Economic inequality

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Economic inequality refers to disparities in the distribution of economic assets and income. The term typically refers to inequality among individuals and groups within a nation or inequality among nations.

Economic inequality has always existed; its nature, cause and importance are open to broad debate. A country's economic structure or system (such as capitalism, socialism or communism), ongoing or past wars, and individuals' different abilities to create wealth are some possible causes of economic inequality.

Contents

Inequality among individuals

Numerical indexes measuring economic inequality among individuals either look at absolute inequality and relative inequality, which compares the well-being and numbers of the rich with those of the poor. Relative income inequality is often measured using the Gini coefficient (defined based on the Lorenz curve). For more details, see the article on income inequality metrics.

Economic inequality among different individuals or social groups is best measured within a single country. This is due to the fact that country-specific factors tend to obscure inter-country comparisons of individuals' incomes. A single nation will have more or less inequality depending on the social and economic structure of that country.

One point of view holds that "pure meritocracy is incoherent because, without redistribution, one generation's successful individuals would become the next generation's embedded caste, hoarding the wealth they had accumulated." (Patrick Diamond and Anthony Giddens, 27 June 2005, New Statesman)[1]

Good or bad?

In political philosophy, various schools of thought have different perspectives on inequality. Marxism favors an eventual communist society where distribution is based on an individual's needs rather than his ability to produce, social class, inheritance, or other such factors. In such a system inequality would be low or non-existant assuming everyone had the same "needs." Libertarianism generally does not take a stance on inequality per se, but opposes government intervention in society meaning that libertarians favor allowing inequality to remain as long as it is a result of the free market. Libertarian Robert Nozick argued that government redistributes wealth by force (usually in the form of taxation), and that the ideal, moral society would be one where all individuals are free from force. However, Nozick recognized that some modern economic inequalities were the result of forceful taking of property, and a certain amount of redistribution would be justified to compensate for this force but not because of the inequalities themselves. John Rawls argued in his A Theory of Justice that inequalities in the distribution of wealth are only justified when they improve society as a whole, including the least well off members. Rawls does not go into the full implications of his theory of justice. Some see Rawls's argument as a justification for capitalism since even the poorest members of society theoretically benefit from increased innovations under capitalism while others believe only a strong welfare state can statisfy Rawls's theory of justice.

In most western democracies, the desire to eliminate or reduce economic inequality is generally associated with the political left. The main practical argument in favor of reduction is the idea that economic inequality reduces social cohesion and increases social unrest, thereby weakening the society. There is evidence that this is true (see inequity aversion) and it is intuitively true, at least for small face-to-face groups of people. Also, there is the argument that economic inequality invariably translates to political inequality, which further aggravates the problem.

Economic inequality may also reduce the total personal utility of a system; for example, a house may provide less utility to a single millionaire as a summer house than it would to a homeless family of five. Applying the law of diminishing utility, it could be said that the marginal utility of wealth is lowest among the richest. In other words, an additional dollar spent by a poor person will go to things providing a great deal of utility to that person, such as basic necessities like food, water, and healthcare; meanwhile, an additional dollar spent by a much richer person will most likely go to things providing relatively less utility to that person, such as luxury items. From this utility standpoint, if there are two societies, all other factors being the same, the one with less inequality would have more aggregated personal utility. However, it does not necessarily follow that making a society more equal increases the net social utility. For instance, reducing inequality through redistribution may lead to less incentive for production and thus less social utility, at least from the point of view of the economic right. Different value systems also have different perspectives on the use of utility in making moral judgments. For example, Marxists, Kantians, and certain libertarians (such as Nozick) all believe utility to be irrelevant as a moral standard or at least not as important as others such as natural rights.

