Income Inequality and Wellbeing - Literature review Example

Macroeconomics By: Income disparity is one of the metrics of economic disparity that refers to how income is distributed among individuals in a group, among groups present in a population or among the different countries of the world. Income inequality usually varies between societies, periods of history and heavily dependent on the income structures and systems put in place by the relevant authorities. This term could also be used to point out the cross-sectional distribution of income and wealth at specified periods of time or spread over time. It significantly demonstrates the financial gap that usually exists between the rich and the poor in individual countries and between the countries themselves (Griffiths & Wall 2012, pg. 11). Different countries have different levels of economic disparities, there are those countries including Japan and Italy whose economies are characterized by high-income inequality and relatively lower wealth disparities while others like Switzerland and Denmark have relatively lower income inequality and higher wealth inequality. According to the available statistics and contrary to expectations, income inequality has continued to rise over the past quarter-century instead of falling. Countries that have been considered to have advanced economies like the United Kingdom and the United States have become much richer and much more unequal in recent times. The United Kingdom for instance had its per capita income rise by 77% in 2010 while during the same period had an increased income inequality by close to 7 Gini points (Milanovic, 2011, p. 8). A lot of different techniques have been employed for the measurements of these disparities in income levels key among which consider the number of poor people, the problems arising from the use of such measurement methods and how frequent people move among the income classes. The overall objective of this exercise, however, is to be able to perform the most objectively possible computation of this highly subjective phenomenon. Most Economists often use household surveys for the measurement of income inequality. They perform this by interviewing a broad spectrum of households to determine their various sources of income, both monetary and through other possessions and their patterns of consumption. Ranking is then done by obtaining the household’s total income, subtracting the direct taxes paid and dividing this by the number of people living in each of the households. The economists then rank all the individuals in the survey from the poorest to the richest; this being done according to their relative household per capita income. The commonly used measures include the Lorenz curve and the Gini coefficient (Milanovic, 2011 p. 17). The Lorenz curve is important in showing the relationship between the cumulative percentage of households and the cumulative percentage of income. This is done after the households whose data are available have been grouped in a particular way. The Lorenz curve plots the proportion of the total income on the y axis and the amount that each quantity of the population has on the x axis, in cumulative terms. A 450 line is drawn to represent the absolute equality and the Lorenz curve to represent the current distribution of the income. Reading from the drawn curves, if the Lorenz curve reaches farther away from the absolute equality curve, then it is deduced that more inequality dominates the distribution (Mankiw & Taylor, 2014, p. 386). The Gini coefficient, generated by an Italian statistician in 191 usually the widely used measure of income inequality is derived from the Lorenz curve. This coefficient measures the ratio of the area between the 450 curve representing the absolute equality of income and the Lorenz curve to the entire area under the 450-degree line. This coefficient is often a measurement of the degree of inequality of income in a country. Comparing it with different countries allows the economists to observe the different income distributions. Its value ranges from 0 to 1, 0 being the value of perfect equality and 1 of maximum inequality where one household takes all the income, and the rest of the other households have none. It follows thus that the higher the Gini coefficient the higher the degree of income inequality and vice versa (Mankiw & Taylor, 2014, p. 388). Illustration of a Lorenz curve As described above, Lorenzo curve is used as an economic concept to describe inequality in wealth or size. It is a function of cumulative proportion of ordered people in relation to their cumulative proportion of their size. The mathematic representation is given by: Whereby; F(y) =cumulative distribution function of ordered people µ=the average size assume that average income of 5 segments in an economy are 10,000, 24,000, 80,000, 50,000, and 110,000 pounds. The total income is given by the sum of the incomes hence £274000. The percentage of total income for each segment is then calculated as shown below; Bottom segment% 10000/274000 3.6% Second segment% 24000/274000 8.8% Third segment% 50000/274000 18.2% Fourth segment% 80000/274000 29.2% Top segment% 110000/274000 40.1% According to the above figures, the bottom 5th of the population gets less than 4% of the total income while the top 5th gets over 40% of total income, hence large degree of income inequality. The income distribution table is shown below: Segment %income Cumulative % income Bottom 20% 3.6 3.6 Second 20% 8.8 12.4 3rd 20% 18.2 30.6 4th 20% 29.2 59.8 Top 20% 40.1 99.9 The table can be plotted to give a graph below: The graph above is what is called a Lorenzo curve. Causes There are numerous causes of income inequality resulting from both individual efforts government actions, and financial and labor markets. Several factors are in play that contributes either individually or in combination in spurring the inequality of income in most countries, both the developed and the developing ones (Salman, 2014, p. 44). Some of these causes include the following: In rich countries like the United Kingdom, several economists have argued that the technological changes being experienced resulting in the increasing demand for highly educated and skilled workers has been the reason that inequality has been on the rise again. Such technological changes coming in the form of improvements in information technologies and communication have been geared towards increasing the productivity of the highly skilled workers as opposed to the unskilled workers. This has contributed to generating a technical change based almost entirely on the skills of an individual. Real wages have thus grown faster for the skilled labor with this technical shift generating higher income disparities (Sloman, Wride & Garratt, 2012, p. 56). A country’s institutional framework to a greater extent also plays a significant role in determining the level of income inequality. Governments of these developed nations can use higher taxes and social transfers to help in the redistribution