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View: Income Inequality is NOT the Real Problem


This economics viewpoint is contributed by a former economics lecturer, and is inspired by his former economics students XB and ZB

Introduction to the View

This paper argues that, while many economists and journalists argue that income inequality is a problem in the world today, it is not fundamentally a real issue or problem, but the lack of economic growth and issues with social mobility are the larger problem. This paper takes a meandering view around various theories, ideas, and opinions surrounding this challenging and often controversial topic.

Income Inequality

What is income inequality? Income inequality is about the extent to which income is being distributed unevenly among a group of people. Economic inequalities are shown by people’s different economic positions within a distribution, in terms of wages, non-wage income, and wealth, for example. However, people’s economic positions are also related to other characteristics, for example, their level of disability, ethnic background, or gender.

Measurements of Income Inequality

And there are various ways of measuring economic inequality. 

While there is no systematic economic measure, and econometric statistics differ, there are some common measures, for instance, the Gini coefficient, which measures inequality across the whole of society. According to economic theory, if all the income went to one person and everyone else got nothing, the Gini coefficient would be equal to 1 (meaning maximum inequality). On the other hand, if income was shared equally, the Gini coefficient would equal 0 (maximum equality). In other words, the lower the Gini coefficient, the more equal a society, the coefficient itself being between 0 and 1, for those who are interested in mathematics.

And the Gini coefficient can measure inequality before or after tax and before or after housing or other related costs, and, most importantly for our purposes, will vary depending on what is actually being measured.

The Gini coefficient is also related to what is known as the Lorenz curve, another method of measuring income inequality. Basically, a Lorenz curve shows the percentage of income earned by a given percentage of the population. A ‘perfect’ income distribution would be one where each percentage received the same percentage of income. Perfect equality would be, for example, where 60 percent of the population gain 60 percent of national income. The further the Lorenz curve is from the 45 degree line, the less equal is the distribution of income. It might be interesting to know that the Lorenz curve is directly related to the Gini coefficient and the area under the curve can be used in calculations of the coefficient itself.

Issue of Poverty

Another related economic issue that has to be discussed when it comes to discussing income inequality is the issue of poverty.

What is it, really? People in poverty are those who are considerably worse-off than the majority of the population. Their level of economic deprivation means they are unable to access goods and services that most people consider necessary to an acceptable material standard of living, or to borrow an academic term, they lack economic affordances.

Absolute vs Relative Poverty

There are two main types of poverty that we can consider here. Poverty can be absolute, where absolute poverty refers to a level of deprivation that does not change over time, or a relative term in which relative poverty means that the definition fluctuates in line with changes in the general material living standard.

Inequality, by contrast, is always a relative economic term: it refers to the difference between levels of material living standards and/or income, across the whole economic distribution. In practice, poverty and inequality are correlated and often rise and fall together, but this need not always be so. For example, income inequality can be high in a society without high levels of poverty due to a large difference between the top and the middle of the income spectrum, especially in cities that are small and dependent on trade, such as coastal cities.

Technological Disruptions and Income Inequality? 

What causes income disparity? 

There are many reasons. It is my view, and the view of some respectable economists, that fundamentally, technological disruptions are right at the centre of income inequality. For example, some have argued that changing and evolving technology is the primary reason for the increasing income gap in the USA. For several decades after WWII, new technology was a great leveller in the US, providing good jobs for workers. In the 20th century, US income inequality reached its low point in the 1950s, when technological change was rapid and material living standards increased dramatically. But around the 1970s, technology’s economic impact began to change. It went from being an equaliser to a factor that became complementary to people who were highly trained and highly skilled. And, in that transition, less-skilled workers were left behind. This was also the time of globalisation, and in a related vein as we approached the financial crisis, there was massive deregulation, liberalisation, and lowering of corporate and income taxes which favoured the rich, wealthy, and skilled, vis-à-vis the poor, asset-poor, and unskilled workers who could not take advantage of these wonderful economic conditions that were propitious for those who could. (In this link, we discuss the economic impact of disruptive technology on Singapore.) 

Social and Economic Mobility 

Another related issue is one about social (and economic) mobility. In his very controversial tome Capital in the Twenty-First Century, Thomas Piketty noted that Napoleon justified concentrations of wealth and high levels of inequality in France because the nation was a meritocracy. If you worked hard and had talent, you could rise to the top of the metaphorical economic ladder. 

Some people say that such claims about income mobility have been made by the privileged at the top of the economic ladder. In fact, the American dream is similarly built on this central assertion. First used by the US historian James T. Adams in his book The Epic of America in 1931, the American dream is a term to describe the complex beliefs, religious promises, and political and social expectations in the US, and for a lot of people this American dream is connected to becoming wealthy and the ability to achieve everything if one only works hard enough for it. And for yet others, the dream is about liberty (not limited to economic liberty but certainly also making references to it) and the US being the country of unlimited economic opportunities.

What did Piketty say, Anyhow?

As an aside, who is Piketty in the first case, and what are his economic ideas? He has been rather famous for a few years now. 

According to The Economist, Capital in the Twenty-First Century was published in French in 2013 and in English in 2014. The English version became a bestseller, and prompted a debate on global inequality. Some economists even believe it caused a shift in the focus of economic policy toward distributional questions. 

