Chapter 29 - Income distribution and welfare Flashcards
What is income?
The flow of wages, salaries and earnings from other sources in a period.
What is wealth?
The stock of accumulated assets
What is income distribution?
The way in which national income is distributed among the population of a country
What is wealth distribution?
The way in which the nation’s wealth is distributed among the population of a country
What is the policy objective of a more even distribution of income?
Inequality in the distribution of income and wealth may be significant in society if it becomes excessive, or if there are households and individuals who become vulnerable because of low income and/or wealth. A sense of social justice suggests that the vulnerable groups in society should be protected and assured of a reasonable level of welfare.
In the UK, the government affects the distribution of income through the use of taxation and transfer payments that help to provide some social security for vulnerable groups. Taxation and government spending cannot be treated in isolation from other policies being implemented at the macroeconomic level.
Inequality in income and wealth is an issue at the macroeconomic level partly because there may be a link between the degree of inequality in society and the rate of economic growth.
The distribution of income may become especially significant for some less developed countries (LDCs), where the need to address concerns about extreme poverty and provide for the basic needs of society may have a high priority. One of the problems with this is that there may be a Catch-22 situation, in which economic growth is impeded by the existence of extreme poverty, but extreme poverty cannot be tackled until economic growth has taken place. The government then faces a difficult dilemma: should the focus of policy be on alleviating poverty in order to enable economic growth, or should it be to promote economic growth in order to have the resources to tackle poverty?
Inequality is not only of concern to LDCs. In the advanced countries, there is still unrest that arises from the existence of inequality between groups, or between regions within a country. Dealing with this by redistributing resources may have an opportunity cost in diverting resources from other priorities. Furthermore, taxing the rich heavily in order to divert resources to the poor may affect the incentives for high-paid workers.
What is the Lorenz curve?
A graphical way of depicting the distribution of income within a country
To interpret the country curves, the closer a country’s Lorenz curve is to the diagonal equality line, the more equal is the distribution. You can see from the figure that Norway comes closest to the equality line, bearing out the earlier conclusion that income is more equally distributed in that country. The UK and the US curves are closer together, but there seems to be slightly more inequality in the USA, as its Lorenz curve is further from the equality line. Brazil has also been included on the figure, as an example of a society in which there is substantial inequality.
What is the Gini coefficient?
A measure of the degree of inequality in a society.
In published data, the Gini coefficient is expressed as a percentage (i.e. multiplied by 100). The closer the Gini coefficient is to 100, the further the Lorenz curve is from equality, and the more unequal is the income distribution.
What is absolute poverty?
Situation of a household whose income is insufficient to purchase the minimum bundle of goods and services needed for survival
What is relative poverty?
Situation in which household income falls below 60% of median adjusted household income in a country
What is headcount ratio?
A measure of the percentage of a country’s population living below a poverty line
What is the International Poverty Line?
An agreed measure that defines the absolute poverty line based on international prices, set at PPP$1.90 from October 2015
What is persistent poverty?
Where a household is currently in relative income poverty and has also been in this state in at least 2 of the preceding 3 years
How does the distribution of wealth cause inequality and poverty?
Perhaps the most obvious way in which inequality in wealth and the ownership of assets influences inequality and its changes through time is through inheritance. Wealth that accumulates in a family over time and is then passed down to succeeding generations constitutes a source of inequality that does not arise from the current state of the economy or the operations of markets.
Notice that, although wealth and income are not the same thing, inequality in wealth can lead to inequality in income, as wealth (the ownership of assets) creates an income flow - from interest, rents and profits - which then feeds back into a household’s income stream.
A significant change in the pattern of ownership of assets in recent decades has been the increase in home ownership and the rise in house prices. For those who continue to rent their homes, and in particular for those who rent council dwellings, this is a significant source of rising inequality.
For developing countries, there is also considerable inequality in the distribution of ownership of assets. Financial markets in developing countries are much less well developed than in developed countries, and many people, especially in the rural areas, do not have access to the formal financial institutions. This inevitably means a concentration in the ownership of financial assets. Furthermore, the ownership of land is highly concentrated in some countries. This is notably the case in much of Latin America, and has contributed to the relatively high levels of inequality that have characterised that region. The situation is further complicated by the fact that property rights are weak in many developing countries, so that even if a household has farmed a piece of land for generations, it may not be able to demonstrate ownership rights over that land. Such inequality in the ownership of assets leads also to inequality in income distribution.
How does the labour market cause inequality and poverty?
There are several ways in which the labour market is expected to give rise to inequalities in earnings. Inequality could arise from demand and supply conditions in labour markets, which respond to changes in the pattern of consumer demand for goods and services, and changes in international comparative advantage between countries. Furthermore, differences in the balance between economic rent and transfer earnings in different occupations and economic sectors reinforce income inequalities.
