Which government policies reduce wage inequality?

Which policy tools do governments have at their disposal to address wage inequality? Many OECD countries have experienced growing wage differentials in the past decade. Existing research points to globalisation and technological and institutional changes as crucial drivers. Growing inequalities have given rise to moral, social, and political challenges, and a growing public demand for policymakers to react to these challenges. Yet, despite the vast literature on drivers of wage inequality, there is no comparative research on existing policy tools governments can use to address wage inequality. This article assesses how policies concerning low wages affect wage inequality. Theoretically, five policies are identified, which most governments already have at their disposal. These policies are characterised by either directly intervening in wage-setting, such as statutory minimum wage, or indirectly influencing wages by affecting workers or employers’ incentives for low paid jobs (e.g., in-work benefits, active labour market policies, unemployment benefits and employment protection legislation). From a theoretical perspective, this article argues that not having a national minimum wage, higher national minimum wage levels, unemployment benefits, and strict employment protection legislation equalises wages. In contrast, in-work benefits and active labour market policies have the opposite effect. The empirical analysis is based on data from 30 OECD countries from 2001-2020 collected from OECD/AIAS ICTWSS database and the Comparative Political dataset. The findings suggest that two of the five policies matter for wage inequality. First, higher statutory minimum wages are associated with a decrease in wage inequality at the bottom of the wage distribution. Second, dedicated in-work benefit policies and generous in-work benefits increase wage inequality. Even when controlling for other important drivers of wage inequality, the effect of these two policies are still most dominant, suggesting that policymakers already have available policy tools to address wage inequality.