The Oxford English Dictionary defines inequality as “the quality of being unequal or uneven”. The instance of being unequal may arise from the disparity of distribution or opportunity and spans all social dogmas including: gender, race, political or religious persuasion. There are many forms of measuring inequality wealth, consumption and opportunity but there are problems inherent in each. Perhaps the most effective way of measuring inequality is comparing income earned, as there is sufficient raw data, it is easily conceptualised and it does not entail normative statements or value judgements.
The most widely used measure of income inequality in society is the Gini co-efficient. It is a precise way of measuring the position of the Lorenz curve (see diagram below), a graph that shows, for the bottom x% of households, the percentage y% of the total income which they have. To compute the Gini Coefficient, the area between the Lorenz Curve and the 45 degree equality line is measured. This area is divided by the entire area below the 45 degree line (which is always exactly a 1/2).
The quotient is the Gini coefficient, a measure of inequality, expressed as a percentage or as the numerical equivalent of that percentage, which is always between 0 and 1. The higher the figure for the Gini co-efficient, the greater is the degree between high and lower income households. For a perfectly equal distribution, where every household is earning exactly the same, there would be no area between the 45 degree line and the Lorenz curve-a Gini coefficient of zero.
For complete inequality, a single household earning a country’s entire income, the Lorenz curve would coincide with the straight lines at the lower and right boundaries of the curve, making the Gini coefficient one. Typically developed countries have a Gini-co efficient rating between 0. 2 and 0. 4. In the UK the Gini coefficient has moved through several distinct phases in the last two decades. The graph below is taken from National Statistics Online and shows the Gini coefficient for equivalised disposable income in the UK from the 1979 to 2002.
During the first half of the 1980s disposable income inequality was fairly stable, with the Gini co-efficient remaining around 0. 27. However the second half of the 1980s was characterised by increasing levels of income equality with the Gini co-efficient peaking at 0. 36 in 1990. During the first half of the 1990s inequality fell slightly, but since then it appears to have risen slightly. By 2001-02, the Gini coefficient had risen back to its 1990 level. Ultimately the level of income one earns will have a direct effect on the wealth they accumulate.
Wealth is considerably less evenly distributed than income. Life cycle effects mean that this will almost always be so: people build up assets during the course of their working lives and then draw them down during the years of retirement with the residue passing to others at their death. The fact that the income gap is widening only means the distribution of wealth is becoming more unequal. It is estimated that the wealthiest 1 per cent of individuals owned between a sixth and a quarter of the total wealth of the household sector in the last decade.
In contrast, half the population shared between them only 6 per cent of total wealth in 2000. The unequal distribution of wealth affects both absolute poverty and relative poverty. Absolute poverty measures the number of people living below a certain income threshold or the number of households unable to afford certain basic goods and services. Absolute poverty is all but eradicated in the UK Conversely relative poverty measures the extent to which a household’s financial resources falls below an average income threshold for the economy.
Although living standards and real incomes have grown because of higher employment and sustained economic growth over recent years, the gains in income and wealth have been unevenly distributed across the population. DDS figures indicate that 6 million people were in living in relative poverty in 1979 compared to 11 million presently. Evidently the income and wealth gap between rich and poor in the UK has risen over the past 20 years magnifying realtive poverty.
The existence and persitence of this has been the result of a complex series of economic and social factors, not all of which are under the control or influence of the government. Income earned is a decisive factor in the increasing levels of income inequality. Naturally people will earn varying wages depending on their vocations however increasing wage inequalities over the past 20 years have worsened this problem. Principally wages and earnings in some jobs have grown much faster than others.
This explains why in 1999, the real hourly wage rate for men in the bottom tenth of the earnings league was 61 % higher than the 1979 level. In contrast, the wages of the top 10% had increased by over 97% of the same period. This is largely down to the fact that real earnings growth is fastest for those workers with high-level skills whose jobs are in demand whereas low skill service sector industries where there is little trade union protection and job insecurity is endemic offer proportionately lower wages.
The distribution of gross weekly earnings in 1999 is seen below, and shows ever increasing pay gap between the highest income earners and those at the bottom of the pay ladder, which ultimately creates an uneven distribution of wealth. The widening wage rate has had a direct effect on the growth in occupational pension income; incomes paid by pension schemes to former employees. High income earners tend to be part of these schemes whereas low income earners are not considered for membership.
It stands to reason that members of these schemes will be able to retire in relative financial security whereas those who are not must rely solely on the state pension scheme. Whereas occupational schemes are linked to rises in earnings, the flat state pension grows only in line with inflation meaning it does not grow in real terms, subsequently worsening pensioner poverty. Generally speaking state benefits as a whole have not increased in real terms over the past 20 years. Therefore, households partly or wholly dependent on welfare assistance see their relative incomes fall over time.
Those who are unemployed must rely on these state handouts and subsequently they fall further behind those employed in terms of income levels. Twice since 1980, mass unemployment has affected Britain resulting in a large rise in relative poverty. To compound this income tax rates have fallen, specifically those targeting high income earners; during the 1980’s the top rate of tax was cut from 80% to 40%. These tax reductions have worsened relative poverty as people in work are able to keep a higher proportion of what they earned.
