Economics B > Theme 3, 3.6 Inequality and Redistribution > Flashcards
Theme 3, 3.6 Inequality and Redistribution Flashcards
Define absolute poverty
Means severe deprivation which makes it a struggle to survive
Define Relative Poverty
Means not being able to live the lifestyle which is normal for the society.
Define Lorenz Curve
Is a visual indicator of inequality or incomes (or wealth), showing households ranked by income level plotted against cumulative share of total income (or wealth).
Define Gini coefficient.
Measures inequality using the shape of the Lorenze curve. A more even distribution produces a lower coefficient. The coefficient will be a ratio between zero and one. Mathematical indicator.
Define HDI
Human Development Index has become the most widely used measure for communicating a country’s development status. HDI is a broad measure of development, since it captures the level of per capita income but also incorporates measure of health ( lief expectancy) and education ( school enrolment and literacy rate).
Define Non-Governmental Organisations (NGOs)
Many NGO’s are formed specifically to help developing countries. The emergency relief work of Medicins Sans Frontieres and the Red Cross, for example, saves lives and meets immediate needs at times of crisis. This is a valuable short term response for people who suddenly lose their homes and livelihoods. Oxfam and Save the Children similarly help in times of disaster but also target long term development, often working with local communities. Plan international, for example, places a heavy emphasis on education and working with children to promote long term development.Its ‘because I am a girl’ project has more than 500 local programmes and hopes to develop role models, leaders and heroines for the future.
Define International Aid
International aid may come as a loan or a grant. It may be bilateral ( gov to gov) or multilateral (UN, World Bank or other agency to gov), or come from an NGO. All these profess to help those most in need.
Define Dysfunctional Society
Is one without the shared values and code of conduct to function effectively in the pursuit of its objectives.
Define Economic agents
An entity in economic activity. This activity can be buying, selling or producing goods and services and influencing markets. There are 4 main types of economic agents: households, businesses, governments and central banks.
Define Stock
Stock measurements count something, such as wealth, at one specified time.
Define Flow
Anything measured over a period of time, such as income, is measured as a flow.
Define Tax evasion
Evasion means using illegal means and risking punishment.
Define Tax avoidance
Avoidance is legal without always being ethical.
Define Tax credits
Are paid to working families whose pay is low; it ensures that they are always better off working than they are when unemployed.
What are the two measures of poverty?
- Human Poverty Index (HPI)
- Lorenz curve and Gini coefficient
What is the difference between HPI-1 and HPI-2?
HPI-1 measures poverty in developing countries, HPI-2 measures poverty in developed countries.
What 3 factors does the HPI take into account?
- Life expectancy
- Education
- Ability of citizens to meet basic needs.
How does the Lorenz curve differ from the line of perfect equality?
The line of perfect equality shows a utopian economy, whereas the Lorenz curve shows a realistic relationship of income distribution.
What does the Gini coefficient show.
Gives this a numerical value showing the inequality in a country.
Formula for Gini coefficient
Gini= A / (A+B)
What does a value of 0 indicate in the Gini coefficient?
Perfect equality
How does economic growth differ to economic development?
Economic growth refers to an increase in GDP, whereas the latter refers to an improvement in living standards and life expectancy.
Which country has Africa received the most aid from?
China
How can FDI help reduce poverty?
It creates employment in the area where the businesses are set up, thus providing citizens with more income.
What are microfinance schemes ?
This involves borrowing small amounts of money to fund new enterprises.
Who are the usual recipients of microloans?
People who don’t have a suitable credit score for a loan from the bank.
How would inequality motivate workers?
It would encourage them to work harder, become more productive and gain a higher wage rate.
How are monopolies linked to inequality?
Monopolies have the market power to exploit consumers by charging higher prices, thus increasing profits for big firms but leaving consumers with less income as a result.
How can government intervention help reduce wealth inequality?
By changing inheritance taxes, the upper class keep less of their wealth, thus reducing the inequality gap.
Give one social cost of inequality?
Social unrest
Describe the difference between wealth and income
Wealth is a stock of assets, whereas income is money received on a periodic basis.
What is the Poverty Trap?
A mechanism which forces people to remain in poverty.
How could taxes become a poverty trap?
If income taxes are too high, workers may be demotivated to work longer hours as they know they’ll receive the same income once taxes are deducted.
Describe a progressive tax
When the tax rate increases as income increases.
How does negative income tax differ from conventional income tax?
Negative income tax is when a worker earns below a certain income level, so instead of paying taxes the government gives them money.
How can we measure poverty and inequality?: Absolute and relative poverty (Basic human needs)
Poverty seems to be a simple concept, but it can have alternative meanings in different contexts. Absolute
poverty is concerned with living in conditions which make it hard to survive. The United Nations definition
is “a condition characterised by severe deprivation of basic human needs, including food, safe drinking
water, sanitation facilities, health, shelter, education and information.” This might seem ponderous, but it
is thought provoking. Besides the ‘basic human needs’ which are obvious essentials, it adds education and
information as indicators that part of the problem is the inability of the absolute poor to escape the situation
they are in.