The acceptance of economic inequality is generally associated with the political right or at least that section of the right that is concerned with economics. The main practical argument in favor of the acceptance of economic inequality is that, as long as the cause is mainly due to differences in behavior, the inequality serves as an economic engine to push the society towards economically healthy and efficient behavior, and is therefore beneficial. This is intuitively true, at least for people who only interact economically. Also, it is pointed out that if one person earns $10 and the other earns $20, this is preferable to both earning $5, again, as long as the differential does not allow the person with $20 to buy enough influence to take away the other's earnings.

The main disagreement between the two sides is basically a disagreement on the importance of each effect, and the where the proper balance point should be. Both sides generally agree that the causes of economic inequality based on non-economic differences (race, gender, etc.) should be minimized. There is, of course, strong disagreement on how this minimization should be achieved.

Causes

Besides simple measurement, the causes of inequality can also be studied by correlating (dis)advantaged groups of the population with certain characteristics of the individuals. Among the acknowledged factors that impact economic inequality in some part are:

  • Racial discrimination - Can range from "soft" discrimination (the glass ceiling) to denial of a job, or equivalent pay, to outright enslavement.
  • Gender discrimination - The same as racial discrimination, but on the basis of gender.
  • Religious discrimination - The same as racial discrimination, but on the basis of religion.
  • Caste discrimination - The same as racial discrimination, but on the basis of caste or social class.
  • Heritage
    • Innate ability - Some people are genetically inclined (or disinclined) to wealth-acquiring behavior by virtue of having (or lacking) a valuable talent (athletic, technical, financial, etc.)
    • Family culture - People who are brought up in families which either encourage or discourage wealth-acquiring behavior will tend to behave accordingly as adults.
    • Family wealth - differences in wealth are maintained by wealth inheritance. Also, family wealth can finance a better education for the children which will usually enhances their wealth-acquisition abilities, just as a lack of family wealth can have the opposite effect.

It should be noted that simply demonstrating a correlation between the above presumed cause and presumed effect will not necessarily imply a cause-effect relationship.

Innate ability

Many people believe that there is a connection between differences in innate ability, such as intelligence, strength, or charisma, between individuals and their level of wealth.

Various studies have been conducted on the correlation between IQ scores and wealth/income. The book titled "IQ and the Wealth of Nations", written by Dr. Richard Lynn, examines this relationship with limited success, while other peer-reviewed research papers have also come across harsh criticisms on their findings. Without further research on the topic, incorporating statistical models that are universally accepted, it is fairly difficult to come towards an objective conclusion on whether or not there is a relationship between intelligence and wealth/income.


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Gender

Although sexism, in various forms, is frequently the proposed cause of income inequality between men and women evidence from the United States labor market does not support this conclusion. While it may be true that outright gender based discrimination of women might lead to undervaluing their work (especially housework), and might bar or discourage women from jobs or hierarchic positions which are felt to be in conflict with the traditional gender roles this has yet to be demonstrated empirically. It may also be the case that such discrimination may be exerted unconsciously by women themselves.

According to the U.S. Bureau of Labor Statistics, the median income for all women is about three-quarters that of men, although the results vary significantly among demographic groups. Some organizations and some politicians point to these statistics as evidence of the United States as a patriarchal society that discriminates against women. But a closer examination points to a different conclusion.

A recent study by the Congressional Budget Office, found that among people ages 27 to 33 who have never had a child, women's earnings approach 98 percent of men's. Women who hold positions and have skills and experience similar to those of men face wage disparities of less than 10 percent, and many are within a couple of points. When evaluating claims of unequal pay one should seek to make apples to apples comparisons.

Gender may play a role in economic inequality in so much as women are able to make different choices than men, and those choices affect how they work. Men for example are unable to bear children. Historically, women have often placed more importance on their relationships - caring for children, parents, spouses, etc. - than on their careers. A study by the Center for Policy Alternatives and Lifetime television found that 71 percent of women prefer jobs with more flexibility and benefits than jobs with higher wages, and nearly 85 percent of women offered flexible work arrangements by their employers have taken advantage of this opportunity.

