Inclusive Growth:

A framework for linking living standards to policies Alain de Serres OECD Economics Department

New Approaches to Economic Challenges (NAEC)

Seminar, 3 February 2014

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Framework for linking outcomes to policies

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What the framework should aim to achieve

1. Provide a clear link between individual dimensions of the welfare function and policies

2. Identify the main channels of transmission

3. Make explicit the main policy trade-offs and synergies

4. Be sufficiently flexible to be adaptable to country-specific challenges and circumstances

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A framework for policy analysis

Outcomes and their distribution:

Material well-being: Income, consumptionjobs

Quality of life: HealthEducationPersonal SecurityEnv. quality of life…

Welfare function

depending on outcomes

Production function or process

Policies

EconomicFinancialCompetition

LabourSocialHealth policies

Education policies

Return on physical and human capital, demand for jobs …

Other drivers(institutions; norms; exogenous factors)

Sources of growth, equality of opportunities

Going for Growth /

Green growth /

Divided we stand

Work on education and health etc.Work on side-effects of growth policiesWork on equality of outcomes and opportunities

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Linking outcomes to policies requires that a number of conditions be fulfilled

1. A good understanding of the key drivers of the outcomes in the welfare function is critical

Firm link to policies requires that processes generating outcomes be well understood and defined

Supported by analytical framework

2. The identification of robust empirical relationships between living standards and policies is also important

Could be more difficult for quality-of-life aspects of certain dimensions (e.g. environment, education)

Constraint of data availability over time and across countries

3. The amenability of outcomes to policy instruments will also determine the choice of variables

Estimated economic impact must be significant

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The case of income and health status

1. Health status (non-material dimension)

Proxied by life expectancy

Matters for both material and non-material living standards

2. Income generation (material living standards)

Measured by mean household disposable income…

… but link to policies anchored in growth accounting framework (drivers of GDP per capita.

3. Income distribution

How aggregate income trickles down across various parts of the distribution

Mean, median, lower part of the distribution

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Linking policies to outcomes

From production to income to living standards taking into account health outcomes and inequality

Income distribution

Production (income generation)

Living standards

Household Income Life Expectancy

MedianMean Bottom

GDP per capita

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1. Health outcomes (non-material dimension although can have a material impact)

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Life expectancy: Substantial improvement in EMEs

Vast majority of OECD countries experienced a significant reduction in the ratio of bottom to middle incomes amid diverging trends in overall income inequality

1.1.1. Life expectancy at birth, 2009 (or nearest year), and years gained since 1960

JapanSw itzerland

ItalySpain

Australia

Life expectancy at birth, 2009 Years gained, 1960-2009

United KingdomGermanyGreeceKorea

IsraelIceland

Sw edenFranceNorw ay

New Zealand

PolandMexicoEstonia

Slovak Republic

CanadaLuxembourg

OECDDenmark

NetherlandsAustria

BelgiumFinlandIreland

Portugal

ChinaBrazil

SloveniaChile

United StatesCzech Republic

IndonesiaRussian Fed.

IndiaSouth Africa

HungaryTurkey

83.0

82.3

81.8

81.8

81.6

81.6

81.5

81.4

81.0

81.0

80.8

80.7

80.7

80.6

80.4

80.4

80.3

80.3

80.3

80.0

80.0

80.0

79.5

79.5

79.0

79.0

78.4

78.2

77.3

75.8

75.3

75.0

75.0

74.0

73.8

73.3

72.6

71.2

68.7

64.1

51.7

405060708090

Years

15.2

10.9

12.0

12.0

10.7

9.9

8.6

8.3

10.7

7.2

9.7

9.4

11.3

7.1

11.7

9.6

11.2

10.4 27.9

10.2

11.0

10.0

15.6

11.2

6.6

10.5

21.4

8.3

6.7

8.0

17.8

6.5

4.4

6.0

25.5

26.7

18.1 30.0

0.0

21.7

2.6

0 5 10 15 20 25 30

Years

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Health status: the policy determinants of life

expectancy

Missing determinants such as poverty, exclusion, discrimination and job insecurity. Less of a problem if they correlate with income inequality

Health care

provisionsPollution

Life Expectancy

Education Life style

Environmental

policies

Productionactivites (pro-

growth policies)

Educationalpolicies

Health policies:SpendingEfficiency

Household income

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2. Production or income generation (material living standards)