Relative poverty means not being able to participate in a ‘normal’ life by the standards of society. This is
a trickier concept, but everyone else having such luxuries as holidays and mobile phones means that the
relatively poor are those who are ‘excluded’ because they cannot afford such things. As a rule of thumb,
anything below 60% of median income is defined as relative poverty
Whilst absolute poverty is rare in the UK, there are people who struggle to meet basic needs. Besides rough
sleepers with no home, Shelter estimates that the number of households in temporary accommodation
fluctuates around 60,000 from year to year. More than two thirds of these are households with children.
There are many families missing meals when they have no money for food and many more with limited
diets. The Trussell Trust reports that more than a million three day food packs were distributed from food
banks in the 2014-15 financial year. There were 56 UK food banks in 2009 but this grew to 445 in 2014.
Food insecurity, uncertainty about having food to eat, has become a widespread problem.
How can we measure poverty and inequality?: Absolute and relative poverty (Child poverty)
Poverty has dietary implications beyond the obvious limit to spending on food. If, say, power bills are unpaid
so supplies are cut off, heating food can become an issue. The psychological impact of poverty is also
unhealthy and adds to both physical and mental health problems. People living in the poorest areas have
lower life expectancy. A downward spiral to despondency and despair can leave people feeling incapable
of changing the situation. Poverty can be particularly difficult for parents struggling to meet the needs of
their children. Early chapters of ‘This Boy’, by Alan Johnson, paint a vivid sample picture of poverty in
London 50 years ago.
UNICEF estimate that globally around 22,000 children a day die from causes related to poverty. Resistance
to diseases is stripped away by malnutrition. Children “die quietly in some of the poorest villages on earth,
far removed from the scrutiny and the conscience of the world. Being meek and weak in life makes these
dying multitudes even more invisible in death” (Globalissues.org). Such situations need not continue
indefinitely. Improvement is possible. By one measure, China’s poverty rate fell from 85% to 15.9% in
40 years.
How can we measure poverty and inequality?: Measures of poverty: the UK (Setting standards)
Successive UK governments have sought to tackle and even eradicate child poverty. Until 2015, the 60%
of median household income was the accepted benchmark. Minister Ian Duncan Smith described this
approach as ‘deeply flawed’ in July, 2015, and announced a change to a range of indicators such as exam
results, workless households, family breakdown, debt and drug and alcohol dependency. Precisely how this
system will work is not currently clear.
This change was announced days after figures using the 60% of median income approach showed an
increase in child poverty from 2.3 to 2.5 million and the four UK Children’s Commissioners warned that
child poverty in Britain was “unacceptably high”. Organisations concerned with child poverty opposed the
change.
As another approach to relative poverty, The Joseph Rowntree Foundation had developed its MIS (Minimum
Income Standard). This surveys what is seen as necessary for a normal UK life and then looks at the income
needed to finance it. Besides obvious items such as rent, food and fuel for heating, this includes less essential items such as motoring costs for a family (but not for single people). It also includes an amount for ‘social and cultural participation’. Around £17,000 p.a. meant an individual could reach MIS in 2015, but around £40,000 was needed for a household of two adults and two children. With median gross annual earnings at £28,000 p.a., a household with children and one parent on median earnings would also need a second earner, at least part-time, to reach MIS.
How can we measure poverty and inequality?: Measures of poverty: the UK (Falling pay)
Around 40% of UK households with children fall below MIS incomes. In recent years, pensioners have fared
relatively well, though 16% of pensioners still live in relative poverty. The number of workless households
has also fallen, but there has been a significant rise in working households with children living in relative
poverty (and below MIS). Factors contributing to this include zero hours contracts, the rise in part-time work
and the extent to which the pay of unskilled earners has fallen behind.
How can we measure poverty and inequality?: Measuring global poverty
The World Bank suggests that poverty can be measured by income, consumption, health, education and
assets owned. However, it concentrates mainly on income and consumption. Setting a global income level
for absolute poverty is difficult and it uses two benchmarks. $1.25 per day is taken as a clear sign of extreme (absolute) poverty. The bank’s estimate is that 1.2 billion people live below this level, around 17% of the
global population of 7 billion. $2.50 per day is thought to show significant deprivation and 2.7 billion
people are estimated to have incomes below this, almost 40% of population. Such poverty is most common
in rural areas in sub-Saharan Africa and parts of Asia, most notably in the Democratic Republic of Congo,
Nigeria, Pakistan, Afghanistan, India and parts of China.
There is no global standard for relative poverty as this depends on incomes in each country. By definition
relative poverty depends on median incomes in each separate country. As one generalisation, there is likely
to be more relative poverty where very uneven income distributions leave a large proportion of households
well below the median income. Looking at world consumption shares by quintile groups (fifths) gives a
‘champagne glass’ distribution.
How can we measure poverty and inequality?: Measuring global poverty (HDI)
Comparisons of living standards between nations often use the Human Development Index (HDI), which
combines measures of income per capita, life expectation and years of schooling. The countries which rank
lowest on HDI comparisons (in sub-Saharan Africa) also tend to have very extensive poverty. The relevance
of HDI is its identification of the way that quality of life depends on more than just income or material
well-being. Many of those in the bottom 40% of the ‘champagne glass’ have a level of deprivation in their
lives which represents the reality of poverty.
