Econ0002 - Unit 19 Notes PDF

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Econ0002 – Unit 19Economic Inequality19 Inequality Across The World and Over Time Two Key Definitions: o Discrimination means that otherwise identical people will have different incomes and economic opportunities which contributes to inequality o Inequalities can both restrict economic opportunitie...

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Econ0002 – Unit 19 Economic Inequality 19.1 Inequality Across The World and Over Time 

Two Key Definitions: o Discrimination means that otherwise identical people will have different incomes and economic opportunities which contributes to inequality o Inequalities can both restrict economic opportunities and also provide incentives to work hard and take risks with innovation and investment

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Wealth, Earnings, Market Income and Disposable Income: o 3 dimensions of inequality:  Wealth is the value of assets owned by a household (net of their debts)  Earnings are income from labour including wages, salaries, and self-employment  Disposable income is the income a household can spend:  after paying tax  after receiving any monetary transfers from the government e.g. unemployment benefit and pensions  Market Income is the sum of:  all income received as earnings  all income from business owned by the household or from investment

 o Two Key things stand out when comparing wealth, earnings and disposable income inequality:  Wealth is more unequally distributed than earning, and earnings are much more unequally distributed than disposable income  Countries have lower disposable income inequality due to modest earnings and also a system of taxes and transfers that benefit those on lower incomes 

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Income Inequalities Over time and Among Countries: o An indicator of inequality which can be used is what fraction of total income or wealth belongs to the richest 1% or 10% of the population o Total Wealth:

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18th/19th centuries until 1910: increasing wealth inequality (except Norway and Denmark)  20th Century until 1980: decreasing wealth inequality  Since: modest increases in wealth inequality o Income (before tax/transfer):

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US is more unequal than China, India, and UK Common trends of less inequality in the first 3/4 quarters of the 20th Century but an increase in inequality since 1980  European countries did not see greater inequality and most major economies in Europe actually saw a fall in income inequality during the 1900s  It began to rise again around the turn of the 21st century o Generally:  There was a fall in inequality between 1920 and 1980  Since 1980 inequality rose more, in US, China and India mainly, whereas in Denmark, France and the Netherlands inequality remained low 

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Inequalities Between and Within Nations: o Capitalist Revolution (kink in the hockey stick) occurred at different times for different countries across the world which has caused widening inequalities across the world o Global GINI coefficient and between countries:  If we construct an entire Lorenz curve we can calculate the Gini coefficient using market income

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Inequality among the world’s individuals falls (1986-2013):  The blue line shows income inequality among all individuals in the world – it is the world’s Gini coefficient  The Hypothetical Inequality Between Countries fall:  The red curve shows the between-country income inequality  This is calculated as if everyone in each country earned the average income for the country  Since the 1980s, inequality started to decline  Within Country Inequality rises:  The decline in between-country inequality accelerated as the growth of the largest poor countries took off e.g. India and China  But income within countries has increased  1988: the global Gini coefficient was 0.69, and this number would have been 0.6, had there been perfect inequality within each country  As a result, we see that 87% (0.6/0.69) of global inequality in income is accounted for by our measure of inequality between countries  It also shows, between-country inequality has fallen rapidly, by 2013, 76% of global inequality was between country (0.47/0.62) o 3 main messages from the figure:  Most of the inequality in the world is between individuals in different countries (red line): not between individuals in the same country (difference between blue and red)  But this is changing: due to poorer countries growing rapidly, so between-country inequality is reduced, but within country inequality increases as this growth normally leads to the resource owners gaining more wealth than the poorest workers  Inequality between individuals is declining: the net result of these opposite trend is inequality among individuals of the world has started to decline 

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The Missing Middle Class: o Changing inequality is associated with changing distribution of jobs  There are more low-paying and high-paying jobs  Middle-income jobs are scarce

o Estimated projected US job growth is seen above Due to the effect of automation and the ‘China effect’ wages of manufacturers has fallen o From the Data:  The Missing Middle:  Both high and low wage occupations are adding many jobs, but employment gains among the occupations with wages in between are more limited  Jobs Replace work done by families:  Biggest increases are in human services, many health related  These growing occupations substitute for work once done primarily by family members, such as personal care aides and home health care aides  Machines do routine work:  Digitalisation has reduced the demand for jobs that involve routine tasks e.g. machine operators  The tasks that machines are not replacing tend to be higher paid or poorly pad e.g. taking care of elderly in a care home  High wage jobs benefit from information technology:  Growing occupations with high wages e.g. researchers are those where digital information processing has greatly increased the productivity of workers with the right skills  Workers with average or below average wage earners are the losers  

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The Gini coefficient and worldwide income differences: Einstein:

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19.2 Accidents of Birth: Another Lens to Study Inequality 

Accidents of Birth: o Accidents of Birth is the term to describe the differences people have of which they have virtually no control of e.g. race, sex, nation, or parents o One’s citizenship is one of the key accidents of birth, it determines  Where you live and so the economic opportunities facing different countries  Even with the same education, capacities etc. where you are born leads to many different life chances  Even with migration people can be still denied access to political and labour rights

