Economics: Income Distribution and Poverty - Essay Example

Economics: Income Distribution and Poverty Introduction "Life is unfair," is a truism often repeated. This applies to many things. Closest to the political mind are the inequalities of income and wealth, which continue to figure prominently in nearly all acceptance speeches at party conventions nominating candidates for president: Equal opportunity is as American as apple pie. In terms of individual justice or injustice, inequalities of income are easy to grasp. As agents in the workings of the national economy, however, these inequalities are far below the surface of ordinary debate. Economic distributions conjure up a wide array of problems: of meaning, measurement, explanation, and policy prescription. The topic should be at the forefront of our current political debate, for economic inequality has been growing in the United States for some time, and very evidently so in the 1980s. Distribution almost always means some degree of inequality. This turns out to be ambiguous. Inequality can be good or bad depending on a host of intricate connections with nearly all facets of economy and society. Income, wealth, size of firms, size of communities--all functioning entities in society can be, and are, of unequal size. As a consequence, they control different sized parts of the whole that is distributed among them. This includes the control of the creation and allocation of human capital. The meaning of inequality touches on many factors, both individual and collective. Among them are incentives to exertion; reward for effort; the resources to realize one's potential; welfare, both individual and collective; and power within society--power to maintain one's private sphere versus the power of great wealth to coerce or enforce the will of the rich and the economically powerful. Money power often tends to infringe on ballot power. James Madison, the principal author of the U.S. Constitution, warned against the possible misuse of money power. The basic explanation of economic inequality was put forth nearly two centuries ago by David Ricardo, in his classical formulation of the theory of rent. Unending debates since then, from Karl Marx to members of the Hoover Institution, have stirred up much dust, but when the dust settles, Ricardo's concept of rent still comes out as the primary idea around which economic inequalities can be explained (John, 1985). The experience of primitive resource abundance got a new lease on life in the Western hemisphere following the geographic discoveries. The North American frontier experience was a breeding ground for economic and political democracy. The same force was frustrated in Latin America because its institutions were patterned on Old World scarcity and inequality. Similar problems also took root in the South of the United States with the slavery economy. Here, the logic of scarcity was inverted: Bondage (as in parts of the Old World) was a response to the scarcity of labor. The history of bondage and labor freedom in Europe, including Russia, reflects this paradox. The same has been true until recently in parts of Brazil, for instance. The American experience with abundant land was paralleled later in the country's unexpected abundance of petroleum and natural gas. Again, as in the Old World, resource owners sought relief from the cheapening of abundant resources by promoting intentionally designed overuse, leading to social waste, and hence contrived scarcity. Contrived scarcity turns the relation between rich and poor into a class conflict rather than a matter of economic rationality. From the New Deal until recently, public policy in the United States to some extent tended to favor less economic inequality among the population, as should be expected from economic development and affluence. In the 1980s, however, this trend was reversed. Tax reform also has moved the trend in the wrong direction, without achieving the consequences for the sake of which it was advanced. An already disturbing tendency toward plutocracy in the nation's political and social life has been furthered by official policy on the mistaken assumption that this would maximize economic growth. Mistaken ideas of so-called conservatism have, in fact, led the nation into a direction that, if pursued, could well mean the end of democracy as well as of sustained economic growth. Economic distributions determine the rewards for ability and effort, as well as welfare and power. The reward is only in part allocated to people according to what they may be worth as producers. It also reflects the use of capital, the ownership of which may or may not be deserved. In modern times, the classical dichotomy of labor versus capital has been complicated by the increasing importance of human capital, which also is not necessarily deserved. Rent (in the wide sense), accruing to both conventional and human capital is an important instrument of distribution (Mark, 1984). Distributions can be discussed in terms of both justice and efficiency. These two criteria do not always lead to the same conclusion, but they overlap to a large extent. In common understanding, just distributions will reward hard work, competence, inventiveness, and initiative. They will also protect the weak or temporarily unfortunate individuals against hardships that may not be their fault and that might otherwise destroy their ability to make their contributions to society in the future. Just distributions should also protect against extreme concentrations of economic and political power. In extreme cases, unjust distributions may be highly detrimental to society as well as to many individuals. Income distributions affect the access to economic opportunity, which is a matter both of justice and of social utility. In