How can we measure poverty and inequality?: Measures of inequality: Lorenz curve (wealth)
Within the richest societies, there are people living in poverty. The poorest societies have a minority of very
rich people. The Lorenz curve gives us a measure of inequality. It plots the share of total incomes held by
household groups. The horizontal axis represents percentage groups of households, working progressively
from households with lowest incomes on the left to the highest on the right. The vertical axis shows the
cumulative percentage of total income held by households. The curve will be fairly flat on the left, because this represents households with least income. The biggest incomes on the right will make that end steep.
The orange line on Figure 2 is a typical Lorenz curve. The black line is a theoretical diagonal line showing
all households having identical incomes. No country actually has identical incomes for all households.
Whilst Lorenz curves normally focus on income, the flow of receipts to households in a time period, the same
approach can be used to chart inequality of wealth. In this case we plot wealth at one moment rather than
a flow over time. The poorest households have few assets and often net debts, the richest have £ billions
of assets. Wealth distribution is more unequal than income distribution.
How can we measure poverty and inequality?: Measures of inequality: Lorenz curve (Tax and benefits)
Two variants of the Lorenz curve are common, one showing ‘market’ incomes before tax and benefits, the
second adjusted to take account of what the government does. Some pre-tax income is normally lost to
taxes both on income and expenditure. As a general rule, those with the highest incomes pay more, though
tax avoidance changes this in some cases. Benefits such as state pensions and child benefit add a supplement
to earned income. Normally, the poorest households have a net gain so higher incomes after taxes and
benefits than beforehand. Those with highest incomes usually pay more tax than they receive in benefits.
How can we measure poverty and inequality?: Measures of inequality: Lorenz curve (Income redistribution)
The extent to which taxes and benefits redistribute income varies from country to country. Some countries
favour higher taxes and benefits so more redistribution; others try to rely on market incentives, which keeps
the two curves on the Lorenz diagram closer together.
How can we measure poverty and inequality?: Measures of inequality: Gini coefficient
Our main numerical indicator of the extent of inequality of income, the Gini coefficient, is based on the
information in the Lorenz curve. A theoretical totally even income distribution would produce a straight
diagonal line. The more uneven the distribution is, the further the line would bend away from the diagonal. The Gini approach uses this. The space between the diagonal and the Lorenz curve is first measured; next the share of that area in the total space under the diagonal is calculated.
Reducing poverty: Economic growth and economic development (Well-being)
Economic growth is a fairly straightforward concept, often measured as real GDP per person. It can be
argued that GDP is not a good measure of growth; unequal income distributions sometimes lift the mean
(arithmetic average) above the median income. But GDP per capita is accepted as a reasonable guide to the
availability of material goods and services.
Reducing poverty: Economic growth and economic development (Quality of life)
Economic development is a broader concept which attempts to take account of wider aspects of well-being
for the bulk of a population. Whereas economic growth measures quantity of income, economic development brings in aspects of the quality of life. Attempts to measure the quality of life often use normative
judgements and opinions, but there are measurable indicators in areas such as health, education and access
to services such as electricity. Specifics such as doctors per thousand people, access to clean water or
ownership of phones can also be measured. Some analysts add less specific concepts of personal freedom
and justice to their view of development.
Economic growth is especially important where there is absolute poverty. Concerns about wider development
become more pressing once basic survival needs are met. Those who flee from a war zone, for example, first
prioritise finding somewhere safe. As they rebuild their lives, growing attention is likely to be paid to the
quality of life.
Reducing poverty: The Human Development Index (HDI)
Since 1990, UN agencies have used the HDI to compare levels of development and to chart progress. The
HDI is comparatively easy to calculate; its weakness is that it takes a rather narrow view. It has three equal
components:
● Life expectancy at birth is taken as an indicator of health.
● Mean years of schooling for adults and expected years for children measure education.
● Average real income at purchasing power parity indicates the material standard of living.
The trend in most countries is for the index to rise gradually over time, reflecting some progress in
development. Telling people in Niger that their HDI ranks lowest has little value, though there could be some
benefit in identifying which component requires most attention. There is value in identifying countries that
have moved up the ranking most rapidly.
Reducing poverty: The Human Development Index (HDI) (Impact of war)
Many poorer economies are growing successfully now, in terms of GDP. But economic development actually
requires sound government policies, the provision of public services and infrastructure and the rule of law,
which can provide trust and security. All of these can, potentially reduce risks. All require government
expenditure, so economic growth is extremely important to provide tax revenue that can be used to create
good education and health care provision. Many economies achieve significant improvements by using
their resources effectively, making good use of foreign aid, being open to FDI and being willing to
collaborate at every level. Wars and serious political discord are perhaps the biggest enemies of development
and corruption can slow down growth.
Reducing poverty: A different measure of development (Happiness)
In the 1970s, the small Himalayan country of Bhutan introduced measurement of Gross National Happiness
(GNH) which it sees as more significant than GDP. The emphasis on human well-being is combined with
concern for the environment.
Variants on GNH have since appeared. For example, the Happy Planet Index (HPI) multiplies a subjective measure of happiness by life expectancy and then divides this total by the ecological footprint per capita.