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Gender and Other Forms of Categorical Inequality: o There is also accidents of birth within countries:  Castes:  For example in India people follow hereditary or hierarchical ‘caste’ boundaries  Caste is a social status that ranges from high to low  Formalised Discrimination:  E.g. the apartheid in South Africa created a system of racial barriers  Colonist and Indigenous People:  There tends to be social and economic inequality between them o These are examples of Categorial Inequality  Which is inequality between different social categories which is normally defined by more powerful social classes  People are born into these categories and it is usually difficult if not impossible to change o The comparison between Men and Women:

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The economy treats men and women very differently

Despite the level of schooling being on average equal between men and women, there are large gaps in pay gap We can also notice how education levels affect your earnings

Intergenerational Inequality: o Inherited Inequality:  Before people expected to be poor or rich if their parents were that already  But due to public schooling and the decline in discrimination etc. this has changed  In some countries, one’s parents economic status matters for their child’s economic success but in others it is weakly transmitted to their offspring o Intergenerational transmission of economic differences is when the economic status of an adult resembles that of their parents, the transmission process takes many forms:  Children inherit the wealth of their parents  The genetic makeup of children is similar to the parents  Through parental influence means parents and children share similar preferences, social norms, knowledge, skills, and social connections acquired outside of formal schooling o Intergenerational inequality occurs when the rich stay rich and the poor stay poor, this occurs due to:  The financial support that rich people can give their children, before and after they die, is substantial and helps to maintain this  This wealth gives kids better schooling and network for them to earn more later on o The Intergenerational Elasticity of income or wealth  Is the percentage difference in the second generation’s status that is associated with a 1% difference in the adult generation’s status  For example;  With two pairs of fathers and sons, an elasticity of 0.5 means if one father is 10% richer, then his child will be on average 5% richer than the other child  The higher the intergenerational elasticity, the greater the degree of intergenerational transmission of economic status and the greater intergenerational inequality  In a society with high intergenerational elasticity, intergenerational mobility is low  Changes in the relative economic or social status between parents and children  Upward mobility occurs when the status of a child surpasses that of the parents  Downward mobility is the converse o Intergenerational Inequality and the Extent of Inequality in a population:

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As we can see that inequality in earnings is typically higher when intergenerational inequality is high e.g. UK, US, Italy Others don’t like Denmark  These societies have strong cultures of fairness and equal treatment, and so have policies to reduce inequality between people  This can be through generous U/e benefits, strong pensions etc.  They also try to limit intergenerational inequality by offering equal opportunities for high quality education and other policies (inheritance tax) There can be correlation of cross-sectional and intergenerational inequality  Some individuals experience good or bad shock which are then transmitted to generations below  These can affect the shocks passed down between generations e.g. if a father was rich because of good fortune, his son or daughter will also be rich through inheritance Thus where intergenerational inequality is high, incomes resulting from good or bad luck will be passed down through generations and contribute to cross sectional inequality

19.3 What (If Anything) is Wrong with Inequality? 

Perceived, Ideal and Actual Inequalities: o People believe there may be too much inequality:  In reality the ideal and estimated amount is very far off the actual amount where the top 20% own up to 85% of the wealth in a country

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When is inequality unfair? o Why people differ?  Differences in self-interest contribute to who thinks inequality is unfair e.g. richer people typically oppose redistribution that favours poor and vice versa  People have differences in beliefs about why the poor or rich became poor or rich  People have strong sentiments towards fairness – some people will give up large sums of money to ensure outcome are consistent with the idea of economic justice  E.g. Ultimatum Game – the responder will rather they and the proposer receive nothing than be treated unfairly o Fairness:  Both rich and poor believe high levels of inequality are unfair and the government should reduce economic disparities – even if it reduces the disposable income of the voter  Procedural theories, fairness is based off how the inequality came to be e.g. why the person is rich or poor opposed to how rich or poor they are  Studies show that a person who thinks that hard work and risk taking are essential to economic success is less likely to support redistribution to the poor than those who think it is due to inheritance, race, connections, or who your parents are

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People will be more likely to think it is unfair if income depends substantially on ‘accidents of birth’ Here, how much inequality is too much would be determined after you know a person’s background Inequalities based on hard work or risks are less likely to be seen as an issue

19.4 How much Inequality is too Much (or too Little)? 

A lens for looking at Unfairness: the Veil of Ignorance o Behind the veil of ignorance we don’t know what position we would occupy in a society that we designed, either rich or poor?  The fundamental idea is that justice should be impartial – one should not favour one group over another  The veil of ignorance makes us think like that

