Economic inequality

For the economic inequality among countries, see international inequality. For the United States, see Wealth inequality in the United States. For income inequality in the United States, see Income inequality in the United States.

Differences in national income equality around the world as measured by the national Gini coefficient. The Gini coefficient is a number between 0 and 1, where 0 corresponds with perfect equality (where everyone has the same income) and 1 corresponds with perfect inequality (where one person has all the income, and everyone else has zero income).

Percentage of people living in slums (2005).

Slums in major cities

Brazil Cochin, India Rio, Brazil Istanbul, Turkey Cairo, Egypt Belgrade, Serbia Jakarta, Indonesia Cape Town, S.Africa Manila, Philippines Medellin, Colombia Slums, also called favelas and townships, are a visible indicator of economic inequality. They are a common feature midst major cities of the world. Above are nine examples.

Economic inequality (also known as the gap between rich and poor, income inequality, wealth disparity, or wealth and income differences) comprises disparities in the distribution of economic assets (wealth) and income within or between populations or individuals. The term typically refers to inequality among individuals and groups within a society, but can also refer to inequality among countries. The issue of economic inequality is related to the ideas of equity, equality of outcome, and equality of opportunity.

Observers differ on both the morality and utility of inequality, whether, and/or how much inequality is necessary in society and how it can be affected. It has been praised as necessary and beneficial, and attacked as a growing social problem. Early studies suggesting that greater equality inhibits growth have been shown to be flawed because they did not account for the many years it can take equality changes to manifest in growth changes, and greater equality has been conclusively shown to cause growth.

Economic inequality varies between societies and historical periods; between economic structures or systems (for example, capitalism or socialism), ongoing or past wars, and differences in individuals' abilities to create wealth are all involved in the creation of economic inequality.

There are various numerical indices for measuring economic inequality. A prominent one is the Gini coefficient, but there are also many other methods.

Magnitude of inequality in the modern world

A study entitled "Divided We Stand: Why Inequality Keeps Rising" by the Organisation for Economic Co-operation and Development (OECD) reported its conclusions on the causes, consequences and policy implications for the ongoing intensification of the extremes of wealth and poverty across its 22 member nations (OECD 2011-12-05).

• "Income inequality in OECD countries is at its highest level for the past half century. The average income of the richest 10% of the population is about nine times that of the poorest 10% across the OECD, up from seven times 25 years ago."
• In both Israel and the United States inequality has increased further from already high levels.
• "Other traditionally more egalitarian countries, such as Germany, Denmark and Sweden, have seen the gap between rich and poor expand from 5 to 1 in the 1980s, to 6 to 1 today."

A study by the World Institute for Development Economics Research at United Nations University reports that the richest 1% of adults alone owned 40% of global assets in the year 2000. The three richest people possess more financial assets than the lowest 48 nations combined. The combined wealth of the "10 million dollar millionaires" grew to nearly $41 trillion in 2008. In 2001, 46.4% of people in sub-Saharan Africa were living in extreme poverty. Nearly half of all Indian children are undernourished, however, even among the wealthiest fifth one third of children are malnourished.

Over the two decades prior to the onset of the global financial crisis, real disposable household incomes increased an average of 1.7% a year in its 34 member countries. However, the gap between rich and poor widened in most nations - the OECD journalist resource (2011-05) entitled "Growing Income Inequality in OECD Countries" states that with the exceptions of only France, Japan and Spain, wages of the 10% best-paid workers have risen relative to those of the 10% least-paid workers and the differential between the top and bottom 10% varies greatly from country to country: “While this ratio is much lower in the Nordic countries and in many continental European countries, it rises to around 14 to 1 in Israel, Turkey and the United States, to a high of 27 to 1 in Chile and Mexico.”

Although a discussion exists about the recent trends in global inequality, the issue is anything but clear, and this holds true for both the overall global inequality trend and for its between-country and within-country components. The existing data and estimates suggest a large increase in international (and more generally inter-macroregional) component between 1820 and 1960. It might have slightly decreased since that time at the expense of increasing inequality within countries.