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Income generation:

The policy determinants of GDP per capita

Basic growth framework anchored in production function approach has allowed for multiple policy channels to be explored and identified

GDP per capita

EmploymentLabour Productivity

Geography

Framework conditions and institutions

Education policies

Human capital

Innovation policies

Knowledge-based capital

Product and financial market policies

Physical capital Life expectancy

Labour market policies

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Income generation:

The policy determinants of GDP per capita

This simple breakdown into labour productivity and employment would be necessary to have the latter dimension explicitly linked to policies

GDP per capita

EmploymentLabour Productivity

Geography

Framework conditions and institutions

Education policies

Human capital

Innovation policies

Knowledge-based capital

Product and financial market policies

Physical capital Life expectancy

Labour market policies

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Income generation:

The policy determinants of GDP per capita

Further decomposing labour productivity into its main underlying drivers would allow for a richer set of policies to be included and to have explicit link to additional dimensions such as education

GDP per capita

EmploymentLabour Productivity

Geography

Framework conditions and institutions

Education policies

Human capital

Innovation policies

Knowledge-based capital

Product and financial market policies

Physical capital Life expectancy

Labour market policies

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3. Income distribution: From GDP to average household disposable income and across the distribution

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Important to understand how GDP per capita trickles

HH incomes at different point of the distribution

Mean and median incomes have in many countries lagged GDP growth during the pre-crisis period

Real annual growth rates in GDP, mean and median income

-0.5

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

5

5.5

6

-0.5

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

5

5.5

6

B. Mid 90s-20071

Median income Mean income GDP per capita

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OECD countries have experienced a

form of cross-country “convergence”

This is based on the Gini coefficient over a specific time period and sample of countries.

Changes in inequality against initial level, mid-1990s to late 2000s

AUSAUT

BEL

CAN

CZE

DNK

FIN

FRADEU

GRC

HUN

IRL

ITA

JPNLUX

MEX

NLD

NZL

NOR

PRTESP

SWE

TUR

GBR

USA

CHL

ISR

-0.1

-0.075

-0.05

-0.025

0

0.025

0.05

0.075

0.2 0.225 0.25 0.275 0.3 0.325 0.35 0.375 0.4 0.425 0.45 0.475 0.5 0.525 0.55

A. InequalityChange

Initial level

Correlation coefficient= -0.76

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Income distribution: Beyond the Gini

Vast majority of OECD countries experienced a significant reduction in the ratio of bottom to middle incomes amid diverging trends in overall income inequality

AUSAUT

BEL

CAN

CZE

DNK FIN

FRADEU

GRC

HUN

IRL

ITA

JPNLUX

MEX

NLDNZL

NOR

PRT

ESP

SWE

TUR

GBR

USA

CHL

ISR

-0.1

-0.08

-0.06

-0.04

-0.02

0

0.02

0.04

0.06

0.08

0.1

-0.3 -0.25 -0.2 -0.15 -0.1 -0.05 0 0.05 0.1 0.15 0.2 0.25 0.3 0.35 0.4 0.45 0.5 0.55 0.6 0.65 0.7

''Overall'' income inequality

A. Developments in the lower half of the income distribution and in "overall" inequality

Increased overall inequality but decreased inequality in the lower half of the income distribution

Increased overall inequality as well as in the lower half of the income distribution

Decreased overall inequality but increased inequality in the lower half of the income

Decreased overall inequality as well as in the lower half of the income distribution

Inequality in the lower half of the income distribution

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Mild decline in the Gini in Spain but falling income at

the low end of the distribution

Relative advantage for the middle class, combined with losses for the poor in absolute terms

-10

0

10

20

30

40

50

60

70

80

90

100

-10 -8 -6 -4 -2 0 2 4 6 8 10 12

Bottom to top-sensitive income standards

Percentage growth of income standard

Mean income

Growth in income standards between the mid-1990s and late-2000s

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Potential policy trade-offs

1. Growth policies

May raise incomes for a majority but also entail higher air or water pollution : unclear net effect health and living standards

2. Environmental policies

May lower GDP per capita and household disposable income but still improve living standards through better health

3. Health policies

Higher spending on health can raise life expectancy but could also crowd-out other types of public or private investment (or consumption)

Higher life expectancy may lead to higher employment and GDP but only if working life is adjusted in proportion