The eight richest people on the planet hold as much wealth as the poorest half of the world’s population put together. The richest of these, Jeff Bezos, has a level of wealth that you wouldn’t match if you earned $180,000 every day from when Jesus was born up to the present day.
Income and Wealth
When discussing inequality, we do need to be clear about whether we are referring to the distribution of income or wealth. Income is a flow of money received over time. The most significant source of income for most people is their wage; however, some may receive rental income on properties they own, or interest on savings. Wealth is a stock of owned assets. The main source of many peoples wealth is property, but other sources include savings deposits and bonds.
We should also clarify the difference between equality and equity (or inequality and inequity). Equality is a positive concept, meaning that it is testable and based on statements of fact. We can measure the distribution of income or wealth in an economy, and once we have done so it would be difficult to argue with the results. Equity is a normative concept, which means it is based on value judgements — everyone will have their own opinions about how fair the distribution of income is and what should be done about it.
Causes of Inequality
One of the main reasons why there is such a high level of inequality both globally and within most countries is that there is a cycle where more unequal income leads to a higher level of wealth inequality. People who earn higher incomes will, assuming they save a reasonable portion, build up their wealth over time. This also means that wealth tends to be subject to greater levels of inequality than income. It does also work the other way though, as wealth can provide a source of income — ownership of property is required to be paid rent, while savings deposits are needed to accrue interest payments.
Other key drivers of income inequality include:
- Wage differentials — wages are determined by market forces of labour supply and demand, which can result in some occupations and job roles receiving astronomical incomes while others struggle on minimum wages.
- Household composition — a household with four children will require a significantly higher income than a single adult to gain access to the same standard of living.
- Government policy — the use of more regressive taxes such as VAT, which take a greater proportion from lower income earners.
Other key drivers of wealth inequality include:
- Propensity to save — the proportion of income that is saved, allowing wealth to accumulate.
- Inheritance traditions — cultures and government policies which allow easy transfer of assets down the generations.
Lorenz Curve
Levels of inequality in a country can be illustrated through the use of a Lorenz Curve, plotting cumulative % of households against cumulative % of income.
The 45 degree line shows perfect equality, with every 10% of households holding exactly 10% of the income available, all the way up to 100%. The more the Lorenz Curve bows away from this line of equality, the greater the level of inequality.
Comparisons can then be made between economies and over time. Successful implementation of progressive taxes, taking more income from higher earners, should help to shift the Lorenz cure to the left. On the other hand, a more regressive tax system would push the curve to the right.
Gini Coefficient
The Gini Coefficient simply distils the information from the Lorenz Curve down into a single numerical value.
To work out the Gini coefficient, you divide area A by area A+B combined. This will give a coefficient between 0 and 1. A coefficient of 0 would put the Lorenz curve exactly on the line of perfect equality (with no area A). A coefficient of 1 would show area A covering the whole triangle — the most intense inequality possible. In reality, every country will be somewhere in between. In 2023, the UK Gini coefficient for income was 0.35, compared to 0.41 in USA, which shows a more unequal distribution of income in the USA.
Consequences of Inequality
When surveyed on how income should be distributed within their country, most people accept that some level of inequality is perfectly equitable. They would argue that those who work more hours and have earned good qualifications should be rewarded with higher incomes. Many of these same people would be quite shocked to learn just how unequal the distribution of income and wealth has become in their country.
Focusing purely on the economic consequences of this inequality, it will help to put yourself in the (very expensive!) shoes of someone right at the top end: Jeff Bezos, Bill Gates or Carlos Slim. If awarded an extra few hundred pounds, how much of it will likely be spent and how much will go straight into their bank account? Economists would say that these individuals have a very low marginal propensity to consume. This means that, by reallocating income from rich to poor, we can help to boost levels of expenditure and promote faster economic growth.
We can also consider what an addition to these individuals’ income will do to their utility (a fancy term economists use to describe their satisfaction). It is fair to say that most would hardly notice an increase of even a few thousand pounds in income. However, an increase like this would change the lives of many of the lowest earners in society. We describe this by saying that, as income rises, individuals will experience diminishing marginal utility — the satisfaction gained from each additional pound will get lower and lower. This matters if we care about the aggregate welfare of all citizens in our economy, as a simple redistribution of income will allow this to be enhanced.
Policies to Tackle Inequality
When the market mechanism fails to produce satisfactory outcomes, governments may intervene, in this case to help redistribute income and wealth. The main tools they have to achieve this are a combination of progressive taxes, which take more from higher earners, alongside welfare benefits, which directly transfer money into the hands of the lowest earners.
Less obviously, providing free healthcare and education is a key method of reducing inequality, and is known as providing benefits in kind. The rich would be unlikely to feel too much pain from having to pay for these resources, but it would be ruinous to many of the poorest in society.
Finally, governments could put in place policies to address wage inequalities in labour markets. Imposing and raising minimum wages is key, as these measures ensure that the lowest earners still have access to a wage they can live on. Trade unions also have a role to play by working in the interests of their members through collective bargaining. If they are truly committed to reducing inequality, governments should encourage these organisations rather than legislating against them.
Wealth Taxes?
Even with many of these policies in place, inequality continues to be one of the most pressing issues in our society. Many economists, including Nobel Prize winner Joseph Stiglitz, have advocated for the use of wealth taxes to help with the redistribution. He backed proposals by US senator Elizabeth Warren for a 2% tax on people with assets of more than $50 million and 3% on those with more than $1 billion. While some find these suggestions unpalatable, it is difficult to wrap your head around just how much money $1 billion is — with that much in the bank, a 3% tax would seem relatively affordable. Here we are back in the realm of normative economics and value judgements — everyone will have their own view.
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