Causes of inequality

There are many reasons for economic inequality within societies. "The single most important driver has been greater inequality in wages and salaries(OECD 2011-12-05)." These causes are often inter-related. Acknowledged factors that impact economic inequality include:

• greater inequality in wages and salaries
  • highly skilled workers earn more than low-skilled/no skills
• wealth condensation
• labor markets
  • globalization
  • technological changes
  • policy reforms
• taxes, tax loopholes, and tax havens
• education
• computerization/growing technology
• racism
• gender
• culture
• development patterns
• personal preference for work, leisure and risk
• innate ability

The labor market

A major cause of economic inequality within modern market economies is the determination of wages by the market. Inequality is caused by the differences in the supply and demand for different types of work. In a purely capitalist mode of production (i.e. where professional and labor organizations cannot limit the number of workers) the workers wages will not be controlled by these organizations, or by the employer, but rather by the market. Wages work in the same way as prices for any other good. Thus, wages can be considered as a function of market price of skill. And therefore, inequality is driven by this price. Under the law of supply and demand, the price of skill is determined by a race between the demand for the skilled worker and the supply of the skilled worker. We would expect the price to rise when demand exceeds supply, and vice versa. Employers who offer a below market wage will find that their business is chronically understaffed. Their competitors will take advantage of the situation by offering a higher wage to snatch up the best of their labor. For a businessman who has the profit motive as the prime interest, it is a losing proposition to offer below or above market wages to workers.

A job where there are many workers willing to work a large amount of time (high supply) competing for a job that few require (low demand) will result in a low wage for that job. This is because competition between workers drives down the wage. An example of this would be jobs such as dish-washing or customer service. Competition amongst workers tends to drive down wages due to the expendable nature of the worker in relation to his or her particular job. A job where there are few able or willing workers (low supply), but a large need for the positions (high demand), will result in high wages for that job. This is because competition between employers for employees will drive up the wage. Examples of this would include jobs that require highly developed skills, rare abilities, or a high level of risk. Competition amongst employers tends to drive up wages due to the nature of the job, since there is a relative shortage of workers for the particular position. Professional and labor organizations may limit the supply of workers which results in higher demand and greater incomes for members. Members may also receive higher wages through collective bargaining, political influence, or corruption.

These supply and demand interactions result in a gradation of wage levels within society that significantly influence economic inequality.

Taxes

Another cause is the rate at which income is taxed coupled with the progressivity of the tax system. A progressive tax is a tax by which the tax rate increases as the taxable base amount increases. In a progressive tax system, the level of the top tax rate will have a direct impact on the level of inequality within a society, either increasing it or decreasing it. Additionally, a steeper progressivity results in a more equal distribution of income across the board. The difference between the Gini index for an income distribution before taxation and the Gini index after taxation is an indicator for the effects of such taxation. Overall income tax rates in the United States are below the OECD average.

There is debate between politicians and economists over the role of tax policy in mitigating or exacerbating wealth inequality. Economists such as Paul Krugman, Peter Orszag, and Emmanuel Saez have argued that tax policy in the post World War II era has indeed increased income inequality by enabling the wealthiest American workers far greater access to capital than lower-income Americans.

Computerization/Innovative Technology

Another factor that contributed to the already growing inequality in the 20th century was computerization and growth in technology with electricity replacing manpower. With this growing change in technology, the United States experienced increasing demand for skilled workers to use computers and operate the electrical inventions. This resulted in a rightward shift in the Demand for Skilled Labor Supply, and this created an increase in the relative wages of the skilled compared to the wages of the unskilled workers. Such a change in wages added to the inequality that was already present.