However, a by-product of changes in the structure of the economy may be rising inequality between certain groups in society. For example, if there is a change in the structure of employment away from unskilled jobs towards occupations that require a higher level of skills and qualifications, then this could lead to an increase in inequality, with those workers who lack the skills to adapt to changing labour market conditions being disadvantaged by the changes taking place. In other words, if the premium that employers are prepared to pay in order to hire skilled or well-qualified workers rises as a result of changing technology in the workplace, then those without those skills are likely to suffer.
The decline in the power of the trade unions may have contributed to the situation, as low-paid workers may find that their unions are less likely to be able to offer employment protection. It has been argued that this is a good thing if it increases the flexibility of the labour market. However, again a balance is needed between worker protection and having free and flexible markets.
The difference in earnings between female and male workers has also been highlighted. In the UK, female workers on average earn 16.8% lower wages than males (based on the male median wage). This is a smaller gap than in the USA, where females receive wages 18.1% below males. However, this is a much greater gap than in some other countries such as Italy (5.6%) and Denmark (5.8%). Research by the Institute for Fiscal Studies showed that the wage gap in the UK has fallen for female workers whose highest educational attainment was at GCSE level, but has remained more or less constant for women with A Levels or degree- level qualifications since the 1990s. Some of the earnings differences between men and women can be explained by the fact that when women have to take time out from working to look after children, they lose human capital by missing out on work experience. However, such market explanations may not suffice to explain all the differences in earnings that are observed.
How does demographic change cause inequality and poverty?
A feature of many developed countries in recent years has been a change in the age structure of the population. Improved medical drugs and treatments have meant that people are living longer, and this has combined with low fertility rates to bring about an increase in the proportion of the population who are in the older age groups. This has put pressure on the provision of pensions, and increased the vulnerability of this group in society. State pensions have been funded primarily by the contributions of those in work, but if the number of people of working age falls as a proportion of the whole population, then this funding stream comes under pressure.
How does government intervention cause inequality and poverty?
There are a number of ways in which government intervention influences the distribution of income in a society, although not all of these interventions are expressly intended to do so. Most prominent is the range of transfer payments and taxation that has been implemented. Another example is minimum wage legislation, which was also intended to protect the poor. Overall, these measures have a large effect on income distribution.
What are the consequences of poverty and inequality?
It could be argued that some inequality is inevitable within a free market, capitalist society. Indeed, it could be argued that without some inequality, capitalism could not operate, as it is the pursuit of gain that provides firms with the incentive to maximise profits, workers with the incentive to provide labour effort, and consumers with the incentive to maximise their utility. It is the combination of these efforts by economic agents that leads to good resource allocation, through the working of Adam Smith’s ‘invisible hand’. In a world in which every individual was guaranteed the same income as everyone else, there would be no incentive for anyone to strive to do better. However, few would argue for this. More important is that there should be equality of opportunity.
The consequences of high levels of poverty are severe. People living in absolute poverty are likely to face inadequate nutrition, poor health and little access to education. They can then be trapped in a vicious cycle: without good health and education they cannot obtain earning opportunities, and cannot escape from poverty. From society’s point of view, this means that the country’s potential labour force is not being fully utilised, which hinders economic growth.
The real dilemma for society concerns how much inequality and poverty can be tolerated. The balance between protecting the vulnerable and providing opportunities and incentives for social and economic improvement is difficult to resolve. This reflects the fact that different people take different viewpoints on the matter so that a consensus is hard to achieve. When we consider the global inequity in the distribution of resources, the dilemma is even greater.
What is the impact of economic growth on inequality?
Weak institutions and poor governance in developing countries mean that measures such as taxation and transfers to influence the distribution of income are largely untried or ineffective. The economist and Nobel laureate Simon Kuznets argued that there is expected to be a relationship between the degree of inequality in the income distribution and the level of development that a country has achieved. He claimed that in the early stages of economic development, income is fairly equally distributed, with everyone living at a relatively low income level.
However, as development begins to take off, there will be some individuals at the forefront of enterprise and development, and their incomes will rise more rapidly. So in this middle phase the income distribution will tend to worsen. At a later stage of development, society will eventually be able to afford to redistribute income to protect the poor, and all will begin to share in the benefits of development.
What are the weaknesses in the Kuznets hypothesis?
One reason why the empirical support for the Kuznets hypothesis is rather weak is that the relationship may not show up clearly in cross-section data - in other words, when the evidence is based on looking at how the relationship varies across countries at a single point in time. Looking at how the relationship changes through time for individual countries (known as time-series data) might be more revealing, but unfortunately, data on inequality are expensive to compile and are not collected on a regular basis.
It is also worth noting that there are substantial regional variations in the degree of inequality. Latin America has been known for wide inequality between groups in society, whereas eastern Europe has shown much lower levels of inequality, partly because inequality was low across the Soviet bloc. This may also conceal the underlying Kuznets relationship.
