Inequality Flashcards
Please explain briefly, why intra-household inequality may be a source of bias in
survey-based estimates of inequality and state if the bias is positive or negative.
Inside the household in the survey-based estimates, people would sometime overvalue their income and undervalue their consumption, when they fill in the survey.
Men and women income is different reported. Men income is reported through labour, where women income in some countries i less reported due to work in agriculture, where the salary is not always reported. For example if it agriculture work for the use of the family. Unreported work.
- Labor markets tend to discriminate against women, paying them less than men for the same work. Combining the work done at home with that done for income, women tend to work many more hours per week.
So the result differs if you measure men and women or both.
Also depends on if you look at consumption or income.
Please explain how it is possible to argue that:
- Global inequality has increased from around 1980 to around 2000
- Global inequality has decreased from around 1980 to around 2000
- Global inequality has been roughly constant from around 1980 to around 2000
Milanovic work:
Based on concept 1, is the cross-country Mini-coefficient based on income per capita across countries, “whiteout” population weighting. In this method, smaller but richer countries can have a disproportionately large impact on the global inequality measure. So when we don’t control for population size small rich countries can have a large effect. Global inequality appears to have increased because the gap between the average incomes of countries widened, irrespective of their population sizes.
- Based on concept 2, I the cross-country Gini-coefficient based on income per capita across countries, "with" population weighting. This method gives more weight to populous countries like China and India, which saw significant economic growth during this period. The rapid economic development in these large countries lifted millions out of poverty and increased the average income levels, reducing overall global inequality when population size is considered. Global inequality appears to have decreased because the economic rise of populous nations like China and India significantly reduced the global income disparity when adjusted for population.
Based on concept 3, only have data from 1980 and forward. Is based on individual incomes. This approach provides a more granular view of income distribution by considering the incomes of all individuals, not just country averages. While some countries (notably China and India) saw significant poverty reduction and income growth, other regions, especially in Africa and parts of Latin America, did not experience comparable progress. The mixed outcomes across different regions balanced each other out, resulting in a roughly constant global inequality (Gini-coefficient).
Please explain how income inequality may affect the accumulation of physical
capital.
Some theories concluded that inequality might raise growth rates. By concentrating income in fewer hands, there might be more savings available to finance investments critical for physical capital accumulation. A classical theory (Kaldor 1957): Richer families have higher savings rates. Therefore, redistribution in favor of the rich (higher inequality) increases savings and thereby accumulation of physical capital.
On the other hand, When inequality is high, worthwhile investments may not be undertaken. Poor people may have promising investment opportunities. Buying a farm animal or improving irrigation, investing in a piece of equipment or building a store all may yield a good economic return. But the individuals or families may not undertake these investments because they cannot afford them. Credit market imperfections and the inability of the poor to offer lenders collateral lowers the amount of productive investment they engage in and leads to less economic growth and physical capital. If the economy had a more equal income distribution, more of these productive investments could be financed and pursued.
Please explain how income inequality may affect the accumulation of human capital.
We assume that we are in an economy where families invest in education for their children (inderectly in Denmark through taxes). If the economy is build, so poor families have a hard time getting a loan, due to e.g. credit market imperfections and fixed costs of investment in education, then poor families will underinvest in education (human capital) because they cannot borrow. We can conclude that income inequality in an ecnonomy with market failure may reduce the level of education in a society.
Please describe the difference between absolute and relative inequality
Absolute inequality measures the actual differences in income or wealth between individuals or groups. It focuses on the gap in dollar terms rather than proportions or ratios. It would be looking at if the gap in dollars between e.g. the middle class and the richest has increased in the last couple of years. The data would show, The serpent graph which have absolut real income gain on the y-axis, that there has been a sharp increase in absolute inequality.
Relative inequality is function of the rations of indvidual incomes to the mean. Implication, if all incomes are multiplied by a constant then inequality is unchanged. Therefore it focuses on the relative differences rather than absolute differences. e.g.
HH1: 1.000 DK to 2.000 DK
HH2: 10.000 DK to 20.000 DK
The rich households remains 10 times richer - But the relative inequality is unchanged, due to the ratio is the same. We have multiplied with a constant.
where absolute is different
Absolute difference has double has doubled, from 9.000 DK to 18.000 DK - absolute inequality has increased doubled.
Please explain how to easily test the poverty-inequality relationship. Comment on
the empirical relationship between:
a. Absolute Poverty and Absolute Inequality
b. Absolute Poverty and Relative Inequality
We want to test if there is an unconditional correlation between poverty and (absolute and relative) inequality. An unconditional correlation refers to the correlation between two variables without controlling for the influence of other variables.