Education

One important factor in the creation of inequality is variation in individuals' access to education. Education, especially in an area where there is a high demand for workers, creates high wages for those with this education. As a result, those who are unable to afford an education, or choose not to pursue optional education, generally receive much lower wages. During the mass high school education movement from 1910–1940, there was an increase in skilled workers which led to a decrease in the price of skilled labor. High school education during the period was designed to equip students with necessary skill sets to be able to perform at work. In fact, it differs from the present high school education, which is regarded as a stepping stone to acquire college and advanced degrees. This decrease in wages caused a period of compression and decreased inequality between skilled and unskilled workers.

Economic neoliberalism

John Schmitt and Ben Zipperer (2006) of the CEPR point to economic liberalism and the reduction of business regulation along with the decline of union membership as one of the causes of economic inequality. In an analysis of the effects of intensive Anglo-American neoliberal policies in comparison to continental European neoliberalism, where unions have remained strong, they concluded "The U.S. economic and social model is associated with substantial levels of social exclusion, including high levels of income inequality, high relative and absolute poverty rates, poor and unequal educational outcomes, poor health outcomes, and high rates of crime and incarceration. At the same time, the available evidence provides little support for the view that U.S.-style labor-market flexibility dramatically improves labor-market outcomes. Despite popular prejudices to the contrary, the U.S. economy consistently affords a lower level of economic mobility than all the continental European countries for which data is available."

Globalization

Trade liberalization may shift economic inequality from a global to a domestic scale. When rich countries trade with poor countries, the low-skilled workers in the rich countries may see reduced wages as a result of the competition, while low-skilled workers in the poor countries may see increased wages. Trade economist Paul Krugman estimates that trade liberalisation has had a measurable effect on the rising inequality in the United States. He attributes this trend to increased trade with poor countries and the fragmentation of the means of production, resulting in low skilled jobs becoming more tradeable. However, he concedes that the effect of trade on inequality in America is minor when compared to other causes, such as technological innovation, a view shared by other experts. Lawrence Katz estimates that trade has only accounted for 5-15% of rising income inequality. Some economists, such as Robert Lawrence, dispute any such relationship. Lawrence, in particular, argues that technological innovation and automation has meant that low-skilled jobs have been replaced by machine labor in wealthier nations, and that wealthier countries no longer have significant numbers of low-skilled manufacturing workers that could be affected by competition from poor countries.

Gender

Median weekly earnings of full-time wage and salary workers, by sex, race, and ethnicity, 2009.

In many countries, there is a gender income gap which favors males in the labor market. For example, the median full-time salary for U.S. women is 77% of that of U.S. men. Several factors other than discrimination may contribute to this gap. On average, women are more likely than men to consider factors other than pay when looking for work, and may be less willing to travel or relocate. Thomas Sowell, in his book Knowledge and Decisions, claims that this difference is due to women not taking jobs due to marriage or pregnancy, but income studies show that that does not explain the entire difference. Men are far more likely to engage in dangerous occupations which often pay more than positions desired and sought by women. The U.S. Census's report on the wage gap reported "When we account for difference between male and female work patterns as well as other key factors, women earned, on average, 80 percent of what men earned in 2000... Even after accounting for key factors that affect earnings, our model could not explain all of the differences in earnings between men and women." The income gap in other countries ranges from 53% in Botswana to -40% in Bahrain. In the United States, among women and men who never marry or have children, women make more than men. Additionally, women who work part-time make more on average than men who work part-time.

Gender inequality and discrimination is argued to cause and perpetuate poverty and vulnerability in society as a whole. Household and intra-household knowledge and resources are key influences in individuals' abilities to take advantage of external livelihood opportunities or respond appropriately to threats. High education levels and social integration significantly improve the productivity of all members of the household and improve equity throughout society. Gender Equity Indices seek to provide the tools to demonstrate this feature of poverty.

