4.2 Poverty And Inequality Flashcards
What is absolute poverty?
is a situation where individuals cannot afford to acquire the basic necessities for a healthy & safe existence
These necessities include shelter, water, nutrition, clothing & healthcare
In 2022, the World Bank defined absolute poverty as anyone who was living on less than $1.90 a day
Absolute poverty is more prevalent in developing countries than developed ones
What is relative poverty?
Relative poverty is a situation where household income is a certain percentage less than the median household income in the economy
Poverty in a household is considered relative to income levels in other households
The UK defines relative poverty as households that are living with less than 60% of the median household income
In May 2022, the median UK monthly household income was £2072/month
This meant that the relative poverty line was any household earning less than £1243,20/month
In early 2022, 22% of the UK population was in relative poverty
Relative poverty is the main form of poverty that occurs in developed countries
What are the causes of poverty?
BREH
Poor education and healthcare- poor access find it difficult to gain human capital, skills and productivity to access jobs in economy- trap them in poverty with very low incomes
Recession- labour is a derived demand. Economic growth= low- less need for labour increasing u/e. once more firms suffering from decrease in rev and less profitability- reduce workforce to compensate- lost income, decrease in sol in either absolute or relative poverty
Born into poverty
Lack of skills- occupational immobility of labour, low productivity
What are the consequences of poverty?
Low standards of living
Poverty traps- could be cyclical with low incomes depriving individuals of access to healthcare and education, keeping levels of human capital and skills low- prevents any increase in productivity trapping these individuals in a life of persistent low income.
Low incomes reduces savings- financial intermediaries don’t have funds to issue loans out to businesses for investment. Low investment- low econ growth ensuring low incomes – persistent poverty
What are the causes of income/wealth inequality?
ET SCAB
§ Education- more educated with school, college and university qualifications = higher incomes. In a capitalist economy compared to those with little education- given individuals paid according to productivity and how much rev they bring in for employer. The higher the skill level the higher the level of income. A country with a poor education system will see greater inequality than one with a good education system
§ One sector dominant and capital intensive production. If economy is highly specialised- output coming from one dominant sector, workers and capital owners in the specific industry benefit from higher incomes whereas rest of economy suffer widening income disparities
§ Globalisation and free movement of labour and trade- increase in inequality within developed countries. Immigration decreases wages of low skilled and low paid- increases pay of those on high salaries, trade liberalisation- increase in foreign comp—decreases ages of low skilled workers as firms look – reduce COP.
§ Technology- replaces various skills of workers redundant -reducing wages in those industries- pushing them into low paid, low skilled work but created niche sector requiring technical experience- high wages. Tech – sub increased profit potential of industries without needing employees, increasing incomes drastically in such professions widening income disparities (banking)
§ Ownership of financial assets and property- own financial assets = greater wealth than those who don’t have enough income to purchase such financial assets.
§ Corrupt governance- worsen income inequality by not re-distributing tax rev to help poor- transfer payments or spending on healthcare/ education- instead pocketing money themselves in hidden bank acc. May divert tax money to elite given voting powers of capital owners and large funding received for electoral campaign
Benefit system- Countries that provide a range of benefits (such as unemployment, disability, child support, housing support etc) raise the income of the lowest 20% of the population resulting in more equal distribution
Pension payments- State pension payments ensure a minimum standard of living for retirees resulting in a more equal distribution of income. Countries without it have a much higher percentage of pensioners living in poverty
Wage rates- The purpose of a national minimum wage is to improve the equity in the distribution of income. Without it, more households would be earning less & inequality would increase
Employment legislation- Generally, the more workers are protected by law, the better the income distribution in an economy e.g. maternity benefits ensure that new mothers have a higher level of income during the first months of leave after a birth
Asset ownership- Assets generate income. The more equal the asset ownership in an economy the less the inequality in income distribution. This was one reason why the UK government changed the law in 1980 allowing council house tenants the right to buy their property at a discounted rate. It is also a reason for the current shared ownership scheme
What are the causes of changes in relative and absolute poverty?
There has been a significant decrease in absolute poverty since 1990
There were 1.9 billion people in absolute poverty in 1990. By 2022 it had fallen to 750 million
Causes of changes in absolute poverty:
There is a strong correlation between economic growth & a decrease in absolute poverty
Economic growth increases household incomes
Government tax & benefit policies can support the most vulnerable groups in society e.g. children, pensioners, people stuck in long-term unemployment
In developed economies, benefit policies can ensure that no household is living in absolute poverty
Causes of changes in relative poverty:
Rising asset prices can decrease relative poverty in households which own their own properties
Asset prices often increase faster than wages or income
Trade liberalisation increases potential market size & output in an economy
This leads to an increase in the demand for labour & a wage rise
This creates additional income which has a multiplier effect & pulls households out of relative poverty
Decreased levels of government benefits can lower household income & increase relative poverty
What is income inequality and wealth inequality?
Income inequality refers to the unequal distribution (flow) of income to households i.e rent, wages, interest & profit
Wealth inequality refers to differences in the amount of assets that households own
What are the consequences of income inequality?