We will use The Ravallion “trick”: Study the changes over time in both measures of poverty and inequality. We use fixed effects estimation.
- Assumption: controlling for “fixed effects” will adequately eliminate other country-specific influences.
Measures:
- Relative inequality - Gini index
- Absolute inequality - Gini index controlling for mean income or consumption (absolute Gini-index)
a. Absolute Poverty and Absolute Inequality
Negative Correlation: There is a negative correlation between changes in absolute poverty and absolute inequality. This means that as absolute poverty decrase, absolute inequality tends to increase.
Explanation: When absolute poverty is reduced, it often means that the incomes of the poorest segments of the population are rising. However, if the incomes of the richer segments also rise, this can lead to an increase in absolute inequality. Thus, lower absolute poverty can be associated with higher absolute inequality.
There is some evidence that lower absolute poverty correlates with higher absolute inequality, suggesting that as the poorest gain more income, the overall gap between the richest and the poorest can widen if the rich also gain substantially.
b. Absolute Poverty and Relative Inequality
Positive Correlation: There is a positive correlation between changes in absolute poverty and relative inequality. This means that as relative inequality increases, absolute poverty also tends to increase. Remember the example with the money and the to households, can easily be thought with absolute poverty.
Explanation: When relative inequality rises, it often indicates that the gap between the rich and the poor is widening. This can make it harder for those in poverty to improve their economic status, thereby maintaining or increasing absolute poverty levels.
No strong evidence supports the idea that changes in relative inequality are consistently associated with economic growth. This implies that simply growing the economy does not automatically reduce relative inequality.
Please discuss how global inequality has evolved over the period 1990-2010. Please draw on the
“elephant” and “serpent” graphs of Ravallion (2018) , reproduced in figure 1, for your answer.
This answer should be based mainly on Ravallion (2018), although an answer that draws on PRLB ch. 6
(namely figure 6-9) is also accepted. In the following, a model solution for an answer based on Ravallion
(2018) is provided.
Ravallion shows a figure of total global inequality, i.e. a Theil measure of individual-level relative
inequality for the period of 1990-2010. This measure has declined, especially since 2000. Total global inequality can be decomposed into inequality between countries and inequality within countries.
The majority of total global inequality stems from inequality between countries. The decline in total
global inequality is driven by a decrease in inequality between countries.
The “elephant graph” of figure 1a is a so-called growth-incidence curve. The curve shows the real income
change in percent for the period 1988-2008 for different percentiles of the global income distribution.
The figure shows that income gains were particularly high for the middle class of the developing world
(around the 50th and 60th percentile) as well as for the very top of the global income distribution.
However, growth rates were lower for the poorest part of the global income distribution and almost zero
for the the world’s upper-middle class (around the 80th percentile). This uneven growth across the
income distribution means that the Lorenz curves for 1988 and 2008 intersect internally. Therefore,
while the Theil measure of Ravallion’s figure 1, as well as a gini measure, shows a decrease in inequality.
The “serpent graph” of figure 1b is also a growth-incidence curve. However, the y-axis now shows
absolute income growth over the period of 1988-2008. It becomes clear, that the top part of the income
distribution had the largest absolute gains in income. Therefore, it is not surprising that measures of
absolute inequality, i.e. measures where the relative income principle is done away with, have been
increasing over this period.
Outline the Kuznets Curve
The Kuznets Curve Explained
Concept: Simon Kuznets, in the 1950s and 1960s, analyzed inequality data across both developing and developed countries.
Observation: Inequality tends to rise with economic development initially and then decreases as countries become wealthier, forming an inverted U-shape curve.
Hypothesis: As countries develop:
Initial Stage: Inequality increases. This is because the economy is transitioning from agriculture to industry. Wealth generation in the industrial sector often leads to greater income disparities.
Later Stage: Inequality decreases. Over time, more people benefit from economic growth, access to education improves, and wealth becomes more evenly distributed.
But many have tested the curve and doomed it.
What can we take from the kuznets curve?
- Two Links
a) Growth -> Distribution:
Kuznets Curve: This concept suggests that as a country develops economically, inequality first increases and then decreases, following an inverted U-shaped curve.
Growth-Oriented Strategies: Policies that focus on economic growth with the belief that initial inequality will eventually decrease as the country becomes wealthier.
b) Distribution -> Growth:
Inequality and Growth Regressions: Studies from the 1990s and early 2000s show that higher inequality can negatively affect economic growth. This is because unequal societies may have less social cohesion, lower levels of investment in human capital, and more political instability.
