakers to tackle

Reading Time: 6 minutes

By Emilia Soldani

Over recent decades many advanced and emerging economies witnessed a slowdown in productivity growth, with weaker technology diffusion and a decline in business dynamism  (Andre and Gal, 2024, forthcoming).  This was accompanied by persistent and pervasive inequalities in economic outcomes and opportunities. A new report by the OECD Economics Department (link) explains why the two challenges should be considered and tackled together (Soldani et al., 2024).

The slowdown in productivity growth  (Figure 1), which at first affected advanced economies and more recently also emerging G20 economies, is associated with increasing gaps between firms at the global productivity frontier and laggard firms across and within countries, even within the same industry (Criscuolo et al., 2021; Andrews, Criscuolo and Gal, 2016).

Figure 1. The slowdown in productivity growth and catch-up

Panel A. Labour productivity average yearly growth rate, %

Panel B – The divergence in productivity dynamics across firms

Notes: In panel A, Real GDP refers to the PPP population-weighted average. Advanced economies include Australia, Canada, Germany, France, UK, Italy, Japan, Korea and the US, and emerging-market economies include Brazil, Indonesia, Türkiye and South Africa. In Panel B, the index (2003 = 100) is approximated by changes in logs. The “Global frontier” is defined as the average productivity of the top 5% firms in the global productivity distribution within each detailed industry (2-digit, NACE Rev.2). “Firms below the frontier” is the average productivity of all other firms within the industry. The chart shows the mean three-year moving average across industries, covering 24 OECD countries. Labour productivity is defined as value added per employee. More details are given in the source paper.
Source: For Panel A, OECD Economics Department Working Paper number 1819. For Panel B, Andre and Gal  (2024, forthcoming) based on the updated calculations described in Andrews, Criscuolo and Gal (2016) using the Orbis firm-level financial account database (2022 vintage).

Meanwhile, while income inequality has decreased across countries (Lakner and Milanovic, 2015), it remains generally high within countries, especially in emerging economies. Across G20 economies with available data, the income ratio between the richest and poorest 10% of the population is still about significantly larger for emerging economies than advanced ones (Figure 2).

Figure 2. The income gap between the top and bottom deciles of the population remains high in emerging G20 economies

Note: The D9/D1 ratio is defined on household equivalised disposable income and refers to the total population. Note that the comparison of data over time is subject to methodological limitations  (OECD, n.d._[58]). Data around 2000 refers to 2006 for Brazil and Korea; 2004 for India and Türkiye; and 2000 for the other countries. Latest data available refers to 2011 for India; 2018 for Japan; 2020 for Australia and Germany; 2021 for Italy, the UK, Canada, France, Japan, and Türkiye; 2022 for the USA, Mexico, Korea and Brazil.
Source: OECD Income Distribution Database, data extracted in July 2024.

The situation deteriorated further because of the COVID-19 pandemic (Mahler, Yonzan and Lakner, 2022; OECD, 2024), which also highlighted the extent of inequalities in other dimensions: access to quality education, health care, savings and social protection. Such inequality of opportunities negatively affect the allocation of talents and social mobility, potentially further dragging down productivity growth.

The OECD report (link) summarises the empirical evidence and lessons on the policy levers available to accelerate productivity growth and make it more inclusive, drawing from a vast array of OECD studies and academic research. The main conclusion is that productivity and inequality challenges should not be looked at in separation, due to many links between the two, in either direction. For example, higher productivity and economic growth can boost aggregate savings, investment, and the accumulation of human and physical capital, which affect economic wellbeing, poverty, social mobility, and inequality. At the same time, these factors also affect occupational choices, political demand for fiscal redistribution, and social and political conflict, all of which may affect economic growth (Barro, 2000).  Intertwined links amid ongoing structural changes such as the  decline in labour force due to demographics, environmental disruptions, and high levels of public and private debt, suggest the importance for policy levers to target both inequality reduction and productivity enhancement.  

Based on the review of extensive research outputs, three main spheres of action to support inclusive growth emerge:

• The development of skills and the efficient matching of workers to firms can be supported by policies to improve access to quality education and upskilling at every age and to reduce labour market insecurity and informality.
• Policies to curb market power in labour and product markets: these may lead to double dividends by improving job quality and workers wellbeing, while also boosting growth-enhancing business dynamism.
• Enhancing the effectiveness, progressivity and equity of taxes and transfer systems. International cooperation, for instance in trade and taxation, should reinforce and support the efforts made at the national level.

The importance of business dynamism to boost productivity is best understood when noting that the productivity gap between laggard firms and those at the productivity frontier, which explains a considerable portion of the productivity growth slow-down, is higher in economic sectors characterised by stark barriers to business entry and dynamism and by higher market concentration (Calvino, Criscuolo and Verlhac, 2020). This suggests that policies supporting business dynamism may accelerate the diffusion of frontier technologies and management practices and promote aggregate productivity growth.