This footprint measures the amount of land and sea needed to sustain production of the resources used and
to absorb waste created. Costa Rica tops this index, along with other countries which are partly helped by
needing little energy for heating. Heavy resource users are well down the rankings, with the USA at position
104, for example.
Reducing poverty: International aid and Non-Governmental Organisations (NGOs) (0.7% aid target)
In 1970, the UN set a target: developed countries should spend 0.7% of their national income on aid. Only
a handful of countries have consistently met this target. The UK set a legal requirement to meet it in 2015.
The poorest economies may have under-exploited natural resources and plentiful supplies of labour, but
limited skills, capital equipment and technology. Aid can be used to kick-start investment and capital
accumulation, to transfer technology and to improve skills. Overall, aid has been of some value to developing
countries, but less than donors and recipients might have hoped.
In the period 1975-2000, some developing economies made rapid progress with relatively little aid. These
countries were mainly in Asia. In other countries, mainly African, aid seemed to generate little real poverty
reduction. An important book, ‘Dead Aid’, by Dambisa Moyo, chronicled reasons why aid might fail to
reduce poverty. Reasons vary, for example:
● Aid in the form of loans rather than grants are repayable, often with interest. If aid is spent on
unproductive or unsuccessful projects which generate little income, repayments will leave a country
worse off than it started.
● Some governments used aid to buy arms; some took aid but could not supervise the projects on which
it was spent, or did not spend it in the way intended.
● Some chose prestige projects such as expensive airports where demand for travel was low.
● Some donors pushed technologies which were inappropriate for the local infrastructure and needs of
recipients.
● Many of the poorest countries are also highly indebted, with debt and interest payments cutting their
capacity to tackle poverty.
Reducing poverty: International aid and Non-Governmental Organisations (NGOs) (Debt)
In some communities, aid often happened to them rather than with them. The arrival of food supplies in an
area of drought, for example, can give the impression that helping yourself by growing food is futile. Local
farmers might find that demand and prices for their output drop if people have access to free food. Such
situations can create a ‘dependency culture’ with little incentive for people to work at producing food
themselves.
Reducing poverty: International aid and Non-Governmental Organisations (NGOs) (Corruption)
Large aid inflows have often been a magnet for corruption. There is limited scope to cream off revenue in
a poor country from its very limited tax income. Aid can change this. As an example, ‘It’s Our Turn to Eat’,
by Michela Wrong, describes how US aid to finance a better passport system in Kenya went astray. Despite
lower priced competition from reputable international firms, ‘Anglo Leasing’ won a $34 million contract for
new style passports. Anglo Leasing allegedly had no ability or intention to fulfil the contract and only
existed to collect the payment. It is also alleged that some Kenyan government ministers and officials were
involved in this deception.
Reducing poverty: International aid and Non-Governmental Organisations (NGOs) (Corruption) 2
Aid can:
-Meet short run emergency needs
-Increase capital stock
-Improve infrastructure
-Promote enterprise
-Spread knowledge and technology
But might:
-Increase debt via loan repayments
- Create a dependency culture
-Attract corruption
-Damage existing local firms
- Tough aid terms can create problems
Reducing poverty: Non-governmental organisations
Many NGOs are formed specifically to help developing countries. The emergency relief work of Médicins
Sans Frontières and the Red Cross, for example, saves lives and meets immediate needs at times of crisis.
This is a valuable short term response for people who suddenly lose their homes and livelihoods. Oxfam and
Save the Children similarly help in times of disaster but also target long term development, often working
with local communities. Plan International, for example, places a heavy emphasis on education and working
with children to promote long term development. Its ‘Because I am a girl’ project has more than 500 local
programmes and hopes to develop role models, leaders and heroines for the future.
Reducing poverty: Poverty reduction strategies (UN goals)
Aid has helped; the early experiences outlined above have created a learning curve. In 2000, United Nations
members adopted eight millennium goals, such as eradicating extreme poverty and hunger and achieving
universal primary education, setting an ambitious timetable. Progress has been made, though some targets
have been missed. Numbers in extreme poverty halved between 1990 and 2015. At this point the millennium
goals were reset with 17 new sustainable development goals. The first goal of these is to end poverty. There
is no single way to achieve this goal. The UN has thousands of programmes, some small and some with
global ambition. National governments, NGOs and individuals, including those living in poverty, can all
make contributions to poverty reduction.
Reducing poverty: Poverty reduction strategies (UN goals) / (Microfinance)
Carefully targeted aid can reduce poverty. Many developments can be facilitated by aid but others may grow without it. Possibilities include:
● WTO negotiations, trade liberalisation and FDI have increased the scope for emerging economies
to increase export revenue, as shown by the Chinese experience. The subsidised and protected EU
agricultural market could be opened to allow exports from African and other countries. South American
farmers could gain from better access to US consumers. In current and future negotiations, developing
economies will ask for fewer restrictions on exports of their agricultural and other primary products.
Better access to rich markets could reduce poverty.
● Access to electricity for a majority of Africans is still a problem, despite the huge potential for
renewables such as solar power. If this limitation is tackled, it will offer a major boost to development.