our "diploma-mill" society, access to opportunity depends on access to institutions of formal education. Even if everyone were to get some comparable measure of education, the resulting diplomas would still have different effects in granting access to careers affording high economic rewards, depending on what seat of learning has issued the diploma. Opportunity is not merely a matter of reward or failure for individuals; it also concerns society's access to its entire potential talent pool. Such access is blocked when the gifted poor are held back and the mediocre offspring of the rich are favored beyond their ability. Economic inequality also affects power. Income means not only the opportunity to consume and invest, including investment in one's own or one's family's human capital. Income also means economic power, which is eventually translated into political power. Increased economic power to one group may impose special constraints on the whole course of economic change, and thus can impinge positively or negatively on the power as well as the welfare of other groups. Income distribution can also influence the rate and direction of economic expansion. This is not just a matter of standard economic theory. It also depends on special forces that may influence the amount of investment versus prestige consumption, for instance. Thus, it can influence the demand schedules for essential supplies such as housing and quality food, and create demand schedules for nonessential goods and services such as fur coats and cosmetic surgery. The various forces that affect income distribution often conflict with each other. Economic Growth and Development We should make a distinction between economic growth and economic development. Growth means becoming bigger; development means becoming more productive, and usually also more advanced and more complex. Growth and development interact; more often than not, they are necessary for each other. Growth, in any event, is what interests most people, for it should mean more income --or so it seems (Henry, 1879). Controversy about inequality and growth centers around the problem of savings and how they are affected by the degree of inequality. The simplistic argument has it that the rich save more of their income; hence there would be more savings and more investment in a more unequal society, and less in a less unequal one. Competing with, and often contradicting, this argument are many historical observations, but also arguments relating to economic structure, demography, class barriers and cultural constraints on both growth and development (Abercrombie, 1967). If the economy as a whole grows faster than the agricultural sector (or the traditional sectors), the slow-growing parts will become a lesser part of the whole. Their slower growth will affect the weighted average of the overall growth rate less and less. This will render possible an acceleration of growth as the economy rises into middle- income levels of per capita national product. It is then that the U-curve may begin to turn around, since the higher paid strata of society now begin to weigh more heavily in the whole economy. On a theoretical level it has been shown that the rate of change in inequality, with economic growth, will depend to a large extent on how much of the added production stays with those who already have high incomes and how much comes down to those who had low incomes to begin with. The problem with many of the low- income countries in recent times is that they often continue to have population growth rates that are higher than those in the present high- income countries at the corresponding levels of industrialization. As a consequence, sector shifts and a resulting reduction in the degree of inequality is slower to come. An often repeated theory states that as the level of per capita income rises in a country, the rate of population growth should go down. This is also known as the principle of the demographic transition, and is well established from studies of Europe and North America. The logic underlying the principle of demographic transition is, briefly, that in rural society, and especially in traditional rural society, children are an asset; whereas in city life, they are a liability. Therefore, the gradual transition from mainly agrarian to mainly urban-industrial ways of life should be accompanied by a gradual lowering of the birth rates and the rates of population growth. The latter consequence would follow rather more slowly than the fall in birth rates, because the same transition also leads to lower infant mortality and higher life expectancies. There is no way to really predict the effect on population growth from economic growth rates or economic sector proportions. Cultural factors may also intervene. This does not prevent us from tracing some influences, intended or unintended, of policy on the demographic trends. France reached a demographic transition earlier in the 1800s than would have happened otherwise because the Civil Code decreed the equal division of inheritance among all sons and daughters. This broke down previous de facto primogeniture, and so favored the prevalence of the two-children family in France, leading to the well-known demographic stagnation that was reversed only after 1945 when allocations familiales in essence paid people to have more children. Population growth thus affects inequality, both by its effect on the demographic transition, influencing sector proportions, and by the direct effect on factor supplies and factor scarcities. It may also, in turn, be influenced by economic inequality. In the literature of economic distributions, in general there is not enough attention given to the fact that we should be looking at two interrelated functions-the distribution of the