D, EG, SC, GC
High levels of debt - more income inequality - more individuals on lower end of income spectrum- will need to borrow to finance expenditures e.g, house, car. This is because free market does account for needs thus excluding poor from consumption – cannot afford market price. Excessive debt and risk taking by banks- create instability in financial system- increase chances of financial crisis and deep recession if loans cant be paid back.
§ Costs to the GOVT. Policies to deal with income inequality are very costly for gov = deal with social costs it causes- carries huge OC. If money had to be borrowed = taxes in future would have to rise. Indirect taxes, VAT, fuel duty go up to fund spending = regressive impacts hurt the poor contradicting intentions of policies. Cutting spending in other areas of economy e.g., education -negative impacts suffered by poor relying on these
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§ Social costs. Poverty brings many social issues e.g., higher crime rates, vandalism, rioting, mental health – greater pressure on Gov finances = negative externalities but also social breakdown of society - Greece for example
§ Lower economic growth- lower incomes= lower levels of education and health= reducing productivity= reducing potential econ growth- growth rates lower than what they could be
Those on lower incomes= higher MPC than rich= high MPS and thus more income inequality - greater share of income is held by a small proportion of wealthy population- wont translate into high levels of consumer spending as if that wealth was more equally distributed to those on lower incomes. Can’t build up stock of assets
What are causes of inequality between countries?
Some countries - held back by wars, droughts, famines and earthquakes. Certain social groups may have been excluded and marginalised.
Developed countries tend to favour each other when trading, negotiating etc. and this helps them to develop more than countries who are not involved in the agreements
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§ 50% of UK goods are imported from EU
What is the Lorenz curve? WITH DIAGRAM ANALYSIS
The Lorenz Curve is a visual representation of the inequality that exists between households in an economy
Data is commonly presented in quintiles (population divided into 5 groups i.e 20%) or deciles (population divided into 10 groups i.e 10%)
E.g. in 2021 42% of the income flow in the UK went to the top 20% of households while only 7% went to the bottom 20%
Perfect income distribution is not the goal (20 % of the population get 20% of the income; 40% get 40% percent of the income etc.)
That would equate to socialism & completely remove incentives for work as everyone would be paid equally
More equal income distribution is desired as it reduces poverty & social unrest
What constitutes acceptable income equality is a normative economic issue
DIAGRAM ANALYSIS:- GREEN LINE UK, RED LINE SWEDEN, INCOME DISTRIBTUON IN UK IS MORE UNEQUAL THAN THAT OF SWEDEN
The line of equality represents perfect income distribution (not desirable)
In the UK the bottom 20% of households receive 5% of the income flow while in Sweden they receive 9% of the income flow
In the UK the top 10% of households receive 45% of the income flow while in Sweden they receive 25%
Sweden has a more equal distribution of income than the UK
What is the gini coefficient?
THE BIGGER THE COEFFICIENT, THE MORE UNEQUAL THE COUNTRY.
The gini coefficient is calculated using the area beneath the line of equality
GINI COEFFICIENT= A / A+ B
A represents the area between the line of equality & the UK Lorenz curve
B represents the area under the Lorenz curve
A value of 0 represents absolute equality (socialism) & 1 represents perfect inequality
In 2022, the USA coefficient was .41 as compared with the UK value of .35
The distribution of income in the UK was more equitable than in the USA
What is the impact of economic change and development? WITH KUZNETS CURVE
Kuznets hypothesis says that as society develops and moves from agriculture to industry, inequality increases as the wages of industrial workers rises faster than farmers. Then, wealth is redistributed through taxation and GOVT spending and so inequality falls.
Industrialisation results in increased inequality as some workers move from the lower productivity, lower paid agricultural sector into the higher productivity manufacturing sector
There is now greater income inequality with the workers left behind
However, at some point, inequality starts to decrease
This is most likely due to government intervention/support funded by increased state tax revenue brought about as a result of the increased production in the economy
§ However, Piketty discredited this theory by arguing that inequality rises as the country develops as the rate of return on capital grows quicker than GDP, so the rich get richer and inequality increases. (between countries)
DIAGRAM ANALYSIS:
As a country changes sectors from primary (farming) to secondary (manufacturing), productivity increases & the per capita income increases
However, inequality is also increasing as the gap in wages between the primary & secondary sector is significant
At some point, the economy will reach a turning point of income where inequality begins to fall
This often occurs as the primary sector diminishes while the secondary & tertiary (services) sectors increase
Developed economies tend to generate more income from secondary & tertiary sectors
What is the significance of capitalism for inequality?
§ A capitalist economy leads to income inequality because of wage differentials. Wages vary as they are based on demand and supply, and demand and supply vary for different jobs.
§ Individuals also own resources and thus wealth differs based on the assets they own. Wealth can be passed on or gained through saving of incomes.