Experience in India has shown how small scale generation projects can speed development.
● Benefits from mobile phones and the internet are already visible. Easier communication makes
markets work better and mobile banking helps businesses.
● Crowdsourcing encourages small businesses and can provide an effective route out of poverty. But
few financial institutions will lend to new entrepreneurs in developing countries. In Bangladesh, the
Grameen Bank brought ‘microfinance’ loans where credit to fund small scale start-up businesses was
not previously available.
● Trade barriers have been used by some governments to protect infant industries from overseas
competition while they become established. However, Brazil’s protection for its computer industry
resulted in higher prices and inferior technology for its computer users.
● Building up the quantity and quality of infrastructure can boost growth and economic development.
Reducing poverty: Poverty reduction strategies (Infant industries)
Political opinions do offer a range of ways to reduce poverty. Some believe that market forces promote
efficiency and create an economic environment in which businesses will flourish and create jobs.
Interventionists want much more active involvement on the part of government. Public provision of education
and training, often free to consumers, can lift the skills level of workers. Managing the currency exchange
rate can keep the price of exports attractively low. Trade barriers can be used to develop infant industries.
Reducing poverty: Poverty reduction strategies (interventionist policies)
Building up the quantity and quality of infrastructure can boost growth and economic develop ment. China’s
spectacular development was based on a strongly interventionist approach. However, interventionist policies can fail; they may make it easy for businesses to survive without becoming competitive.
Reducing poverty: Poverty reduction strategies (China’s FDI)
Africa, with its rich natural resources, has become an increasingly important economic partner for China.
Chinese FDI in Africa grew from $210 million in 2000 to $3.17 billion in 2011. China uses a blend of aid,
direct investment, joint ventures and trade in its dealing with African countries. There is Western criticism
of Chinese willingness to work with undemocratic regimes.
However, there has been a clear contribution to
poverty reduction. There is strong emphasis on infrastructure development, using ‘tied aid’ to favour Chinese construction businesses. One highly visible result is that dirt roads that made transport slow and uncertain
have been replaced by properly surfaced roads. One consequence of this is that farmers can now easily
reach markets in towns; another is that commuting has become easier. Previously isolated communities
have become better integrated into their region. This has contributed to poverty reduction.
Reducing poverty: Poverty reduction strategies (Market-based policies)
Where there is sound government, policies to target poverty reduction are influenced by the attitude to
market forces. Where free markets are seen as most likely to promote growth and so increase well-being, promarket policies are more likely to be adopted.
These can include trade liberalisation to give firms better
access to foreign markets and allow imports into the home market, stimulating efficiency and allowing
industries to expand. FDI and joint ventures can bring investment and hopefully growth. Making microfinance
available can lead to more start-ups. Where there are wasteful public sector organisations, privatisation may
bring better resource use. South Korea successfully followed a broadly market based approach. On the other
hand, privatisations can lead to increased prices and have a negative impact on poverty. In practice, many
governments use a mixture of intervention and market forces to get the results they want
Reducing poverty: Poverty reduction strategies (Market-based policies) 2
Market based policies:
-Trade liberalisation
-FDI and joint ventures
-Microfinance
-Privatisation
Interventionist policies:
- Education and training
-Infant industry protection
- Managed exchange rate
-Infrastructure improvement
Reducing poverty: Good governance (Growth)
Good governance can aid poverty reduction; the benefits of growth can be shared when governments
promote practical measures, such as extending clean water supplies and educational provision. Corruption
can cause funds for poverty reduction to be siphoned off towards individual pockets. Where there is armed
conflict, GDP often falls, poverty increases and the poor are the most vulnerable.
What are the effects of inequality?: How inequality affects individuals and households (Deprivation)
If income and wealth are distributed very unequally, the high share of resources going to the wealthy will
leave a relatively small share for those with least. The poorest households will live in relative poverty and
perhaps absolute poverty. Their relative or absolute deprivation will disadvantage them in material terms.
The poorest households fare badly on indicators such as life expectancy, educational attainment and obesity.
It might be tempting to think that the converse of this is that households which have most in material
terms will score well on all indicators of well-being, but this is not necessarily so.
What are the effects of inequality?: How inequality affects individuals and households (Trust)
Wilkinson and Pickett’s work suggests
that many aspects of development depend more on the distribution of income and wealth than on GDP.
A country with a lower GDP per head and less inequality might be more ‘developed’ than a richer country
with greater inequality. Economic growth might not bring greater well-being if it is combined with increasing
inequality. The data correlations in the study are statistically significant, despite the efforts of other
researchers to question both methodology and findings. What the data cannot do is to point out precise
causes of the results shown
What are the effects of inequality?: How inequality affects individuals and households (Social Cohesion)
The issue of trust is probably significant. Many towns and cities have ‘sink’ areas in which the poorest
households are concentrated. Some of the richest households live in ‘gated communities’ from which non-residents are excluded. In these circumstances, social cohesion is likely to be weak. Contact between
different groups will be limited, making mutual understanding and respect less probable.