Women more than men tend to enter and leave the workforce to raise children, take care of elderly parents or move with their families. Working mothers are nearly twice as likely to take time off to care for their children as are working fathers in dual-earner couples. Yet time out of the workforce is an enormous obstacle to building an attractive resume and working up the corporate ladder. Women 25 years of age and over have been with their current employer 4.4 years, on average, compared to 5.0 years for men. Data from the National Longitudinal Survey reveal that women between the ages of 18 and 34 have been out of the labor force 27 percent of the time, in contrast to 11 percent for men. Women ages 45 to 54 who have recently re-entered the workforce after a five- or 10-year break are competing against men who have had 20 years of continuous experience.

Women are also more likely to work part-time than men. In 2000, one-quarter of all women employees worked part-time, compared to less than 10 percent of men. Nearly 85 percent of those who worked part-time did so for non-economic reasons; e.g., to spend more time with the family or to further their education. In general, married women would prefer part-time work at a rate of 5 to 1 over married men.

While part-time work usually increases flexibility, the part-time worker loses out on promotions and pay increases. Part-time work also tends to mean lower hourly pay. Shorter labor stints and part-time work contribute to the probability of working for the minimum wage. Nearly two-thirds of minimum wage earners are women.

However, women's wages hold up quite well to men's wages when comparing specific job categories. Among adults working between one and 34 hours a week, women's earnings are 115 percent of men's. Among part-time workers who have never married, and who thus confront fewer outside factors likely to affect earnings, women earn slightly more than men. These statistics suggest that skill level, tenure and working hours - not gender - determine wages.

Beyond work behavior, women gravitate to sectors of the economy that compensate workers at lower levels. While women hold 53 percent of all professional jobs in the United States, they hold only 28 percent of jobs in professions averaging $40,000 or more in annual compensation. For example, fewer women have chosen to enter such technical fields as computer sciences, math and science teaching, medicine, law and engineering. In 1998, women earned only 26.7 percent of computer science degrees.

Despite all these factors, the gap between men and women's wages has been closing. Over the last 20 years women's earnings have jumped at least 12 percentage points relative to men's earnings, closing the wage differential at every level of education. A change in women's work expectations also has tended to close the gap. Until the 1970s, a minority of women expected to work after marriage. Today, almost 75 percent of young women expect to be working at age 35.

Changing work expectations are an apparent cause of women's increased focus on education, and the enrollment of women in higher education has grown much faster than that of men. Women were awarded more than 50 percent of associate's, bachelor's and master's degrees in the 1990s. Women currently earn more than 40 percent of Ph.D.s, medical and law degrees.

The narrowing of the gender wage gap approximately one percentage point a year since 1980 is particularly significant, since during the 1980s and '90s the overall wage level rose little and the wage inequality between skilled and unskilled workers grew. Without enhanced skills, women's wages likely would have fallen further behind men's. However, market pressures have helped to generate corrective mechanisms, and as the costs of denying employment to women mounted, prejudices were set aside.

Women's work-life patterns and their occupational preferences are significant factors in determining wages. Rather than being "funneled" into low-wage, low-prestige and part-time positions, women often choose these occupations because of the flexibility they offer. After adjusting for these factors, scholars find that the difference between men's and women's earnings is very narrow.

See also gender gap, income disparity.

Race

It is felt that in many countries, individuals belonging to certain racial and ethnic minorities are found more often among the poor than others. Empirical data should provide evidence with respect to the factual status of such claims. For those countries where this can be established, among the proposed causes for this discrepancy we find:

In the United States, it is harder to make the claim that race plays a direct role. In the United States, most jobs start with wages higher than the minimum wage, which is currently $5.15. A two wage earner household, even earning the minimum wage, would earn $21,000 annually. According to the U.S. Census, in 2003, the poverty threshold for one person was $9,393, for a two-person household it was $12,015, and for a family of four it was $18,810. Taking a minimum-wage job is not seen as highly desirable, but it does produce an income higher than the Bureau of Census' poverty threshold. In addition, participation in the labor force does increase future wage potential dramatically.