of some of the higher incomes earned by skilled workers. The form of active redistribution in some of the European countries has helped in explaining why income inequality did increase much less as compared to the English speaking countries (Sloman, Wride & Garratt 2012, p. 85). Another possible cause for increased inequality is the changing social norms. Societies in the past did not welcome the idea of having huge pay gaps between industry chiefs and their employees. The current society has tolerated and learned to accept the existence of such disparities and even encouraged them (Salman, 2014, p. 64). Globalization too has also been blamed for the rising income inequality in the developed nations. Specializing in highly skilled exports has led to the increasing gap between the skilled and unskilled wages. In addition, cheap low-skill imports and outsourcing also reduce wages or increase unemployment among the low or moderately skilled workers; this leading to further increases in income inequality (Salman 2014 pg 72). Education as a factor has also contributed immensely to the larger income inequalities in most countries; this is in reference to its policies and its variable access. A country with poor access to education could be likely to find itself in a situation where the few who were able to obtain education and acquire the necessary skills would be allocated the working positions that offer high salaries. If the supply of these skilled workers isn’t enough meet the country’s demand, the wages will rise even further. And, on the other hand, when the supply of the non-skilled individuals who weren’t able to get access to education soars, the wages would be driven even lower. This would, in essence, have contributed to the widening of the wage gap between these two groups of people. Another aspect of education that would soar up this income inequality involves the introduction and the involvement in policies that lack a formal coherence between what the labor markets demands and the skills being supplied. This can create significant wage differential that in the end translates to income inequality. Lack of enough technical skilled workers as opposed to the excess graduates being supplied in the industrial labor market would mean that the industries would need to outsource such skills, of course with an indication of higher wages and on the other hand reducing the wages for such jobs performed by the graduates (Salman, 2014, p. 82). Consequences Income inequality is directly linked to the self-satisfaction and well-being of individuals. This relates to a number of social structure facets that promotes cohesion, democracy, close family membership and others. It affects everyone linked to it in one way or the other. It was found that the existence of permanent aggregate income inequality often reduced welfare of individual. This is in terms of income distribution and regardless of their level of income. One interpretation was that income inequality was detrimental to wellbeing in the long run because it undermined social cohesion, reinforced social exclusion, and hindering the formation of social capital (Cooper, & Theodossiou, 2013, p. 940). A couple of consequences for the income inequality include among the others: The high and increasing inequality interfere with the various progress made towards poverty reductions. The efforts to be made towards achieving this feat are often linked to the economic growth, poverty linkages and the income inequality prevalent in the country (Sloman Wride & Garratt 2012, p. 98). The increasing income inequality is a vital driver of domestic financial instability typically associated with adverse growth, poverty, and the impacts of distribution. As the living conditions of the low-income earners worsen and income inequalities soars amidst depressed growth, budgetary allocations to sustain governments investments becomes difficult to sustain (Hoeller & Pisue, 2014, p. 71). Income inequalities can be a precursor to other inequalities. A case in point would be on the supply of publicly subsidized education which would be likely to be limited especially where the high earners would resist a larger tax burden to finance that which they can privately purchase privately. It is important to note though that there a need to deal with the inequitable distribution of income because a major determinant of health inequality is often income inequality (Griffiths & Wall, 2012, p. 39). For poorer countries that experience acute poverty consisting of majorly those that live below the absolute poverty line, the policies that would be put in place to address the poverty reduction at the margins will be limited. The prosperity of a country or groups of people would have rare chances if enough domestic resources were not stimulated by growth to help in poverty reduction. Such low growths would not guarantee the generation of resources required for measures that can be implored to protect economies against the aftermaths of both domestic and external shocks (Griffiths & Wall 2012, p.48). Increasing or stagnant income inequality conditions often reduce the possibility that the stipulated economic and social policies encouraging inclusive community growth and human development will be adhered to and implemented. The high income earners in such scenarios could induce for themselves more economically inefficient advantages like regressive taxes and/or allocation of funds meant for use by the public for interests of their own other than that of a collective interest (Hoeller & Pisue, 2014, p. 60) In certain countries mostly of unstable democracies with weaker and friable government institutions, the existence of higher income inequalities usually escalates the trouble of putting up and sustaining an accountable and a straightforward government, encouraging the adoption of policies, both economic and social, that are regressive and that which inhibit growth and fights against poverty reduction schemes (Hoeller & Pisue, 2014, p. 67). Reference Cooper, D. McCausland, D & Theodossiou, I. (2013) Income Inequality and Wellbeing: The Plight of the Poor and the Curse of Permanent Inequality, Journal of Economic Issues, Dec. (Available on the module web) Griffiths, A. & Wall, S. (2012) Applied Economics, 12th edition, Prentice Hall, chapter 13 (Available on the module web) Hoeller, P. & Pisue, M. (2014) Chapter 1 – Introduction in Hoeller, P & Joumard, I. (2014) Income Inequality in OECD Countries: What are the Drivers and Policy Options, Singapore, SGP: World Scientific Publishing Co. (e-book accessible via Locate) Mankiw, N. & Taylor, M. (2014) Economics, 3rd edition, chapter 18 (will be made available on the module web) Milanovic, B. (2011) More or Less. Finance and Development, September (available on the module web) Salman,S. (2014) The Ninety-Nine Percent and the One Percent, Research in Applied Economics, 6(3) (Available on the module web) Sloman, J., Wride, A. & Garratt, D. (2012) Economics, 8th edition, Pearson: London. Chapter 10 Read More