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An Occupy Wall Street protester. The growing income and wealth gap has been a mainstay of the protest movement, and the OECD says trickle down economics is dead. (Eduardo Munoz/Reuters/Eduardo Munoz/Reuters)
An Occupy Wall Street protester. The growing income and wealth gap has been a mainstay of the protest movement, and the OECD says trickle down economics is dead. (Eduardo Munoz/Reuters/Eduardo Munoz/Reuters)

income inequality

OECD calls time on trickle down theory Add to ...

Trickle down theory is dead. The belief fostered by Ronald Reagan in the U.S. and Margaret Thatcher in the U.K. in the 1980s, that if the rich got richer, their income and wealth would trickle down the income scale so that a rising tide lifted all the boats, has had the last rites pronounced on it – by the Organization for Economic Co-operation and Development.

Its report “Divided We Stand” published on Monday highlights how income inequality is rising almost everywhere in the developed world. Not just, as it first did, in the Anglo-Saxon countries, such as the U.S. and Britain, but more recently in traditionally more egalitarian countries such as Denmark, Sweden and Germany.

At the best of times, extreme differences in income and wealth are not good for social cohesion. In times like these, the sense that those at the very top are more or less spared the effects of the economic crisis – while benefits are cut, unemployment rises and the living standards of those still in work suffer – is even more corrosive.

“The social contract is unravelling,” Angel Gurría, OECD secretary-general, said.

The causes of rapidly rising income inequality are hotly debated and far from clear. Globalization has removed low-paid manufacturing jobs to developing countries. Technological change has displaced both craft and non-craft jobs – routine metalwork and carpentry are done by machines while computers do the work of filing clerks. The same technologies have delivered higher rewards to those with the skills to use them.

Other factors appear to play a part, including social sorting – for example, doctors marrying doctors rather than nurses; the rise in single-person and lone-parent households; couples in work being more likely to both work; and unemployment benefits becoming steadily meaner. In the U.K., the latter have been linked to prices rather than earnings, with money instead going into in-work benefits to try to ensure that it pays to do low-paid work.

The most striking effect, however, is not just that the top 10 per cent of the income distribution has moved away from the bottom 10 per cent. It is that the top 1 per cent, and even the top 0.1 per cent, has accelerated away from everybody else – a phenomenon driven by top pay for “stars,” whether in sport, entertainment or business, and by banker and executive bonuses.

The share of income taken by the top 1 per cent in the U.K. rose from less than 10 per cent in 1990 to more than 14 per cent by 2005, and will have risen more before the credit crunch.

All this, the OECD argues in what will be one of its more controversial recommendations, points to the top earners having a greater capacity to pay taxes. It is not that they do not at present: the top 1 per cent of earners account for about 27 per cent of all income tax. But their taxable capacity has risen.

Very high top rate tax risks flight by those who can move and there is evidence that it discourages enterprise. So the OECD suggests tackling evasion and avoidance; limiting tax reliefs at the top, as the U.K. has done for pension contributions, and taxing wealth harder – wealth being even more unequally distributed than income. That could be done, for example, by boosting high-end property taxes and taxing lifetime gifts, as well as inheritances, more heavily.

In a world where the rich can indeed go where they will, however, the question of how far any one country can go on its own remains.

Copyright The Financial Times Ltd. All rights reserved.

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