Meaning and measurement of income inequality in a developed economy. 3
Measurement of inequality. 6
Possible causes if income inequality. 8
The essay discusses the issue of income inequality with reference to a developed economy, the UK. It is a social and political whose economic causes have been discussed. The essay has two sections; the first part defines and explains what income inequality is and how it is measured, and challenges in measuring it are included. The second part borrows from a wide range of literature to discuss how income inequality arises, its trends in the UK and what can be done to bridge the gap.
Firebaugh (2009)Income inequality is defined as “the relative magnitude of incomes”, where “ at the individual level, income remains constant when income grows at the same rate for every individual” (pg. 73). It is assumed to be the difference or the income gap between the top and bottom earned by citizens in a given economy. Using the evidence of the UK, there is evidence of disproportionate income distribution in the country, a factor that has been attributed to income and wealth disparities in the country. The gap in income inequality determines the difference between the rich and the poor in the country. Narrow gaps in income inequality levels do not necessarily indicate better living standards in an economy. For example, Belfied et al. (2015) noted that in a report that was dated 2002, income inequality was fast increasing, and living standards and levels of poverty were increasing. The gap has been increasing steadily since 1977 from 0.24 to 0.34 in 2014. The widening of the gap does not necessarily poverty but the quality of life would be better if these gaps were diminished.
Source: Mankiw & Taylor (2014)
The graph above indicates changes in income inequalities in the UK since 1970 where 1 refers to perfect inequality and 0 means no inequality in the Gini coefficient. The results are used to show declining inequality levels but it is not any different from the way it was in 1995. It is low but relatively high compared to other developed economies. According to Tetlow (2016), income inequality is a major issue in the UK that contributed to the results of the Brexit vote. Further, the figure below shows the top 5% have increased their incomes since 1970, with the exception of the top 1%.
This is further accentuated by the infographic below on actual figures of average incomes in the UK.
Source: Equality Trust (2012)
Whereas the 0.1% highest income earners had in excess of £1m and the top 10% earners over £79,000, the rest of the country’s 90% earned slightly less than £13,000.
Although it was noted that the general increase in income level tends to remain constant where there is a general increase for all individuals, it would be assumed that the measurement of these changes is not affected general increase or decline of the same. There is no consensus on whether income increases or decreased at the same rate for everyone. The fact that is widely supported is that changes in income levels vary differently among individuals. Gini Coefficient is one of the ways of measuring inequality but there is no standard way of doing it due to different ways of interpreting the term. Even so, income is the basic factor that is measured in income inequality. (Hynková, 2011)The fact that households own a number of inputs and the trend of workers receiving much less income than they deserve also pose challenges to measuring the same.
Gini Coefficient and Lorenz Curve are the two main ways of measuring income inequality. The two are used together as shown in the figure below. The area between the two points of Lorenz curve, A and B are used to calculate the Gini coefficient using the formula: G=(A-B)/A. Realized values vary from 0 to 1 where 1 or 100% means absolute inequality while 0% means absolute equality.
Source: Mankiw and Taylor (2011), pg. 352).
Arnold (2013) cautioned in the use of Gini Coefficient where at certain points, values in countries do not necessarily signify their degree of income distribution using percentiles. The natural inclination to think that the bottom quantile receives more income as a percentage of total income is inaccurate as indicated below. Bottom 20% receive a larger share of total income.
Source: Arnold (2013) of. 352
Income inequality is a social problem that needs macroeconomic policies to provide solutions to narrow the gap and improve the general quality of living standards. According to Hoeller et al. (2015), the main driver of labour inequality is individual labour income inequality. Income for the very top tended to rise faster than anywhere else in the income levels.
At the lowest cadre of income are wages for low-skilled workers, which means that the level of skills determines their income potential. Hemous and Olsen (2014) attributed the stagnation of real wages and increase in income inequality to a low level of automation, which is also a function of wages earned. An increase in skills can stimulate increased investment in automation which is necessary to reduce these disparities. Machines tend to do work for low-skilled labourers, leading to their wages being slow or cut from employment. The same observation was supported by Macchin (2008) who noted that skilled workers’ income was higher due to possession of technological skills but those that refused to embrace these skills were pushed to the lower level. The unskilled workers in the technologically advanced production system or working environment also saw them out of their jobs.