Development patterns

A Kuznets curve

Main article: Kuznets curve

Simon Kuznets argued that levels of economic inequality are in large part the result of stages of development. Kuznets saw a curve-like relationship between level of income and inequality, now known as Kuznets curve. According to Kuznets, countries with low levels of development have relatively equal distributions of wealth. As a country develops, it acquires more capital, which leads to the owners of this capital having more wealth and income and introducing inequality. Eventually, through various possible redistribution mechanisms such as social welfare programs, more developed countries move back to lower levels of inequality. Kuznets demonstrated this relationship using cross-sectional data. However, more recent testing of this theory with superior panel data has shown it to be very weak. Kuznets' curve predicts that income inequality will eventually decrease given time. As an example, income inequality did fall in the United States during its High School Movement in the 1940s and after. However, recent data shows that the level of income inequality began to rise after the 1970s. This does not necessarily disprove Kuznets' theory. It may be possible that another Kuznets' cycle is occurring, specifically the move from the manufacturing sector to the service sector. This implies that it may be possible for multiple Kuznets' cycles to be in effect at any given time.

Diversity of preferences

Related to cultural issues, diversity of preferences within a society often contributes to economic inequality. When faced with the choice between working harder to earn more money or enjoying more leisure time, equally capable individuals with identical earning potential often choose different strategies. This leads to economic inequality even in societies with perfect equality in abilities and circumstances. The trade-off between work and leisure is particularly important in the supply side of the labor market in labor economics.

Likewise, individuals in a society often have different levels of risk aversion. When equally-able individuals undertake risky activities with the potential of large payoffs, such as starting new businesses, some ventures succeed and some fail. The presence of both successful and unsuccessful ventures in a society results in economic inequality even when all individuals are identical.

Wealth concentration

Main article: Wealth concentration

Wealth concentration is a theoretical process by which, under certain conditions, newly-created wealth concentrates in the possession of already-wealthy individuals or entities. According to this theory, those who already hold wealth have the means to invest in new sources of creating wealth or to otherwise leverage the accumulation of wealth, thus are the beneficiaries of the new wealth. Over time, wealth condensation can significantly contribute to the persistence of inequality within society.

As an example of wealth concentration, truck drivers who own their own trucks often make more money than those who do not, since the owner of a truck can escape the rent charged to drivers by owners (even taking into account maintenance and other costs). Hence, a truck driver who has wealth to begin with can afford to buy his own truck in order to make more money. A truck driver who does not own his own truck makes a lesser wage and is therefore stuck in a Catch-22, unable to buy his own truck to increase his income.

As another example of wealth concentration, savings from the upper-income groups tend to accumulate much faster than saving from the lower-income groups. Upper-income groups can save a significant portion of their incomes. On the other hand, lower-income groups barely make enough to cover their consumptions, hence only capable of saving a fraction of their incomes or even none. Assuming both groups earn the same yield rate on their savings, the return on upper-income groups’ savings are much greater than the lower-income groups’ savings because upper-income groups have a much larger base.

This correlation between being rich and earning more is also contributed by plutocracy: the ability of the rich to influence government disproportionately to their favor thereby increasing their wealth. The term "plutocracy" is formally defined by the wealthy class that controls a government, often from behind the scenes. More generally, a plutocracy is any form of government in which the wealthy exercise the preponderance of political power, whether directly or indirectly. The relatively fixed group of privileged people might shape the economy and government for their own benefit. Nevertheless, the owners and top level managers in large income-producing properties are far and away the dominant power figures in the country.

Related to wealth concentration are the effects of intergenerational inequality and housing inequality. The rich tend to provide their offspring with a better education, increasing their chances of achieving a high income. Furthermore, the wealthy often leave their offspring with a hefty inheritance, jump-starting the process of wealth condensation for the next generation.

In his 1985 book Regular Economic Cycles: Money, Inflation, Regulation and Depressions, Ravi Batra argues that a growing concentration of wealth, measured as the 'share of wealth held by the richest 1 percent', is linked to bank failures and depressions. In Table 1 on page 127, there is data for this measure for the years 1810-1969, showing a rise in this measure prior to the 1929 stock market crash.

"...as the concentration of wealth rises, the number of banks with relatively shaky loans also rises. And the higher the concentration, the greater is the number of potential bank failures."

Batra predicted the same would happen if the 1% share rose again.