Equity Objectives in Development: Emphasizing equitable distribution of resources and opportunities can support sustainable growth. Policies aimed at reducing inequality can promote economic stability and growth.
Soooo,
Institutional Perspectives
Inclusive Growth and Development: Institutions like the World Bank (WB), International Monetary Fund (IMF), and the World Economic Forum advocate for policies that promote inclusive growth and shared prosperity. They emphasize the need to address inequality to achieve sustainable development.
E.g. Reduce Inequality: SDG (verdensmål) #10 aims to reduce inequality within and among countries. This goal aligns with the idea that equitable development is crucial for long-term prosperity and social stability.
Please explain how data for measurement of inequality is gathered in the developing world and discuss possible data problems.
Solution guide.
1. The data gathering and data issues are discussed in Ravallion (2018), section 3. Data is collected
using household surveys. Ravallion writes “[A]lmost all household surveys use personal interviews. The household data refer to either consumption expenditure or disposable income, as reported by respondents for stipulated (often rather short) recall periods. Standard practice by statistics offices is to use a survey instrument that can cover all income sources and/or market
goods and services consumed, including imputed values for consumption from own production,
as is important for farm households.” The main problems listed in sections 3 of Ravallion
(2018) are
a. Selective non-compliance by rich households and/or under-reporting of consumption and income by rich households. The effect of such problems are theoretically uncertain,
but in practice they seem to be associated with under estimation of the inequality (a negative bias).
b. Household surveys assume equality of income and consumption within households (household income is divided by the number of household members to get per capita
income/consumption). Ravallion states that this is “almost certainly wrong, and the direction of bias is clear: we will underestimate overall inequality”.
c. Finally, there is an issue with prices. “Differences in prices between countries are dealt
with using purchasing power parity (PPP) rates of exchange. Since price levels tend to be higher in richer countries (…), using PPPs rather than official exchange rates tends to
reduce the level of inequality between countries.” Further, “[I]t is not common to include deflators for geographic cost-of-living differences within counties. Within-country
inequality is likely to be overestimated due to this omission.” (Students need not know
the within country price-problem).
Please give a brief summary of the main theories explaining how income inequality affects
economic growth.
The links between inequality and economic growth are described in PRLB chapter 6, Weil
chapter 13 and Berg et al. (2018). There are 5 explicit links from inequality to economic growth
of which only 4 are covered in detail in PRLB and Weil:
a. Following Weil (p. 400), more inequality leads to a higher level of physical capital accumulation. The reason is that more inequality leads to higher total savings because
individuals’ savings rates tend to rise with income. Hence, this link relates high inequality to high growth.
b. A more unequal distribution of income leads to lower human capital accumulation. An important reason is that human capital is embodied (installed in a specific person).
Consequently, human capital cannot be used as collateral, leading to a missing (financial) capital market. Therefore, poor people have to fund educational choices out of retained earnings, wealth or abstention from currently productive work. Because they are poor the marginal cost of doing so may be prohibitively high, exceeding the marginal
return. In the end, poorer people underinvest in human capital, leading to lower total human capital accumulation in economies with more unequal income distribution. This link relates high inequality to low growth.
c. A more unequal distribution of income may also lead to crime and risk of violent conflicts (sociopolitical unrest). The risk of destruction of output and loss of ownership
of capital implies lower expected return on investment. This leads to lower capital accumulation even without actual conflict. This link relates high inequality to low
growth.
d. In Weil p. 404-405 it is explained how inequality leads to a desire for redistribution. This comes about because an individual with pretax income above the mean would prefer a redistributive tax rate of zero while individuals with pretax income below the mean will want a positive tax rate. The specific desired tax rate will be higher for individuals with lower pretax income. The tax rate in a country is assumed determined by a political process involving voting. Thus, the tax rate in the country will be the rate that is optimal for the voter with the median level of pretax income (the median voter). A higher tax rate may have negative effects on economic growth for two reasons: (1) lower capital accumulation if taxes are imposed on the margin, and (2) lower efficiency, as explained in Weil p. 406. The overall outcome of the model with political redistribution is that higher pretax inequality leads to lower economic growth.
e. Berg et al. (2018) mentions a link between inequality and growth through an effect of inequality on fertility (the quality/quantity relation). This link relates high inequality to
low growth. Students are not expected to explain this link as it is not well described in the texts.
The table below (covering 2 pages) is Table 4 from Berg, Ostry, Tsangarides and
Yakshilikov,“Redistribution, inequality, and growth: new evidence”, J Econ Growth (2018)
23:259–305.
Please relate the results in the table to the main theories given in Problem B2, and discuss the
extent to which the theories are supported or refuted by the empirical findings.