§ It is argued that equality can never be achieved in a capitalist society - possibility of having more is important to encourage hard work. Without the incentive to gain more, people will not try hard or take risks since they have no reason to= economy won’t grow; inequality is essential for capitalism to work. Boost productivity- labour increases- increase productive potential
§ A degree of inequality is necessary and desirable, but excessive inequality causes problems with efficiency and social justice. If everyone is in poverty- no incentive to improve situation and take risks
§ Lower taxes- increase investment- start-ups, entrepreneurship
The principles of capitalism are considered important as the incentive to acquire income raises productivity & output
The long-term cost of capitalism is that the factors of production become concentrated in ownership with relatively few individuals developing extreme wealth, at the expense of many who lose out
It has been argued that capitalism needs checks & balances to limit the income & wealth inequality that will naturally develop
This calls for government intervention
What are policies to redistribute income?
Transfer payments - redistribute income and provide different types of assistance to groups in economy to improve SOL. Support assistance, U/E benefits and payments to the disabled. Transfer payments prevent those unfortunate enough to have the skills needed to find work from living in extreme poverty and allows those who have children or who are disabled to maintain a decent SOL, increasing incomes for the poor and helping to close large disparities
Government spending on essential goods and services that socially desirable = positive externalities of consumption, such as health care, education, sanitation,water supplies- poorer members of the economy have access to essential goods and services increasing living standards. Policy would reduce income inequality by allowing the poor a means to inc skills, productivity = incomes
§ Evaluation. policies, cost gov large sums - funding would serve OC as gov has budget. If money had to be borrowed, taxes in future would rise, if regressive vat or fuel duty to go up to fund this spending. If gov funds these policies through cutting spending in other areas of economy such as public transport= neg impact could be suffered by poor
Government could implement or adjust progressive income taxation, increasing income taxes on those who earn salaries that place them In highest income tax bands using extra tax rev to finance transfer payments/ gov spending on health and ed= reduce disposable incomes for rich and inc incomes for poor = reducing income inequality
§ Evaluation- by inc taxation levels specifically for those who earn higher incomes, incentives in labour market could be distorted preventing entrepreneurial risk-taking activity to detriment of economy. The Laffer curve illustrates this
below ( Laffer - raising taxes on Rich - point where TRev decreases as tax rate inc - higher income tax = disincentive for workers to work for higher incomes as heavily taxed. The income effect becomes negative whereby workers work -earn less to reach satisfactory income = reducing income tax revenue. Higher taxes promotes tax evasion/ avoidance and incentivising the highly skilled workers/entrepreneurs to emigrate to countries where tax rates are lower. Not only will this reduce expected tax revenue for gov to use in redistributing income - dampen productive potential as innovation/ entrepreneurial spirit decreases)
A minimum wage -directly boost incomes of poorest in society. Gov imposing min wage at more equitable levels, producers are burdened without any damage made to gov’s fiscal position. Min wage set above equilibrium. With higher wages, those at the lower end of the income spectrum will be able to move out of relative poverty by improving both their material and non-material SOL- closing large income gap in a country
§ Evaluation- min wages can distort efficient labour market outcomes - cause u/e harming those supposed to protect. Low skills = difficult to find work at higher wage rate when their productivity isn’t enough for firms to justify employment at min wage. This could inc U/E, classical u/e = gap between rich and poor even worse
In theory these policies to redistribute income would shift the Lorenz curve to the left moving closer to the line of perfect equality= reduction in income inequality as seen below. This can be mathematically shown using the Gini coefficient which would move closer towards 0 indicating a smaller distance between the Lorenz curve and line of perfect equality; more equal distribution of income
What is the general evaluation of policies to redistribute income?
Where its set, gov position, dependency on benefits, is it a problem?
Whether or not policies like redistributive taxation can reduce income inequality depends on the level of income tax which tax is targeted
. If income taxes on higher earners are set too high disincentive effects = promoted where workers end up working less or moving country -not reduce inequality. S/R - may be quick rise in tax rev- workers adjust to higher tax rev- this policy likely to fail increasing revenue and not reduce inequality. If set too low there is no guarantee that enough revenue will be generated to fund transfer payment and spending on education and healthcare. If regressive taxes rise in L/T to fund spending related policies overtime income inequality may rise
The state of GOVT finances- If gov is suffering with high levels of debt and persistent budget deficits, its not viable to greatly inc transfer payment or spending on health & education = reduce income inequality. In fact, the reverse is likely to take place, welfare spending and health/ edu will be cut to reduce national debt, cuts that inc income inequality
Incentives. The temptation to reduce inequality is to raise direct taxes such as income tax– tax rich heavily and distributing money to the poor. Laffer’s criticism is of great significance here. Progressive taxation set at an efficient level which promotes work and risk-taking activity but also provide a large enough fiscal dividend for the gov - used to reduce income inequality. Gov should also beware of incentives created when increasing spending on U/E benefits or other transfer payment - may promote the welfare mentality and dependency rather than workers seeking to get out of relative poverty by finding work - dangerous L/T impact on govt finances and productive potential of economy
Does income inequality have to come down. Though income inequality has problems some amount of inequality is desirable. Provides strong incentives for those on lower incomes to gain education, skills, and qualifications to boost productivity and earn higher incomes whereas targeting low income inequality levels through excessive GOVT intervention can take away these- reducing productive capacity and L/R growth rates