The need for policies to curb employers’ labour market power and reduce informality is apparent in light of the widespread decoupling between the growth of labour productivity and wages. Indeed, the growth of average and median wages over recent decades has been limited. Over the same period wage dispersion has increased as wages have grown relatively more at the top of the income distribution (Schwellnus, Kappeler and Pionnier, 2017), despite some signs of a partial reversal in wage inequality through 2022 and 2023. Here, too, policies to support education and upskilling may help reduce wage dispersion while also enhancing productivity growth (OECD, 2021; OECD, 2020), including by ensuring that the workforce has the right skill sets to face the ongoing transitions (OECD, 2022; Causa et al., 2022).

In the context of education policies, the latest OECD PISA scores highlight the need to improve inclusiveness and effectiveness. Average students’ performance starkly deteriorated between 2018 and 2022, and the gaps in scores along the socioeconomic dimension increased, with disadvantaged students falling further behind.

While the task may seem daunting, the stakes in reducing inequality and promoting inclusive growth exceed purely economic considerations: the combination of slow growth, persistent inequalities, especially in economic opportunities, may further erode social cohesion and the support for democratic institutions (Rodrik, 2017; Guriev and Papaioannou, 2022; Rodrik, 2021) and spark support for protectionist measures and hostile sentiments against international trade (Millot and Rawdanowicz, 2024; Criscuolo et al., 2022).

References

Andre, C. and P. Gal (2024, forthcoming), Reviving productivity growth: A review of policies.

Andrews, D., C. Criscuolo and P. Gal (2016), “The Best versus the Rest: The Global Productivity Slowdown, Divergence across Firms and the Role of Public Policy”, OECD Productivity Working Papers, No. 5, OECD Publishing, Paris, https://doi.org/10.1787/63629cc9-en.

Calvino, F., C. Criscuolo and R. Verlhac (2020), “Declining business dynamism: Structural and policy determinants”, OECD Science, Technology and Industry Policy Papers, No. 94, OECD Publishing, Paris, https://doi.org/10.1787/77b92072-en.

Causa, O. et al. (2022), “The post-COVID-19 rise in labour shortages”, OECD Economics Department Working Papers, No. 1721, OECD Publishing, Paris, https://doi.org/10.1787/e60c2d1c-en.

Criscuolo, C. et al. (2021), “The human side of productivity: Uncovering the role of skills and diversity for firm productivity”, OECD Productivity Working Papers, No. 29, OECD Publishing, Paris, https://doi.org/10.1787/5f391ba9-en.

Criscuolo, C. et al. (2022), “Are industrial policy instruments effective?: A review of the evidence in OECD countries”, OECD Science, Technology and Industry Policy Papers, No. 128, OECD Publishing, Paris, https://doi.org/10.1787/57b3dae2-en.

Guriev, S. and E. Papaioannou (2022), “The Political Economy of Populism”, Journal of Economic Literature, Vol. 60/3, pp. 753-832, https://doi.org/10.1257/jel.20201595.

Lakner, C. and B. Milanovic (2015), “Global Income Distribution: From the Fall of the Berlin Wall to the Great Recession”, The World Bank Economic Review, Vol. 30/2, pp. 203-232, https://doi.org/10.1093/wber/lhv039.

Mahler, D., N. Yonzan and C. Lakner (2022), The Impact of COVID-19 on Global Inequality and Poverty, The World Bank, https://doi.org/10.1596/1813-9450-10198.

Millot, V. and Ł. Rawdanowicz (2024), The return of industrial policies: Policy considerations in the current context, https://doi.org/10.1787/051ce36d-en.

OECD (2024), Annex A. Meeting of the Members of the Council on the 2030 Agenda for Sustainable Development – Background and draft Agenda, https://one.oecd.org/document/C(2024)9/REV1/en/pdf.

OECD (2022), OECD Employment Outlook 2022: Building Back More Inclusive Labour Markets, OECD Publishing, Paris, https://doi.org/10.1787/1bb305a6-en.

OECD (2021), The Role of Firms in Wage Inequality: Policy Lessons from a Large Scale Cross-Country Study, OECD Publishing, Paris, https://doi.org/10.1787/7d9b2208-en.

OECD (2020), Competition in Labour Markets, OECD, https://web-archive.oecd.org/2020-03-10/546723-competition-in-labour-markets-2020.pdf.

OECD (n.d.), OECD Income (IDD) and Wealth (WDD) Distribution Databases, https://www.oecd.org/social/income-distribution-database.htm.

Rodrik, D. (2021), “Why Does Globalization Fuel Populism? Economics, Culture, and the Rise of Right-Wing Populism”, Annual Review of Economics, Vol. 13/1, pp. 133-170, https://doi.org/10.1146/annurev-economics-070220-032416.

Rodrik, D. (2017), Populism and the Economics of Globalization, National Bureau of Economic Research, Cambridge, MA, https://doi.org/10.3386/w23559.

Schwellnus, C., A. Kappeler and P. Pionnier (2017), “Decoupling of wages from productivity: Macro-level facts”, OECD Economics Department Working Papers, No. 1373, OECD Publishing, Paris, https://doi.org/10.1787/d4764493-en.