A relatively small and privileged elite might have little genuine understanding of others whose circumstances are very different, possibly feeling uneasy about them rather than empathy and trust. Households at the bottom of the scale can see the situation as unfair and might well become alienated, not just from the rich but also
from institutions and organisations, such as the police, which maintain the status quo.
What are the effects of inequality?: How inequality affects individuals and households (
Children from the poorest households are likely to be less successful at school for a range of reasons
including poorer health, lower expectations and less encouragement to study. When they are old enough
to leave school, even low earnings can alleviate poverty a little. Carrying on with full-time education has
both the opportunity cost of lost earnings and direct costs which can include tuition fees and repayable
loans for living expenses. The prospect of debt from time spent studying is likely to be most daunting to
those longing to escape from poverty. This results in long term losses for the individual and for society as
part of the potential contribution of many able individuals is lost. Some young people overcome such
disadvantages, triumphing over adversity.
The combination of growing differences between social groups and falling potential to move away from
deprivation might help to explain a shift to a more dysfunctional society. Those who feel trapped in
absolute or relative poverty might come to see efforts to improve their situation as futile. At the other end
of the scale, preserving personal advantage might seem more important than working towards a more
equitable society.
It would be an overstatement to see societies with a great deal of inequality as ‘profoundly sick’, but the
evidence from Wilkinson and Pickett is that they function less effectively in terms of trust, physical and
mental health, obesity, educational attainment, teenage births, violence, imprisonment and social mobility.
The most unequal societies face greater problems in some important areas.
What are the effects of inequality?: Impact on firms (Productivity)
In an economy with an unequal distribution of income, there will be large groups of people with low incomes
and periodically, many will be unemployed or underemployed. Competitive markets, which are generally
good for consumers, require businesses to keep costs down and also to be flexible – adapting readily to
change in the market place. Being able to draw on cheap labour can be regarded as advantageous. There
are, however, some considerable disadvantages. Poorly paid employees do not necessarily have high
productivity.
What are the effects of inequality?: Impact on firms (Motivation)
● People who have been poorly educated are liable to have limited skills and little optimism about their
future; their commitment and motivation to work may be weak.
● People on low incomes tend to have more health problems; they may therefore be absent more often
due to sickness.
● Fear of losing the limited job and income they have will lead some to be careful. As a generalisation,
though, the enthusiasm and productivity of low paid and insecure workers can be low.
What are the effects of inequality?: Impact on firms (Productivity) 2
Some employers compound this situation by their treatment of employees. In a high staff turnover
environment where people are working part-time or for short periods, the return on time and money spent
training and developing workers is likely to be low. If employers come to expect that poor performance and
productivity are inevitable with such staff, this can colour their attitude and approach. The working
relationship can become mutually suspicious and is unlikely to be a happy and productive one. It may be
more profitable to train employees properly, to regard them as potential assets and to pay them accordingly
What are the effects of inequality?: Impact on firms (Short-term and zero-hour contracts)
For students zero-hours contracts can be a good way of combining study with earning and they may perform
well. For others the insecurity of income is a problem but they see no alternative. Similarly, some of the
8.4 million people working part-time in the UK prefer a part-time job but others are underemployed and
want to work full-time. Those on short-term contracts have little job security. From the employer’s
perspective, zero hours, part-time work and short-term contracts offer flexibility at low cost, usually at or
near the minimum wage.
What are the effects of inequality?: Impact on firms (Productivity) 3
Some people are trapped in unrewarding jobs with low productivity and pay, while employers are struggling
to fill more attractive and better paid jobs. Many people don’t have the education, qualifications and training to move into areas such as engineering and nursing where there are serious staff shortages. The potential these people might have had as children has faded.
Some problems with occupational mobility are inevitable. However, it is likely that inequality partly explains
why some workers get stuck in unskilled jobs and cannot acquire skills which are in short supply. Lack of
timely training can mean that top skilled jobs are done less well by people with less innate potential. This
can damage the performance of firms.
What are the effects of inequality?: Impact on firms (Austerity)
If income and expenditure are lower than predicted, there will be less revenue from direct taxes such as
income tax and indirect taxes such as VAT. A government that prioritises debt reduction will cut public
spending (e.g. on benefits) or raise taxes. Both will cut disposable income, consumption and aggregate
demand. At a time of ‘austerity’, there can also be a temptation to reduce public sector investment in
infrastructure. In the short run this reduces investment, an injection to the circular flow of money. In the
long run it can hold back productivity and growth, for example by congestion and transport delays or by
waiting lists for medical treatments.
Another of the arguments made by Stiglitz is that the small minority at the top of the income distribution
gain power and influence over key decision makers, lobbying to get their views heard. Decisions may reflect
their narrow interests, creating market failures affecting the whole community.
What are the effects of inequality?: Impact on firms (Training) / (Evidence)
An OECD study suggests that increasing inequalities reduce the incentives for the bottom 40% of income
earners to invest in their own education and training. Over time, this reduces the human capital of the
working population and causes slower economic growth. Number crunching suggested that “rising
inequality by three Gini points would drag down economic growth by 0.35% per year for 25 years.”