The Children's Defense Fund and other civil rights organizations frequently discuss the number of African American children living in poverty. When African American children are compared to Caucasian children living in identical circumstances, mainly in a two-parent household, both children will have the same probability of being poor.

Factors that might play into economic inequality for African Americans would likely include single-parent families with a welfare dependency as well as higher than average high school drop out rates. Template:Sect-stub

Job negotiation

One important factor of inequality is the ability of the individuals to improve their wages. Most firms will act to maximize profits, which means paying each worker the lowest salary or wage he or she will accept. The result is that compensation matters are intentionally kept obscure by firms; some formally disallow discussion of salaries. Matters of salaries and raises are determined in complex negotiation processes. This results in some workers being able to negotiate better salaries than others.


Wealth condensation

Besides other factors, it is possible that inequality preserves itself in a vicious circle, through a process known as wealth condensation, by which newly-created wealth tends to go to already wealthy individuals or groups (rather than being distributed evenly or going preferentially to poor individuals). This is reflected in the common saying: the rich get richer and the poor get poorer.

For example, truck drivers who own their own trucks consistently make more money than those who do not, for the same amount of work, since the owner of a truck can effectively charge rent to its driver in the form of reduced wages. The principle is the same for other forms of capital. Investment as a method of obtaining substantial income is available only to the wealthy. Since investment can provide incomes hundreds of times greater than the highest wages, this advantage can be substantial.

A similar inequality exists between corporations. In general, larger corporations are more efficient (owing to economy of scale), capable of more types of business strategy (for example, predatory pricing), have access to more markets (with high costs of entry), and have greater access to political power than smaller corporations. Thus, the largest corporations tend to grow larger, while the smallest tend to fail or be purchased. The number of firms within a market tends to decrease with time, and the profit margins within a market tend to increase as the number of firms falls (see oligopoly). There are, however, important exceptions: new technologies and other changes can create new markets, make old ones irrelevant, or allow small investments to result in huge new monopolies.

Inequality in economic theory

Many people accept inequality as a given, and argue that the prospect of greater material wealth provides incentives for competition and innovation within an economy.

Some modern economic theories, such as the neoclassical school, have suggested that a functioning economy requires a certain level of unemployment. These theories argue that unemployment benefits must be below the wage level to provide an incentive to work, thereby mandating inequality. Other theories, such as socialism, and Keynesianism dispute this alleged positive role of unemployment.

Simon Kuznets argued that levels of economic inequality are in large part the result of stages of development. Kuznets saw a curve-like relationship between level of income and inequality. This relationship is now known as Kuznets curve. Supposedly, countries with low levels of development have relatively equal distributions of wealth. As a country develops, it acquires more capital, which leads to owners of this capital having more wealth and income and thus greater inequality. Eventually, through a variety of possible mechanisms such as trickle down effects and social welfare programs, more developed countries move back to lower levels of inequality. Kuznets showed this relationship as empirically strong using cross-sectional data. However, testing this theory with superior panel data has shown it to be very weak.

The meaning of equality

The antonym of inequality is, of course, equality, but there is debate as to what equality should mean. Different definitions include:

There are many posited solutions from those who see economic inequality as improper; these solutions usually concentrate on equality of outcome and/or opportunity. Aside from the ethical arguments against inequality, there is evidence that "inequity aversion" is a shared human characteristic.