Inflation

Some Austrian school economists have theorized that high inflation, caused by a country's monetary policy, can contribute to economic inequality. This theory argues that inflation of the money supply is a coercive measure that favors those who already have an earning capacity, disfavoring those on fixed income or with savings, thus aggravating inequality. They cite examples of correlation between inflation and inequality and note that inflation can be caused independently by "printing money", suggesting causation of inequality by inflation.

Mobility

Entrenched strata of power — whether economic, political, status, ascribed, or meritocratic — can lead to decreased mobility by the assertion of that power, and lead to increased inequality.

Mitigating factors

Countries with a left-leaning legislature have lower levels of inequality. Many factors constrain economic inequality—they may be divided into two classes: government sponsored, and market driven. The relative merits and effectiveness of each approach is a subject of debate.

Typical government initiatives to reduce economic inequality include:

• Public education: increasing the supply of skilled labor and reducing income inequality due to education differentials.
• Progressive taxation: the rich are taxed proportionally more than the poor, reducing the amount of income inequality in society.
• Minimum wage legislation: raising the income of the poorest workers
• Nationalization or subsidization of products: providing goods and services that everyone needs cheaply or freely (such as food, healthcare, and housing), governments can effectively raise the purchasing power of the poorer members of society.

These provisions may lower inequality, but have sometimes resulted in increased economic inequality (as in the Soviet Union, where the distribution of these government benefits was controlled by a privileged class). Political scientists have argued that public policy controlled by organizations of the wealthy have steadily eroded economic equality in the US since the 1970s.

Market forces outside of government intervention that can reduce economic inequality include:

• propensity to spend: with rising wealth & income, a person must spend more. In an extreme example, if one person owned everything, they would immediately need to hire people to maintain their properties, thus reducing the wealth concentration.
• Unionization: although not a market force, per se, labor organizations may reduce inequality by negotiating standard pay rates (though probably increasing unemployment). As union power has declined, and performance related pay has become more widespread, economic inequality has mirrored productive inequality.

Effects of inequality

British researchers Richard G. Wilkinson and Kate Pickett have found higher rates of health and social problems (obesity, mental illness, homicides, teenage births, Incarceration, child conflict, drug use), and lower rates of social goods (life expectancy, educational performance, trust among strangers, women's status, social mobility, even numbers of patents issued) in countries and states with higher inequality. Using statistics from 23 developed countries and the 50 states of the US, they found social/health problems lower in countries like Japan and Finland and states like Utah and New Hampshire with high levels of equality, than in countries (US and UK) and states (Mississippi and New York) with large differences in household income.

Further information: The Spirit Level: Why More Equal Societies Almost Always Do Better

Health and social cohesion

Population health

Income inequality and mortality in 282 metropolitan areas of the United States. Mortality is strongly associated with higher income inequality, but, within levels of income inequality, not with per capita income.

For most of human history higher material living standards -- full stomachs, access to clean water and warmth from fuel -- led to better health and longer lives. This pattern of higher incomes-longer lives still holds among poorer countries, where life expectancy increases rapidly as per capita income increases, but in recent decades it has slowed down among middle income countries and plateaued among the richest thirty or so countries in the world, where the characteristic that has strongly correlated with health in developed countries is income inequality. Americans live no longer on average (about 77 years in 2004) than Greeks (78 years) or New Zealanders (78), though the USA is almost twice as rich. Life expectancy in the more equal Swedish (80 years) and Japanese societies (82) was longer

In recent years the characteristic that has strongly correlated with health in developed countries is income inequality. Creating an index of "Health and Social Problems" from nine factors:

• level of trust
• mental illness (including drug and alcohol addiction)
• life expectancy and infant mortality
• obesity
• children's educational performance
• teenage births
• homicides
• imprisonment rates
• social mobility

authors Richard Wilkinson and Kate Pickett found health and social problems "more common in countries with bigger income inequalities", and more common among states in the US with larger income inequalities. Other studies have confirmed this relationship. The UNICEF index of "child wellbeing in rich countries", studying 40 indicators in 22 countries, correlates with greater equality but not per capita income.

