Inequalities in Income

Economic inequality includes both inequalities in income and inequalities in wealth.

Income is a flow; it is received at a certain rate in a given period of time. For instance I may get paid an annual salary or receive a monthly rent from a house I own and let out.

Economists distinguish between 3 types of income that households may receive:

Earned income refers to salary or wages from employment (including self employment)

Unearned income refers to income from assets (wealth), such as property, shares and savings; ie rent, dividends and interest.

Transfer payments refers to income received from state benefits and pensions. These do not count as part of national income (GDP) because they are not paid in return for the production of goods and services. They are instead a redistribution of income (mainly from taxpayers to recipients).

Inequalities of income ___within ___a country because:

Some occupations are more highly paid than others

Some people are not in work and rely on benefits (including pensioners and people with disabilities). The extent to which the government redistributes income through the tax and benefits system can have a significant impact on inequality of incomes.

Wealth is very unequally distributed, and therefore income from wealth is also unequal.

Product markets may be insufficiently regulated. This can lead to monopolies, which charge high prices, make excess profits, so that shareholders gain a larger share of income at the expense of workers.

Inequalities of income ___between ___countries arise because:

Developing countries are less likely to have a comprehensive system of state benefits, making it likely that the incomes of people not able to work will be very low indeed.

Productivity is generally lower, due to lower levels of education and skills (human capital).

Developing countries tend to suffer higher levels of corruption, which can lead to much of the income in a country going to a small elite (usually people connected to the government)

Foreign multinational companies may own substantial economic assets in developing countries, such as mines or factories, pay little tax in the host country and take the profits out of the country.

Product markets are likely to be less well regulated in developing countries, partly because of corruption and poor governance.

Inequalities in Wealth

Wealth is a stock; it refers to the money value of a person’s marketable assets. It is measured at a particular moment in time. For the majority of the population, the house or flat they live in is likely to be their main source of wealth, plus their accumulated savings in pension and life assurance policies. Other sources of wealth include possessions such as jewellery and vehicles.

Inequalities of wealth ___within ___a country arise because:

Incomes are unequal. People on high incomes can not only save more than those on lower incomes, they can also save a higher % of their incomes. This enables high income individuals to accumulate a lot of wealth during their lifetimes. Those on the lowest incomes struggle to save at all, and are more likely to accumulate debt rather than wealth.

_Inheritance _tends to perpetuate inequality as those with wealth pass it on to their children, whilst poorer families have little to pass on.

Wealth creates more wealth.Relatively few people become billionaires having started with nothing. If you start with a substantial fortune, you can afford to take risks with some of it. High risk activities are more likely to yield a higher return and therefore generate more wealth. A person with only modest savings is more likely to invest it in a safer, such as a building society account, where it earns only a modest rate of interest.

Inequalities of wealth ___between ___countries arise because:

Developed countries have had longer to accumulate wealth. Rich industrialised countries have had many generations to accumulate both public and private wealth. Developing countries may have had subsistence economies until relatively recently.

Resource endowment is unequal. Countries with large stocks of valuable natural resources are generally wealthy. Norway and Saudi Arabia are good examples of countries with vast deposits of oil and gas, but relatively small populations. But unless the income from this wealth is well managed, it may not benefit much of the population. Much of the mineral wealth in developing countries is owned and controlled by foreign multi-nationals, who sometimes bribe politicians in order to gain the rights over those resources.

Measuring Inequality of Income and Wealth

This can be done using a Lorenz curve. This is shown in Fig 1 below:

Inequality, figure 1

The vertical axis shows the cumulative % of income and the horizontal axis shows the cumulative % of the population. The red line shows how the country’s income is shared amongst the population. You can see, for instance that the poorest 80% of the population in this example have 50% of total income between them, leaving the other 50% in the hands of the richest 20%.

The blue line, which is at 45% to the origin is called the line of equal distribution. If income was distributed this way, everyone would have the same income. 10% of income would be shared by 10% of the population and so on.

We can measure from the Lorenz curve diagram the extent of inequality by calculating the Gini coefficient. It is calculated by dividing area A by the sum of area A+B.

The value of the Gini coefficient lies between 0 and 1. A value of 0 means that income is completely equally shared (along the line of equal distribution). A value of 1 would mean that a single person has all the income (the red line would follow the horizontal axis and then become vertical at 100% of the population).

The closer the Gini coefficient is to 1, the more unequal is the distribution of income. In terms of the diagram, the more the red line moves outwards from the blue line, the more unequal is the distribution.

We can also use the Lorenz curve and Gini coefficient to measure how wealth is distributed, simply by replacing income with wealth on the vertical axis.

Explain the difference between wealth and income, and identify why both are unequally distributed.
Your answer should include: stock flow / earned income / unearned income / transfer payments / developing countries / productivity / inheritance / corruption / multinational companies / resource endowment / accumulate wealth / accumulation of wealth