The OECD suggests that the best way to increase the incomes of the poorest 40% is to increase welfare
benefits and improve “access to high-quality education, training and health care… Strategies to foster
skills development must include improved job-related training and education for the low skilled over their
whole working lives.” This would improve the supply of skilled labour, raising incomes for the individuals
involved whilst also boosting productivity and growth for the entire economy.
Many of the arguments linking greater inequality with slower development and poorer economic
performance are theoretical. There are also contrasting theoretical arguments that lower taxes on top earners
will improve incentives and so lead to faster growth. It is important to test hypothetical (theoretical)
arguments against empirical evidence. The evidence is increasingly clear. The OECD analysis found, for
example, a “negative and statistically significant” correlation between income inequality and economic
growth.
Can income and wealth be redistributed?: Income and wealth (Stocks and flows)
We can measure flows over a period of time. Rainfall and income are two examples of this. To say that there
were four centimetres of rain means very little without a time period. Four centimetres in a day is exceptional
in Britain. Four centimetres in a year is more likely in desert regions. Similarly, saying someone has an
income of £10 means little without a time period. A Bangladeshi garment worker might earn £10 per week,
a top banker or CEO might be paid £10 per minute.
In recording floods, we tend to look at the high water mark. We call this a stock measure because it refers
to the amount of water at one time, in this case the peak flood level. Wealth is a stock measure of the
assets people own at any given time. Whilst it would be hard to survive with no income, there are households
with negative wealth because they have more debts than assets. Early in 2016, Oxfam claimed that the
richest 62 people in the world had as much wealth as the poorer half of the global population.
Can income and wealth be redistributed?: Taxation and benefits
Most income is received as earnings, but it can be supplemented by receipt of benefits and services for which
there is no direct charge. So most households receive education and medical services from the public sector.
Since the recession, record numbers of households have depended on food banks to maintain adequate
nourishment.
Can income and wealth be redistributed?: Taxation and benefits (Benefits)
Earnings can either be counted gross, before any
deductions, or net to see ‘take home pay’, which is the
amount actually received. Many taxpayers resent the income tax and other deductions which can take net pay
well below their gross earnings. Only rarely do they
consider the benefit of payments and services which
add to their household’s well-being. It can come as a
surprise that the average household receives more in
benefits and services than it pays in taxes, as shown.
Can income and wealth be redistributed?: Taxation and benefits (Public sector services)
If we divide people into quintile groups according to
incomes, the amount paid in direct taxes rises relatively
steeply as we move up through income levels. The
amount of indirect tax also rises with income but less
steeply. Cash benefits are significantly lower for the
top two quintile groups but benefits in kind are more
evenly distributed.
Can income and wealth be redistributed?: Taxation and benefits (Household income)
Original -> (+Cash benefits) -> Gross Income -> (- Direct taxes, National Insurance and local taxes) -> Disposable income -> (- Indirect taxes) -> post-tax income -> (+ Benefits in kind e.g. health and education) -> Final income.
Can income and wealth be redistributed?: Income redistribution by progressive taxation (Progressive tax)
Taxes can be regressive, proportional or progressive, depending on the share of each income they take. Taxes on tobacco are regressive for two reasons. Firstly, there is a higher proportion of smokers in the bottom quintile so more people in that group pay the duty on tobacco. Secondly, if a smoker with £10,000 per year and a smoker on £100,000 a year both pay £1,000 a year in duty, that will take 10% of the lower income but only 1% of the higher income. Some US states have a proportional income tax, but examples of proportional taxation are relatively rare.
UK income tax is structured to be progressive. A personal allowance is tax free, so everyone with incomes below this allowance pays no income tax. In the 2016 budget, the personal allowance for the 2017-18 tax year was set at £11,500 for most people. Income between £11,500 and £45,000 is taxed at the standard rate of 20%. Beyond £45,000 the marginal rate is a higher rate of 40%.
Earnings above £150,000 have a 45% marginal tax rate.
The average rate paid by taxpayers is lower than their marginal rate. For example, an income of £100,000 would have £11,500 tax free, £33,500 at 20% (= £6,700 tax) and £55,000 at 40% (= £22,000). Total tax would be £27,700 so 27.7% of income. This tax is progressive as
someone with income at £10,000 pays nothing, someone with £40,000 pays 20% of £28,500 (= £5,700) so 14.25%.
Can income and wealth be redistributed?: Income redistribution by progressive taxation (Percentages paid)
The analysis of income tax above assumes that people make an honest tax declaration. In practice, many
people structure their incomes to avoid tax. Wealthy investor Warren Buffet benefits from a lower tax rate
on income from investments, like many of the richest. Some years ago, he said his cleaner was paying tax
at a higher tax rate than he was. This is because he makes most of his money from capital gains (rising share
prices), which are taxed at a lower rate than dividends in the US. He now campaigns for capital gains tax
to be levied at a higher rate. But he is a remarkably honest person.
Can income and wealth be redistributed?: Avoiding tax (Tax evasion and avoidance)
Some individuals on the highest incomes buy specialist help to exploit similar loopholes. Many MNCs also
avoid tax in varied ways, often using transfer pricing strategies (see page 62). Some top earners are tax
exiles, spending most of the year abroad in order to avoid UK income tax. Most government Budgets include
an estimate for extra revenue from clamping down on tax evasion and avoidance, but the extra revenue
actually collected is often well below the budget target.