Effects of inequality

Economic inequality may negatively affect social capital, which could contribute to crime or even revolution. Karl Marx based much of his critique of capitalism on inequality between providers of capital and providers of labor. Alberto Alesina, Rafael Di Tella, and Robert MacCulloch find that inequality negatively affects happiness in Europe but not in the United States. [2]

Several economists have also investigated the relationship between inequality and economic growth. Robert Barro wrote a paper arguing that inequality reduces growth in poor countries and helps growth in rich ones. [3]

Inequality among nations

Current economic differences between rich and poor countries are considerable. According to the United Nations Human Development Report 2004, the GDP per capita in countries with high, medium and low human development (a classification based on the UN Human Development Index) was 24,806, 4,269 and 1,184 PPP$, respectively (PPP$ = purchasing power parity measured in United States dollars).

The major component of the world's income inequality (the global Gini coefficient) is comprised by two groups of countries (called the "twin peaks" by Quah [1997]).

  • The first group has 13% of the world's population and receives 45% of the world's PPP income. This group includes the United States, Japan, Germany, France and the United Kingdom, and comprises 500 million people with an annual income level over 11,500 PPP$.
  • The second group has 42% of the world's population and receives only 9% of the world PPP income. This group includes India, Indonesia and rural China, and comprises 2,100 million people with an income level under 1,000 PPP$. (See Milanovic 2001, p.38).


Economic inequality is generally considered to be approximately exponential as one traverses the strata of national and world societies from top-to-bottom. More sophisticated models of income distribution may apply (see Pareto distribution).

The evolution of the income gap between poor and rich countries is related to convergence. Convergence can be defined as "the tendency for poorer countries to grow faster than richer ones and, hence, for their levels of income to converge" [4]. Convergence is a matter of current research and debate, but most studies have shown lack of evidence for absolute convergence based on comparisons among countries (with regard to this debate see for instance Cole and Newmayer (2003) or [5]).


Comparisons

Some of the economic disparities among nations can be better appreciated when rich and poor countries or societies are contrasted. For example, according to some estimates by Branko Milanovic from the World Bank:

  • "An American having the average income of the bottom US decile is better-off than 2/3 of world population." (Milanovic 2000, p.50)
  • "The top 10 percent of the US population has an aggregate income equal to income of the poorest 43 percent of people in the world, or differently put, total income of the richest 25 million Americans is equal to total income of almost 2 billion people." (Milanovic 2000, p.50)

Other disparities can be better appreciated when rich individuals (or corporations) are compared against poor individuals. According to some estimates, for instance:

  • "The richest 1 percent of people in the world receive as much as the bottom 57 percent, or in other words, less than 50 million richest people receive as much as 2.7 billion poor." (Milanovic 2000, p.50)
  • The three richest people possess more financial assets than the poorest 10% of the world's population, combined.
  • As of May 2005, the three richest people in the world have assets that exceed the combined gross domestic product of the 47 countries with the least GDP, (calculation based on data from list of countries by GDP (PPP) and list of billionaires). However, the three richest individuals' wealth consists largely of stock in their own companies. The value of these assets was largely created by the economic conditions in their respective countries.
  • As of May 2005, the 125 richest people in the world have assets that exceed the combined gross domestic product of all the least developed countries (calculation based on data from list of countries by GDP (PPP) and list of billionaires).

See also

Books

References

  • Milanovic, Branko (World Bank), True world income distribution, 1988 and 1993: first calculation based on household surveys alone, The Economic Journal, Volume 112 Issue 476 Page 51 - January 2002. Article: [6]. Actual report on which the article is based: [7]. News coverage: [8] and [9].
  • Cole, Matthew A. and Neumayer, Eric. The pitfalls of convergence analysis: is the income gap really widening? Applied Economics Letters, 2003, vol. 10, issue 6, pages 355-357 [10]
  • Quah, Danny (1997), "Empirics for growth and distribution: stratification, polarization and convergence clubs", London School of Economics and Political Science, Center for Economic Performance Discussion Paper No. 324, pp. 1-29. [11]
  • Martin Ravallion, World Bank, 5 May 2005, Policy Research Working Paper no. WPS 3579, A poverty-inequality trade-off?
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