According to Piketty, in the 18th and 19th centuries, western Europe was highly unequal. Private wealth dwarfed national income, concentrated in rich families who sat atop a rigid class structure. Only the chaos of WWI and WWII and the Great Depression in between disrupted this economic pattern of control. High taxes, rising inflation, and the growth of welfare states caused wealth to shrink dramatically, and ushered in a period in which both income and wealth were distributed in egalitarian fashion. (Do note the Eurocentric slant of his analysis and the provenance of his data.)

But the economic and political shocks of the early 20th century faded and wealth is now reasserting itself. On many economic measures, Piketty reckoned that the importance of wealth in modern economies was approaching levels seen before WWI. From this economic history, Piketty derives an economic theory of capital and inequality: other things being equal, faster economic growth will diminish the importance of wealth in a society, whereas slower growth will increase it, and demographic change that slows global economic growth will make capital more dominant. 

But there are no natural economic forces pushing against the steady concentration of wealth. Only a burst of rapid economic growth, for him, either from technological progress or rising population, or government intervention can keep economies from returning to patrimonial capitalism. 

Piketty in fact recommended adopting a global tax on wealth to prevent soaring inequality contributing to economic or political instability. The book has attracted plenty of criticism. Some wonder whether Piketty is right to extrapolate about the future from past data. And economic theory suggests that it should become harder to earn a good return on wealth the more there is of it, because of diminishing marginal returns. Also, today’s rich, such as Gates or Zuckerberg, come by wealth through work rather than inheritance. Piketty’s policy recommendations are likely ideologically than economically driven.

Is There a Problem with the US' Social and Economic Mobility?

But many of the economic sceptics nonetheless have kind words for the book’s contributions. And since the last few years nonetheless, however, the findings of Piketty and other economists have entered mainstream debate, challenging long-held assumptions. From examples in the USA, bringing into focus how lopsided US income distribution is, findings have not only shown that inequality is widespread, they have also demonstrated that there is relatively little opportunity for those in the lower quintiles of earners to move up to a higher bracket.

Economic conservatives have long argued that inequality is fine as long as income mobility is robust. However, economic data gathered since the early 2000s have shown that US social mobility is low and has been so for half a century, and indeed, it is considerably lower than the US’ European competitors, where social safety nets are much larger and taxes much higher.

In response, many economic commentators and journalists have decried the unequal distribution of income and wealth and argued that governments should limit inequality at the top and make it easier for people to climb the economic ladder. There is an economic problem with this, however. Think about it. For every poor kid who rises to the top fifth in income, someone must fall out of the top fifth. And the proportion of those who rose was never robust, even in the nineteenth century. Some go up, and others go down.

What matters more is absolute social mobility: the degree to which the economy can produce rising wages for all. In other words, the American dream should be built on expanding opportunities for society, which can only come about if average real wages go up. Earning more than your parents is as much or even more a result of the rise of wages after inflation across the economy as it is a reflection of income mobility. In other words, if you are born into the bottom quintile but real wages rise, you will likely exceed your parents’ income even if you remain in that quintile.

Possible Solutions

What we now know is that we cannot rely purely on social mobility to solve these economic problems. Because there has been economic growth, about two out of three children these days are doing better than their parents. But many of them are not doing much better, and about half of this group remain in the same quintile they were born into. Indeed, rising income inequality also makes it harder to move from one quintile to another: the rungs on the economic ladder are farther apart.

Redistribution is not a sustainable solution to the whole complicated issue: For two decades, the inequality lobby tended to focus on a tax solution – how the rich can be taxed more and how that tax can be better spent on reducing the gap between rich and poor. It is not a good way to solve the economic problem, although it is definitely a fast way of creating flatter income graphs. 

Social and Economic Policies

And the main point for all of us is that a combination of social policies and economic growth policies are needed to produce wages for all. They could include a higher minimum wage (but not necessarily a Universal Basic Income or universal income), child allowances, and more and higher level educational programmes. 

But they should also include serious economic stimulus measures by governments to promote economic growth. And for example, government spending programmes should aim to sustain decent income levels through unemployment insurance, expanded earned income and child tax credits, and outright cash allowances. The government should also aim at foundational projects that facilitate long-term economic growth, including expansion of transportation and online infrastructure.

Have Faster and More Economic Growth

There is simply no escaping the central fact here that welfare depends on faster economic growth. In fact, there is always some inequality in any vibrant economy. 

The focus should rightly be on the vitality of the overall economy. And to that end, equality of opportunity which gives workers chances to succeed, is the bigger and more important concern that all governments should address. Give more economic chances - but how can the economy create more economic opportunities?

Entrepreneurship

The answer could be entrepreneurship. In a related issue, this whole issue is related to the fact that we need more entrepreneurs in society as a whole. When entrepreneurship drops, job creation drops, dragging economic growth with it. Perhaps, economic innovation, creativity, and the willingness to take risks will reduce and ameliorate income inequality and produce economic growth for all – so perhaps in the final analysis pro-growth entrepreneurship is the real economic answer to income inequality.


JC Economics Essays - We aim to be an economics blog with opinions, views, and perspectives. The article was contributed by S and he worked in conjunction with XB and ZB. The rest of the research came from academic articles. (XB once raised some of these important economic issues at a forum and some of the views are his.) Thank you for reading and cheers. 

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