Table 4 presents several sets of regressions of inequality (measured by the Gini-coefficient) on GDP growth (regressions (1)-(6)) and on the channels through which inequality is expected to affect growth (regressions (7)-(12)).
a. Regression (1) estimates the impact of investment (investment/GDP) on growth, when
also controlling for inequality and redistribution, while regression (7) estimates the impact of inequality and redistribution on investment. It is somewhat surprising that investment only has a weakly significant impact on growth (albeit the effect is more precisely estimated in regressions (2)-(6)). Further, inequality and redistribution does not appear to influence investment, whereby Berg et al. do not find support for the classical
link given in B2a. Moreover, there is no support for the investment part of the redistribution link given in B2d. One explanation could be that the influences on capital
accumulation (savings, political unrest and redistribution) cancel each other out in the
sample.
b. The human capital link is estimated in regressions (2), (9) and (10). Neither education nor life expectancy appear to have statistically significant effects on growth, conditional on inequality and redistribution. However, inequality has a statistically significant, negative impact on both education and life expectancy, leading Berg et al. to conclude that this is an important channel through which inequality affects growth.
c. Berg et al. argue that they find some support for the socioeconomic unrest theory as inequality has a negative impact on political institutions (measured by the variable “polity”). However, polity appears not to have a statistically significant effect on growth. Hence, as for the human capital link, the first part of the link can be established, but the second part cannot—in the regressions presented in the paper.
Overall, the empirical support for the individual theories linking inequality and growth is not as clear as one could wish for.
Please give an overview of why inequality is considered to be important for development.
Several reasons why inequality is important has been discussed during the course. The most important
are:
Inequality matters for poverty. This discussion should be based mainly on PRLB ch. 6. It is also discussed
in Ravallion (2018). Keeping the average income level constant (i.e. in the absence of economic growth),
an increase in inequality will result in an increase in poverty. Likewise, if economic inequality is constant
and the average income level increases, poverty will decline.
Inequality matters for social welfare. This discussion should be based on Jones and Klenow (2016).1
Using a framework of expected utility, Jones and Klenow show how inequality in a country plays a role in
the expected utility of citizens of that country. The reason is that Jones and Klenow assume that marginal
utility is declining in income. Therefore, a high level of inequality reduces expected utility, since the
(expected) disutility from low income is higher than the (expected) utility from having a high income.
Inequality matters for economic growth. This discussion should be based mainly on Weil ch. 13. There
are several channels through which inequality can affect economic growth. A good answer should
mention several of these. The channels include:
* Through savings and investment. Richer families are thought to have higher savings rates. This
implies that higher inequality leads to higher savings. If savings are identical to investment, this
leads to higher levels of capital, which, in a standard Solow model, leads to higher levels of
output.
* Through investments in human capital. For low quantities of investment, the returns to human
capital may be higher than the returns to physical capital. If human capital is not transferrable,
lowering inequality may increase investments in human capital. This will then lead to an increase
in output. This can be thought of as a gain from allocative efficiency.
* Through income redistribution. High levels of inequality may increase the political need for
redistribution through taxation. However, taxation distorts incentives, which reduces growth.
* Through sociopolitical unrest. High levels of inequality may increase sociopolitical unrest. The
risk of destruction of output and loss of capital ownership reduces expected investment returns,
which lower investments. This reduces output.
Through intergenerational mobility. When parents material circumstances are important for
opportunities of their children, higher inequality reduces growth, since the potential of some
children will be wasted. This is also discussed in Aiyar & Ebeke (2019).2
* Finally, we note that economic growth and development are not necessarily identical.
Nonetheless, there is often a high degree of correlation between other indicators of
development and the level of e.g. GDP. Therefore, when inequality matters for growth, it also
matters for development.
Please explain briefly, why intra-household inequality may be a source of bias in estimates of
inequality and state if the bias is positive or negative.
This is explained in Ravallion (2018). Household surveys assume equality of income and
consumption within households (household income is divided by the number of household
members to get per capita income/consumption). Ravallion states that this is “almost certainly
wrong because, and the direction of bias is clear: we will underestimate overall inequality”.
Please provide an argument for why income inequality may affect growth and future income levels
negatively.
Weil describes several channels for why income inequality may be harmful to growth. Here, a model
answer using redistribution is provided:
High levels of inequality can lead to a high demand for taxes and transfers that aim to decrease
inequality. Taxes can reduce efficiency because they distort incentives; in particular, they reduce labour
supply. Further, tax-payers may take costly actions to try to avoid paying taxes. Both channels reduce
economic efficiency, and reduces income levels.