According to Jaumotte and Buitron (2015), there is an increased demand for highly skilled workers who are also highly remunerated compared to those with low or poor skills. Globalisation has spurred competition among economies and top earners are the ones who have benefited from this trend compared to average skilled workers. OECD (2012) noted that product and market regulations have an effect of stifling competition whose long term impact is unemployment and labour income inequality. Policies that promote competition and reward innovation can boost income and reduce income inequalities.
Due to the need to increase efficiency and productivity to remain competitive, organisations are embracing technological solutions. In such a scenario, there is a need for policy changes to reduce this gap. Policies to improve educational and vocational skills, and adjust the minimum wage in the labour market ought to be legislated and implemented. In the same vein, salaries of the very top CEO ought to be regulated, and laws on poaching workers by luring them with huge salaries. The High Pay Commission (2011) noted some of the top CEOs are paid excessively and this trend is not only creating a rift between them and their subjects but external stakeholders, especially shareholders. Salaries for top managers ought to be rationalised. While not risky or challenging as thought, it is not. While this happens to be a general trend, deserving workers’ salaries are not increased as they ought to. This is an issue that should be solved from all angles including political social and economic to rationalise them.
The taxation system used has been mentioned as one of the causes of income inequality. Tax on income is supposed to reduce income earned and contribute revenue to the exchequer. According to ONS, the taxation system can also be used to reduce income inequalities by reducing the amount of money people of different incomes categorised. While this may work in theory, it has not been consistent and very robust in containing this widening gap, especially in UK incomes. ONA noted that indirect taxes such as VAT and fuel had a significant effect on disposable income, as indicated in the graph below.
The impact of direct taxes acted to reduce income inequality by 3% to 4% but indirect taxes has the opposite effect of increasing income inequality (ONS, 2015). This indicated that tax on its own is inconsequential to tackling the problem of income inequality. Inman (Inman, 2016) noted that taxing the rich was an ineffective way of reducing income inequality or even generating the government. The only way in terms of tax-reducing income inequality according to OECD (OECD, 2012), is by tax transfers which were said to have worked in the reduction of tax income inequality across OECD nations. Tax transfers mean that money is redistributed to those in need as opposed to budgeting for other national functions. however, taxation on income also can be imposed using a progressive regime where money from high-income earners is not spent on them. Tax reliefs from such groups also ought to be scrapped to improve income equity.
Income inequality is a concern for governments that aim to achieve equity in a country. As was lightly mentioned, income inequality has an effect on the poor or lowered living standards and disintegration into society. It is an issue that involves political economic and social aspects and solutions therefore must use this approach. Economic solutions were mainly suggested here such as progressive taxation and social and political interventions of workable policies on skills and training and market regulations.
Arnold, R. A., 2013. Microeconomics. New York: Cengage Learning..
Belfield, C., Cribb, J., Hood, A. & Joyce, R., 2015. Living Standards, Poverty and Inequality in the UK: 2015, London: IFS.
Equality Trust, 2012. Income Inequality in the UK. [Online]
Firebaugh, G., 2009. The New Geography of Global Income Inequality. Cambridge: Harvard University Press.
Hemous, D. & Olsen, M., 2014. The Rise of the Machines: Automation, Horizontal Innovation and Income Inequality. CEPR, pp. 1-91.
Hoeller, P., Joumard, I., Pisu, M. & Bloch, D., 2015. Mapping income inequality across the OECD. Washington: OECD.
Hynková, V., 2011. Income Policy, s.l.: Investments in Education Development.
Inman, P., 2016. UK tax and benefit changes worsening inequality, IFS warns. [Online]
Jaumotte, F. & Buitron, C. O., 2015. POWER from the PEOPLE, London: Finance and Development.
Machin, S., 2008. Big Ideas: Rising wage inequality, London: CEP.
Mankiw, N. G. & Taylor, M. P., 2011. Economics. 2nd ed. New York: Cengage Learning.
OECD, 2012. Reducing income inequality while boosting economic growth: Can it be done?. [Online]
ONS, 2015. The effects of taxes and benefits on income inequality: 1977 to financial year ending 2015. [Online]
Tetlow, G., 2016. Is income inequality increasing in the UK?. [Online]
The High Pay Commission, 2011. Interim report of the , London: High Pay Commission.