Tax avoidance and evasion strategies deliberately seek to reduce the amount of income redistribution that
takes place. The loss of tax revenue often leaves governments with insufficient funds to maintain public
services and pay benefits to disabled and unemployed people. Few taxpayers consider the detrimental
effects this has on people in need.
Can income and wealth be redistributed?: The distribution of wealth
A household with no income would struggle to survive. Living without wealth is more feasible. Some
households live in rented, furnished accommodation. Their assets might amount to little more than some
clothes (part worn) and a few other items. Debts could mean that such households have negative wealth
overall. At the opposite end of the scale, wealthy households with property, shares and other assets benefit from unearned income from profits and rents, plus increases in asset values that provide capital gains over time. Between these two extremes, many homeowners have acquired wealth from rising house prices. (This capital gain is not taxed because people need a place to live.)
Can income and wealth be redistributed?: The distribution of wealth (Home ownership/Distribution of wealth)
Mortgages slowly bring home-buyers ownership as repayments are made. Their equity (share of ownership)
increases faster when house prices rise. Those who have lucrative pension funds have a second source of
wealth.
The age at which people buy their first house in the UK has been rising recently and the proportion of
households renting has risen. Rising house prices and tougher mortgage conditions have increased the
deposit needed for a mortgage. Also, many people have heavy student debts to repay, reducing their ability
to save for a deposit.
Can income and wealth be redistributed?: The distribution of wealth (Redistribution)
Some taxes on earnings from wealth have been cut, allowing the wealthy to become wealthier. Some wealth
is redistributed via inheritance tax, currently on estates above £325,000 for a single person and £650,000
for a married couple. This tax is unpopular with the wealthy and avoidance schemes are common. 2014
ONS data showed the distribution of wealth becoming less even.
Can income and wealth be redistributed?: Income redistribution by benefits (Tax credits)
At the time of writing, the UK is in a transitional phase to a new ‘universal credit’ system. A complex web
of benefit payments, such as job seekers allowance, working families’ tax credits and housing benefit, are
to be absorbed into the single universal credit. There are positive claims about simplicity and fairness but
also deep suspicions about this reform in different quarters.
Further adjustments to the new scheme are likely as it is rolled out. Universal credit is ‘means tested’ so will
go to households below set incomes. Some benefits have been paid to all households, (such as state
pensions and formerly child benefit,) but now the benefits system mainly targets poverty reduction by
helping those most in need.
All households benefit from public sector provision, from roads and street lighting to the police and libraries.
Education and the Health Service are available for all, though some households prefer to use private sector
provision. Low income households depend more heavily on public sector services, which make a useful
contribution to their quality of life.
Can income and wealth be redistributed?: Redistribution and incentives (Redistribution and Incentives)
The tax and benefit system is said to risk disincentive
effects on both top earners and the low paid.
● Some politicians argue that high marginal tax rates discourage able people from working. However, data
on top earners’ responses to rising tax rates do not suggest that they work less. Some people have a
target lifestyle. Behavioural economists say that those who want posh cars, private swimming pools and
similar luxuries will earn enough to pay for them. If their tax rate rises, they might work harder to get
what they want.
The evidence on this is mixed. Sweden and Finland have marginal rates around 60% for top earners, yet their
economies perform as well as most and the holders of their top jobs don’t noticeably underperform their
peers in other countries. On the other hand, a few top global performers such as racing drivers have moved
their home base away from the UK to lower tax locations such as Monaco.
Can income and wealth be redistributed?: Redistribution and incentives (Poverty trap)
● For the lowest earners, there is the risk of a poverty trap. Many benefits are means tested so earning
more can cut benefit entitlement whilst also bringing liability to income tax. Combining these two factors
could mean that working an extra day for £60 leaves the worker just, say, £20 better off; then extras such
as transport to work can add more costs.
There will be a temptation not to bother working. In the past the poverty trap meant that some people were
actually worse off working than unemployed. The working families’ tax credit ensured that this could not
happen. However, benefit cuts currently under discussion could bring a return of the poverty trap if
politicians do not take care to maintain incentives.
● Some people build their identity and self-respect through work. Others see a low paid job as a stepping
stone to a better future. They may be motivated to work even for very low pay. Many unemployed people
are desperate to work.
Many job adverts attract hundreds or thousands of applicants. On the other hand, some people do give up
trying for work and become voluntarily unemployed. There has never been firm evidence of large numbers
in this position.
There is also a minority of benefit cheats, who work whilst claiming they have no income. There are complex
ethical issues here. It would be wrong to punish the honest unemployed (and their children) by setting
benefits too low for anyone to choose voluntary unemployment or bother to cheat the system.
The move from the national minimum wage to a higher living wage has at least two advantages. A higher
living wage creates an incentive to work; voluntary unemployment becomes less attractive. Higher pay may
reduce some households’ need for benefits (and their entitlement). This is expected to reduce public
expenditure. At the same time though, some of those who gain extra income from the living wage are
second earners in reasonably well-off households. If the higher wage increases unemployment, some
households will lose out.
