ECONOMICS 5e
Michael Parkin
Inequality,
Redistribution of
income
Learning Objectives
• Describe the inequality in income and
wealth
• Explain why wealth inequality is greater
than income inequality
• Explain how economic inequality arises
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-2
Learning Objectives (cont.)
• Explain the effects of taxes and social
security and welfare programs on economic
inequality
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-3
Learning Objectives
• Describe the inequality in income and
wealth
• Explain why wealth inequality is greater
than income inequality
• Explain how economic inequality arises
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-4
Economic Inequality in
the United States
Should we look at the distribution of income
or wealth?
Income is the amount that is received in a given
period of time.
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-5
Economic Inequality
Should we look at the distribution of income or
wealth?
Wealth is the value of the things it owns at a point in
time.
WEALTH =
(1) real property + (2) financial assets – (3) debts
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-6
Wealth
• Wealth is a person's net worth, expressed as:
WEALTH = assets – liabilities
The word "wealth" is often confused with “income". These
two terms describe different but related things. Wealth
consists of those items of economic value that an
individual owns, while income is an inflow of items of
economic value. The relation between wealth, income, and
expenses is:
change of wealth = income − expense
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-7
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-8
Wealth levels across Countries
• global household wealth =
o US$20,500 per person using official exchange rates
o PPP$26,000 when adjusted for country price levels
• average wealth per capita =
o $144,000 in USA
o $181,000 in Japan
o $1,400 in Indonesia
o $1,100 in India
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-9
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-10
Geographical spread of wealth
• wealth is heavily concentrated in North America, Europe, and
high income Asia-Pacific countries
- collectively own nearly 90% of world wealth
• North America has 6% of the world adult population, 34% of
household wealth
• Europe and high income Asia-Pacific countries also own
disproportionate amounts of wealth
• For Africa, China, India, and lower income Asian countries, share
of wealth is considerably less than population share, sometimes
by a factor of more than 10
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-11
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-12
Wealth inequality is very high
• concentration of wealth within countries is generally high
• share of the top 10% around
o 40% in China
o 70% in the United States
o higher still in other countries
• even higher for world as a whole
o richest 2% of adults own more than half global wealth
o global wealth Gini for adults is 89% (PPP: 80%) - same as group of 100 where 1
o
gets $900 and other 99 each get $1
the between country Gini is 70% indicating that the between country inequality
explains most of the global inequality
• wealth more unequally distributed than income across countries
o high income countries have bigger share of world wealth than world GDP
o reverse is true of middle- and low-income nations
o exceptions include Nordic and Eastern Europe transition countries
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-13
The global rich (exchange rate basis)
• $2,200 per adult to be in top half of world wealth ranking
• $61,000 to be in richest 10% of adults
• more than $500,000 to be in richest 1% of adults (group with
37 million members worldwide)
•
•
•
•
•
richest 1% of adults owned 40% of global assets in 2005
richest 2% owned 51%
richest 5% owned 71%
richest 10% owned 85%
bottom half owned barely 1%
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-14
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-15
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-16
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-17
Millionaires and billionaires
Wealth ($)
Number above
1 million
13 568 229
10 million
451 809
100 million
15 010
1 billion
499
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-18
• Country differences in wealth > than in income
• World wealth inequality high
•
Share of top 10% is
71% using PPP
85% using official exchange rate
A study by the World Institute for Development
Economics Research at UN University reports that the
richest 1% of adults alone owned 40% of global assets
in the year 2000, and that the richest 10% of adults
accounted for 85% of the world total. The bottom half
of the world adult population owned 1% of global
wealth.[10] Moreover, another study found that the
richest 2% own more than half of global household
assets
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-19
• Wealth dominated by Real Assets in low income countries
• Financial Assets more important in high income countries
• Large differences in wealth composition for countries at
similar income
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-20
Wealth condensation
: is a theoretical process by which, in certain conditions,
newly-created wealth tends to become concentrated in
the possession of already-wealthy individuals or entities,
a form of preferential attachment.
According to this theory, those who already hold wealth
have the means to invest in new sources and structure
thus creating more wealth or to otherwise leverage the
accumulation of wealth, thus are the beneficiaries of the
new wealth
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-21
Economic Inequality
Lorenz Curves
A Lorenz curve graphs the cumulative
percentage of income against the cumulative
percentage of families.
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-22
Lorenz Curves for
Income and Wealth
Families
Income
Wealth
Cumulative
Cumulative
Percentage Percentage Percentage Percentage
Cumulative
Percentage Percentage
a Lowest 20
20
3.7
3.7
0
0
b Second 20
40
9.1
12.8
0
0
c Third 20
60
15.2
28.0
4
4
d Fourth 20
80
23.3
51.3
11
15
e Highest 20
100
48.7
100.0
85
100
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-23
Cumulative % of income & wealth
Lorenz Curves for
Income and Wealth
100
e
80
60
40
20
0
d
Line of
equality
Income
c
a
20
Wealth
b
40
60
80
100
Cumulative % of families
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-24
Trends in the Distribution of
Income: 1950–1998
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-25
GINI Coefficient
• Invented by the Italian statistitian Corado Gini, is a number
between zero and one that measures the degree of inequality in
the distribution of something.
• The coefficient would register zero (0.0 = minimum inequality)
for a society in which each member received exactly the same
amount.
• A coefficient of one (1.0 = maximum inequality) would mean
one member got everything and the rest got nothing.
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-26
Economic Inequality in
the United States
Who Are the Rich and the Poor?
The poorest household is likely to be:
• a black woman
• over 65 years of age
• lives in the South
• has fewer than eight years of education
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-27
Economic Inequality in
the United States
Who Are the Rich and the Poor?