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Feasible Inequality:

o E: rich and poor receive the same income, on the 45 degree line R: the maximum feasible income of poor – the poor are as rich as possible The Feasible Set: is the frontier of the feasible set of income distributions of the economy, it is the curved red line and its slope is MRT  Maximum expected income: to maximise this, you would choose A, where the gains of the rich are exactly offset by income losses by the poor, so the MRT = -1  If you knew you would be rich: you would pick F  Worst Solution for the Poor: Point D – not pareto efficient  Inequality Aversion: point B – chosen by an inequality averse person o Some inequality is necessary to incentivise people in the economy o Points B and R show possible combinations in which the rich are richer than the poor, but the poor are richer than complete equality  This is a win-win possibility: giving more income to the rich allows the poor ro have more income as well  R is pareto inefficient because the rich and poor are better off at R than E  At R is where the poor are as rich as they can possibly be in this economy (shown by the FF)  The point Rawls, the philosopher, favoured  Notice, above R the frontier is steep, so it is possible to make the rich much richer by making a small reduction in the income of the poor   

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We assume governments can adopt policies to bring about any of the economically feasible points  But there are limitations to this which would shrink the feasible set o MRT, the income losses of poor transfer to income gains of rich  Slope of FF = MRT  MRT = income gains for the rich / income losses for the poor o If we had to choose which point to move, where expected income is = 0.5(income of rich) + 0.5(income of poor) we would choose  Move to R, as income gains for rich come at little expense of the poor – highest income for poor  If you wanted to maximise your expected income without caring about the degree of inequality you would choose A – highest average income for rich and poor  Above A, inequalities would be so severe that average income will fall and the rich would get a larger slice of a smaller pie  Might occur if poor are net fed enough to work, or angry at their condition  More unequal societies devote more resources to workers employed in private and public security activities than more equal countries with similar GDP 

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A Preference for Fairness: o Where would we choose:  Points in FF would be ignored as they are all pareto-inefficient and each point is inferior to F and R  The decision between F and R will be based on the indifference curves and what is valued more based on this  Curves further away from the origin are preferred (more income for both groups)  The slope of indifference curves is the marginal rate of substitution between income for the rich and income for the poor  Slope of indifference curves = MRS  MRS = marginal value of poor income / marginal value of rich income o You would then maximise utility at the point where MRT=MRS  If you wished to maximise your expected income you would place equal value on the income of the rich and poor because you are equally likely to be either  If you are inequality averse then you care about your own payoff but also dislike inequality across groups even if you were in the richer class and will choose B  B is somewhere between Rawls’ ideal (highest feasible income for poor) and point A (highest average income)  We can find which points we want but not how the points can be implemented  To do this you must alter one or more cause of the current state of inequality

19.5 Endowments, Technology, and Institutions  Income and Endowments: o Endowments are the factors that affect a person’s income e.g. what they own or have, who they are etc. and include:  Their financial wealth: E.g. savings or stocks or bonds they own or which they receive interest or dividends  The physical assets they own: E.g. land, buildings, company machinery from which they may receive profit or rents or can use as collateral  Their schooling and work experience: affects their value to an employer and therefore their earnings on the labour market (human capital) 10

Their race, gender, age, and other aspects: that may affect wages, access to credit, or other exchanges  Their citizenship and whether they have a visa will determine if they can legally work in a country and therefore their earnings in the labour market  Any other attribute: or possession, or capacity that affects the income they receive o Hence an individual’s income depends on their endowments and their income from each endowment o From looking at peoples endowments we can understand income inequality  The factors influencing one’s income can be understood using the model of cause-andeffect relationships below: 

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  The arrows point from a cause to and effect Institutions and Policies effect on intergenerational inequality:  Inheritance tax can reduce intergenerational inequality, but if it is low it allows the wealthy to maintain their wealth  Elite education, such as top universities, can have positive assortments as they provide networking opportunities for their offspring to the wealthy Technology matters too:  It can create strong economies of scale e.g. digital platforms that support winner-takeall forms of competition  A few people, the winners, will end up with substantial endowments as financial or real assets whilst others end up with little Both tech and institutions contribute to endowments, but also on supply and demand  If the demand of one’s skill is limited, e.g. due to cuts in that area, then one may not be able to work full time or if a firm faces new competition that prevents usual profit Technology has also changed the value of endowments  E.g. physical skills in farming became less important with mechanisation  The change in technology can reduce the value and demand of a skill relative to others  E.g. land will depend on how productive it is in growing marketable crops (technology) or if it is zoned for commercial or residential uses (institutions)

Model to Review Inequality from previous units: o How differences in endowments determined economic outcomes, including inequality a few examples:

Situation, actors and unit

Endowment

Landlord and farmer: Bruno and Angela (Unit 5)

Bruno owns the land; Angela has 24 hours of potential labour

Firm: owners and employees (Unit 6)

Owner: ownership of

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Reservation option Bruno: rent land to another farmer; Angela: government support Owner: hire some other employee;

Conflict over? Rent paid by Angela to Bruno and the hours that Angela works Wage, working conditions,

Institutions and policies (examples) Angela’s reservation option (which depends on whether slavery is legal) and legislation limiting work hours. Level of unemployment insurance, employment level,

Way Technology affects degree of inequality (examples) Angela’s increased productivity due to an improvement in see...