Lecture 3: Inequality Flashcards
Elephant Curve
By Milanovic (2013). Illustrates changes in real income growth at various percentiles of the gloabl income distribution, between 1988 and 2008. The curve shows significant income gains for the global middle class (especially Asia) and the top 1%, but stagnation or minimal gains for the lower middle class in developed countries and the poorest segments globally.
See notes for picture!!!
How is inequality data obtained in the developing world and what issues is related to this?
Data is always survey based, why the quality is based on the response complience. Several issues arises in this context, among others are under or miss-reporting. Can lead to biased measures of inequality
The four fundamental principles
- The anonymity principle: it does not matter who is earning the income
- Entails that we can sort consumption levels (or what ever measure) - The population principle: size doesn’t matter
- Means that we can scale the first-axis by total population; to get population shares - The relative income principle or “scale independence axiom”(SIA): size really doesn’t matter
- Means that we can scale the second axis, consumption fx., by total consumption; to get consumption shares - The transfer principle (Dalton or Pigou-Dalton): a transfer from a poorer individual to a richer individual will increase the inequality
If all four are satisfied then a measure is Lorenz consistent
Lorenz curve
Respresents distribution of income or wealth, with a 45 degree line: the line of inequality, indicating perfect equality where each cumulative percentage of recipients receives the same cumulative percentage of income.
The Lorenz Curve furthest away from the line of equality indicates greater inequality
First degree Lorenz dominance: curves do not cross. Indicates clear dominance in terms of inequality comparison
Crossing curves are a mess to compare: not clear which has lower or higher inequality
Kuznets ratio or curve (PRLB ch. 6)
Income of x% richest / income of y% poorest.
Does not include whole distribution, and fail Dalton principle –> not Lorenz consistent.
A higher ratio means greater income inequality, while a lower ratio indicates less income inequality, suggestin a more even distribution on income
Curve
- inverted U-shape: The hypothesis behind the curve is that as a country develops and income pr capita rises, the income inequality will first rise and then fall
No empirical evidence for this curve!
Gini Coefficient
A measure of statistical dispersion inteded to represent the income or wealth distribution of a nation.
Ranges from 0 (perfect equality) to 1 (perfect inequality)
G = A/(A+B)
- measure the distance from perfect equality (45-degree line)
Theil index
Used by Milanovic. Decomposes inequality into class (within country inequality) and location (between country inequality).
Ranges 0 (perfect equality) to higher values (greater inequality).
Includes whole distribution.
Satisfies all four fundamental principles –> Lorenz consistent
Relative vs. absolute inequality
Relative inequality is a function of the ratios of individual incomes to the mean.
- Implication: if all incomes are multiplied by a constant then inequality is is unchanged
Absolute inequality: depends on the absolute differences in levels of living, rather than relative differences
- Implication: the measure is unchanged if all incomes increase by the same amount
Concepts are important: considering relative or absolute inequality is crucial in terms of the tradeoff between poverty and inequality
Milanovic (2013): Cross country and global inequality
Considers historical trends, recent changes and the implications of the patterns. The study spans from the industrial revolution to present (2013), focusing on the globalization from late 1980s to 2010s, and the winners (top 1% and middle classes of emerging economies) and losers (poorest 5% and upper middle class) of this.
Global inequality trends:
Significant deadline in global inequality from late 1980s to 2010s, which is a period characterized by increased convergence in mean incomes between countries
- So lower inequality between countries
- This was the first decline in global inequality since the industrial revolution, driven largely by rapid economic growth in countries like China and India
Concepts of inequality
1. Inequality between nations based on GDP or mean incomes without considering population size (weighting)
2. Similar to 1, but accounts for population size (weighting)
3. Inequality among individuals, based on individual incomes. Measures global inequality.
Elephant curve.
Class to location (decomposing inequality using Theil index
Inequality around the world
Advanced economies:
US has had high income inequality for a long time (lower around post war, probably effect thereof)
- Gini index of around 0,4
Evolution of inequality in English speaking countries follows U-shape: 10-20% in 1920s, 5-10% in 1980s and 10-20% in 2014 again
Evolution of inequality in continental Europe and Japan follows L-shape: generally strikingly higher in 1900-1920 at around 17-27%, to lower in 2014 at around 5-10%
Developing economies:
- Varying inequality, but also high levels
Inequality-growth link
Inequality, physical capital accumulation and growth
- A classical theory: richer families have higher savings rates. Therefore, redistribution in favor of the rich increases savings and thereby accumulation of physical capital, yielding growth.
Inequality, human capital and growth
- Human capital is not transferable. If accumulation of human capital is costly – and we have capital market imperfections or restrictions – then poorer people will underinvest in human capital, entailing even more inequality, which is a limiting factor for economic growth
Inequality, political redistribution and growth
- A modern political economy model: inequality leads to desire for redistribution by the median voter. The redistribution, that is distortionary taxes, lowers investment and thus growth.
Inequality, capital markets and development
- Capital market imperfections have a negative effect on the poorest people they underinvest in human capital higher inequality and les growth.
Ravallion (2005)
Examines whether developing countries face a trade-off between poverty reduction and inequality, which suggests that policies aimed at reducing poverty might inadvertently increase inequality and vice versa.
Focus on absolute poverty
Conclusion:
- No tradeoff between absolute poverty and relative inequality. According to Ravallion reductions in poverty often coincides with reduction in inequality
- Tradeoff between absolute poverty and absolute inequality. This indicates that reducing the absolute income gap might result in lower absolute levels of living for the poor
The Ravallion trick
The Ravallion trick defines the relative Gini as we know it: G = A/(A+B), and the absolute Gini,
G* = relative Gini times mean income (or consumption). In this way it is possible to study the possible correlation between poverty and inequality over time. Thus, the change in relative poverty can be measured as the changes in the relative Gini and the absolute changes in poverty is measurable by the absolute change in the Gini-coefficient plus the absolute changes in the mean income (or consumption).
By using this trick Ravallion concludes that there is no sign of tradeoff between absolute poverty and relative inequality but that there is a tradeoff between absolute poverty and absolute inequality (if absolute poverty declines, then the poor are worse off). Ravallion states, that knowing this, it is not possible to fulfill all SDGs because of a systematic flaw in the design, which ultimately means that there has to be chosen between absolute poverty and relative inequality.