The wealthiest household is likely to be:
• a college-educated white married couple
• between 45 and 54 years of age
• has two children
• lives in the Northeast
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-28
The Distribution of Income by
Selected Family Characteristics in USA
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-29
Economic Inequality in
the United States
Poverty
Poverty is a state in which a family’s income is
too low to be able to buy the quantities of food,
shelter, and clothing that are deemed necessary.
Poverty is a relative concept.
The distribution of poverty by race is unequal:
• 12 percent of white families
• 31 percent of Hispanic-origin families
• 33 percent of black families
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-30
Learning Objectives
• Describe the inequality in income and
wealth in the United States
• Explain why wealth inequality is greater
than income inequality
• Explain how economic inequality arises
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-31
Comparing Like with Like
How do we measure a person’s economic
situation?
• Measure their income?
• Measure their wealth?
• Long period of time?
• Short period of time?
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-32
Comparing Like with Like
Wealth Versus Income
• Wealth is a stock of assets.
• Income is a flow of earnings that results from
the stock of wealth.
• Wealth data measures tangible assets and
exclude human capital.
• Income data measures income from both
tangible assets and human capital.
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-33
Capital, Wealth, and Income
Lee
Peter
Wealth
Income
Wealth
Income
200,000
10,000
499,000
24,950
Nonhuman Capital 800,000
40,000
1,000
50
$50,000
$500,000
$25,000
Human Capital
Total
Copyright © 1998 Addison Wesley Longman, Inc.
$1,000,000
TM 17-34
Comparing Like with Like
Annual or Lifetime Income and Wealth?
• Incomes vary with age.
• Some inequality results from differences
in peoples' stage of the life cycle.
• Therefore, inequality of annual incomes
overstates the
inequality.
Copyright © 1998 Addison Wesley Longman, Inc.
degree
of
lifetime
TM 17-35
Learning Objectives
• Describe the inequality in income and
wealth in the United States
• Explain why wealth inequality is greater
than income inequality
• Explain how economic inequality arises
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-36
Resource Prices,
Endowment, and Choices
Family income depends upon:
• Resource prices
• Resource endowments
• Choices
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-37
Resource Prices,
Endowment, and Choices
Resource Prices
• Individuals with different skill levels earn
different incomes.
Resource Endowments
• Individuals have different family endowments
in capital and human abilities.
• Distribution of income and wealth is nonnormally distributed.
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-38
Price (dollars per chip)
The Distribution of Income
8
Mode income
6
Median income
$31,241
4
Mode Income
$44,938
2
0
10
20
30
40
50
60
Income (thousands of dollars per year)
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-39
Resource Prices,
Endowment, and Choices
Choices
• Wages and the Supply of Labor
People who earn higher wage rates tend to work
more hours.
• Savings and Bequests
• Debts Cannot Be Bequeathed
• Assortative Mating
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-40
Learning Objectives (cont.)
• Explain the effects of taxes and social
security and welfare programs on economic
inequality
• Explain the effects of health-care reform on
economic inequality
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-41
The Scale of
Income Redistribution
Market income is a family’s income in the
absence of government redistribution.
Redistribution reduces the inequality of incomes.
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-42
Cumulative % of income & wealth
Income Redistribution
100
80
60
Line of
equality
Distribution
after taxes
and benefits
40
Redistribution
20
0
Market
distribution
20
40
60
80
100
Cumulative % of families
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-43
Income Redistribution
The Big Tradeoff
Income redistribution creates a big
tradeoff:
• Uses scarce resources
• Weakens incentives
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-44
Negative Income Tax
Negative Income Tax gives every
family a guaranteed minimum annual
income and taxes all income above
the guaranteed minimum at a fixed
marginal rate.
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-45
Income after redistribution
Comparing Traditional Programs
and a Negative Income Tax (USA)
No distribution
Current
redistribution
arrangements
Taxes
Welfare
trap
Current
programs
and taxes
G
Benefits
0
Copyright © 1998 Addison Wesley Longman, Inc.
A
C
Market Income
TM 17-46
Income after redistribution
Comparing Traditional Programs
and a Negative Income Tax (USA)
No distribution
Current
programs
and taxes
Higher
benefits
Higher
taxes
G
A negative
income tax
Negative
income tax
Break-even
income
0
Copyright © 1998 Addison Wesley Longman, Inc.
B
Market Income
TM 17-47
History of redistribution of income and wealth
• In many societies, attempts have been made, through property
redistribution , taxation, or regulation, to redistribute wealth,
sometimes in support of the upper class, and sometimes to
diminish extreme inequality.
• Examples of this practice go back at least to the Roman republic
in the third century B.C., when laws were passed limiting the
amount of wealth or land that could be owned by any one family.
Motivations for such limitations on wealth include the desire for
equality of opportunity, a fear that great wealth leads to political
corruption, to the belief that limiting wealth will gain the
political favor of a voting bloc, or fear that extreme
concentration of wealth results in rebellion.
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-48
History of redistribution of income and wealth
• During the Age of Reason, Francis Bacon wrote "Above all things good policy
is to be used so that the treasures and monies in a state be not gathered into a
few hands... Money is like muck, not good except it be spread.
• Socialism arose as a reaction to a distribution of wealth in which a few lived in
luxury while the masses lived in extreme poverty. In the Communist Manifesto
Marx and Engels wrote "From each according to his ability, to each according
to his need.” While the ideas of Marx have been embraced by various states
(Russia and China in the 20th century), Marxism has seldom if ever worked in
practice.
• On the other hand, the combination of labor movements, technology, and social
liberailsm has diminished extreme poverty in the developed world today,
though extremes of wealth and poverty continue in the Third World.
Copyright © 1998 Addison Wesley Longman, Inc.
TM 17-49