Ultimately cuts in any form of direct taxation will tend to disproportionately favour the better off. Other factors that affect inequality in society include the composition of the household. Although an individual may be a high income earner, supporting a large family will mean the income per person in the household is relatively low. Conversely a household where all members of the family are earning a wage despite the fact it is low may have a high household income. Subsequently inequalities differ depending on whether they are being measured per individual or per household.
Generally it is accepted by the government that income inequality constitutes market failure as the market mechanism produces an allocation of resources which is sub optimal. When the government chooses to address market failure concerning income equality it does so in terms of equity or fairness rather than merely what is unequal. The concept of equity distinguishes between inequality and fairness. Not all inequalities are necessarily unfair. For instance, many poor pensioners today are poor because they failed to make an adequate pension provision for themselves whilst they were working.
Conversely those who saved their money in a pension scheme rather than spending as they earned deserve to enjoy a higher pension. Although in this example inequality exists in terms of unequal pensions, this is not necessarily unfair. Although the concept of equity is a normative issue, in that the government must make decisions concerning ‘fairness’ based on value judgment, it is accepted that the government takes into account both horizontal and vertical equity when implementing policies to reduce income inequality.
Horizontal equity is the principle that identical individuals in identical situations face identical treatment. Therefore certain situations such as the application of a job must be conducted with complete impartiality regardless of age, race or background. Vertical equity, on the other hand, concerns the different treatment of people with different characteristics. The concept acknowledges those who are disadvantaged through job, race income or social background must receive different handling in order to achieve equity.
The twin concepts of horizontal equity are evident in government policy to redistribute income in society. Take for example taxation, a system which plays a crucial role in the distribution of income in society. Horizontal equity governs that taxpayers in similar financial circumstances must be treated in the same way, i. e. people on the same incomes should pay the same amount of income tax. Conversely vertical equity is achieved because taxpayers with different resources are treated differently, for example, by introducing a tax structure with progressively rising tax rates.
The current Government has introduced reforms to make the current tax and benefit system more progressive in order to increase vertical equity. The more progressive a tax, the greater the link between ability to pay the tax and as a result this is likely to redistribute wealth. The charts below illustrate the impact of taxes in reducing the scale of inequality. Principally the post tax income of the poorest households is substantially higher than their original income due to redistribution from higher income earners.
The original income of the richest fifth of households is nearly 17 times that of the poorest. However after taxes the ratio has fallen to 7. Alternatively the government could provide monetary benefits through social security or National Insurance to those requiring financial support. Through the provision of goods and services which are deemed basic to any standard of living in a modernized industrial economy, such as education, housing and health care, the government seeks to give citizens equal opportunity in society.
With respect to health care horizontal equity is achieved by providing equal access to medical services to all individuals irrespective of factors such as location, ethnicity, religion and the age of a patient. Vertical equity would be improved by treating patients equally irrespective of income or financial wealth. Although access to the same education and healthcare will ultimately improve equality of opportunity is it ‘fair’ to restrict those capable of affording private education and health.
Furthermore state provision leads to a dependence on government handouts and will ultimately depress economic growth. In the long run the key to reducing relative poverty for the British economy is to create sufficient jobs which offer a decent rate of pay as high employment rates are consistent with rising average incomes. The current government intends to achieve this through legislation targeting supply side factors. For instance the introduction of a national minimum wage has forced employers to increase rates of pay for the lowest paid workers, ultimately encouraging the unemployed to seek work.
They also intend to expand the New Deal Programme for the long term unemployed in order to provide effective retraining, significantly raising their earning potential. Although government intervention in the economy may lead to higher economic welfare, free market economists argue that welfare losses resulting from the redistribution of income far outweigh any benefits. Raising taxes, for instance, creates disincentives to work and take entrepreneurial risks, thus reducing the rate at which aggregate supply increases.
Furthermore individual entrepreneurs may be encouraged to leave the country in order to take advantage of lower tax rates abroad. This coupled with high employment benefits provided by the state which make it make it more worthwhile to remain unemployed than to gain employment, will raise the level of unemployment and could have a detrimental effect on the long term growth rate and prosperity of the national economy. Other polices employed by the government to redistribute income including minimum wage legislation and equal pay legislation may lead to further loss of employment.
This is because these legislations are designed to encourage more people to seek work through higher wages; however firms cannot cope with these extra costs and as a result will employ fewer staff. Essentially free market economists claim that redistribution policies employed by the government will lead to increased unemployment which will inevitably lead to lower economic growth. They argue that income inequality cannot be improved without producing significant negative effects on the National economy and therefore reason it is impractical to narrow the gap between poor and rich.
Instead they argue that income differentials should be widened through low taxation, minimal government legislation in the private sector and the bare minimum of state provision, in order to improve the welfare of those less fortunate in society i. e. to improve poverty. Although the poor may lose out in state benefits they will be more than compensated through increased growth which in theory should ‘trickle down’ from the better off in society to the less fortunate.
Although inequality rises it can be argued that being better off is a matter of absolute quantities rather than relative quantities. Through this theoretical mechanism a system is created where wealth in society will benefit not just the rich but also the poor, particularly those who are unable to work. As it can be seen from free market theory inequality is not necessarily a bad thing, but rather it acknowledges that poverty, a symptom of inequality must be addressed. However it must be questioned whether the use of increased economic growth to tackle poverty is sustainable or indeed viable.
January 9, 2018
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