population and the distribution of the good that is distributed among the population. Whether the distribution is of income, wealth, size of business firm, size of farm, or some other factor, it is always true that any function portraying the distribution of population numbers (of income recipients, farms, and so forth) must have a companion function portraying the distribution of the good being distributed (aggregate income, total farmland, and similar elements). The distribution of the good cannot be described in arbitrary numbers, but rather must bear a distinct relation to the distribution of the population. Distribution of the good has a place in economic analysis for its own sake. The viewpoint is then focused on economic power rather than welfare or distributive justice. The companion function can, however, also be used as an important indicator as to whether the population function, as written in mathematical terms, can exist in the real world. When the distribution of population numbers by size groups is given in some detail, the distribution of the good can be inferred, if approximately, from that of the numbers. In a given population function there can be only one possible distribution of the good. Given the slope of the main function, each size interval must have an average size (within the interval) that is consistent with the slope of the function at that part of the curve. Obviously, the interval average defines the interval's share of the good. The sum of all the interval shares of the good must add up to 100 percent of the good being distributed. If some other total is reached, then the population function as written cannot be accepted as a portrait of any real economic distribution. Sometimes this kind of analysis can be used to unmask very bad statistics. It can be used also to weed out theoretical distributive functions that cannot exist in the real world. Conclusion Full employment and vigorous industrial expansion should of themselves lead to less inequality. Rising employment and an increasing abundance of ordinary consumer goods and services should render the rent profile less steep and thus allow more of the surplus product of society to become wages for the lower income classes. That this logic of economic development was reversed in the United States in recent times can only be read as a sign of decay in an aging economic system. Recently, earned income of individuals (the incentive aspect of inequality) in this country has fallen to where the ratio of median to average is close to .70:1.00. At that level of inequality, the upper half of the population gets five-sixths of all the income, while the upper one-tenth of the population receives about sixty times as much as the lowest one-tenth. Between households (the welfare aspect of inequality), inequality is somewhat less; the median/average ratio is close to .80:1.00, and the upper half of the population gets only four-fifths of the income, while the highest one-tenth of the households receives between twenty-five and thirty times the income of the lowest one-tenth of the households. This is much more inequality than was the case twenty years ago. To get back to the level of the late 1960s or early 1970s is hardly satisfactory, however. Even then, the United States was more unequal than many other countries, especially the highly developed nations. The inequality of the years around 1970 did set the stage for the following downslide, so we should aim at something better. As an example of what may be possible, look at the case in which the earned income of individuals has a median/average ratio of about .85:1.00, and that of households about .90:1.00. For individuals, the upper half of the population win still get three-quarters of the income, and the upper one-tenth will have between fifteen and twenty times that of the lowest one-tenth. For households, the proportions would again be somewhat closer: The upper half would get over two-thirds of the income, and the upper one-tenth about ten times the income of the lowest one-tenth of the households. Would such proportions not provide sufficient incentive for gifted and energetic individuals to exert themselves Most people have to be content with such prospects--in a high- income society, they are indeed quite good. We will even argue that getting away from the kind of lottery jackpot mentality that underlies much of the star performance in arts and sports would be a good thing. The economy cannot at length live and thrive on high records. A quality job well done has many rewards of its own, and the economic rewards, therefore, need only be substantial; they do not need any astronomical prospects of star incomes. Where does that leave the cultural crisis The quality of culture is not in the province of economics, and we therefore will not match the promises sometimes made by conservative economists who represent capitalism as culturally productive. However, it is arguable that the truly creative minds, which are now too often drowned out in the din of cash registers and bottom lines, will find society's climate somewhat more hospitable when the pressure of money has been reduced. The pressure will be reduced, but not eliminated. Within new parameters of competition, the role of the market mechanisms--as distinct from market forces-will continues to be the same. Reference: Abercrombie K. C. 1967. "Incomes and Their Distribution in Agriculture in Relation to the Rest of the Economy," FAO Monthly Bulletin of Agricultural Economics and Statistics 16, no. 6.. Creedy John. 1985. Dynamics of Income Distribution. Oxford: Basil Blackwell. George Henry. 1879. Progress and Poverty. San Francisco, CA: Wm. N. Hinton. Lilla Mark. 1984. "Why the 'Income Distribution' Is So Misleading." The Public Interest 77. Read More