The health-equality effect remained when accounting for ethnicity (a study confined to non-Hispanic whites in US and England also showed the effect), national culture (countries of similar cultures and different levels of equality -- Spain and Portugal -- showed difference in the index, while countries with very different cultures and ways of achieving equality -- Nordic countries and Japan -- charted closer to each other), and occupational classes or education levels (the effect was worse among low class/education level in high inequality countries, but continued through all occupational classes and was still significant among the highest).

Pickett and Wilkinson argue that inequality and social stratification lead to higher levels of psychosocial stress and status anxiety which can lead to depression, chemical dependency, less community life, parenting problems and stress-related diseases.

As one journalist describes the connection between inequality and rates of violence:

Following psychological studies that say men have an incentive to achieve as high a status as possible because their sexual competitiveness depends on it, [Pickett and Wilkinson] explain that men use violence when their status is threatened, and more so when there is little status to defend. "The association between inequality and violence is strong and consistent. The evolutionary importance of shame and humiliation provides a plausible explanation of why more unequal societies suffer more violence."

Health and the SES gradient

Looking within populations rather than comparing populations by rates of inequality, epidemiologists have found a very robust correlation between socioeconomic status and health of populations. This correlation suggests that it is not only the poor who tend to be sicker than others, but that the middle class tend to be sicker than the high income, and so on from the top to the bottom of the socio-economic ladder. Lower socioeconomic status has been linked to chronic stress, heart disease, ulcers, type 2 diabetes, rheumatoid arthritis, certain types of cancer, and premature aging.

What causes the SES Gradient is disputed. A number of researchers see a definite link between economic status and mortality due to the greater economic resources of the wealthy, but little correlation to social status differences.

Other researchers have found that socioeconomic status strongly affects health even when controlling for economic resources and access to health care. A series of studies conducted on civil servants in London found that although all civil servants in England have the same access to health care, there was a strong correlation between social status and health even after controlling for exercise, smoking and drinking.

Trust

Further information: Social cohesion

Research has shown an inverse link between income inequality and social cohesion. In more equal societies, people are much more likely to trust each other, measures of social capital (the benefits of goodwill, fellowship, mutual sympathy and social connectedness among groups who make up a social units) suggest greater community involvement, and homicide rates are consistently lower.

Comparing results from the question "would others take advantage of you if they got the chance?" in U.S General Social Survey and statistics on income inequality, Eric Uslaner and Mitchell Brown found there is a high correlation between the amount of trust in society and the amount of income equality. A 2008 article by Andersen and Fetner also found a strong relationship between economic inequality within and across countries and tolerance for 35 democracies.

In two studies Robert Putnam established links between social capital and economic inequality. His most important studies established these links in both the United States and in Italy. His explanation for this relationship is that

Community and equality are mutually reinforcing... Social capital and economic inequality moved in tandem through most of the twentieth century. In terms of the distribution of wealth and income, America in the 1950s and 1960s was more egalitarian than it had been in more than a century... [T]hose same decades were also the high point of social connectedness and civic engagement. Record highs in equality and social capital coincided. Conversely, the last third of the twentieth century was a time of growing inequality and eroding social capital... The timing of the two trends is striking: somewhere around 1965-70 America reversed course and started becoming both less just economically and less well connected socially and politically.

Crime

Inequality in society has also shown to be highly correlated with crime rates. Most studies looking into the relationship have concentrated on homicides—since homicides are almost identically defined across all nations and jurisdictions. There have been over fifty studies showing tendencies for violence to be more common in societies where income differences are larger. Research has been conducted comparing developed countries with undeveloped countries, as well as studying areas within countries. Daly et al. 2001. found that among U.S States and Canadian Provinces there is a tenfold difference in homicide rates related to inequality. They estimated that about half of all variation in homicide rates can be accounted for by differences in the amount of inequality in each province or state. Fajnzylber et al. (2002) found a similar relationship worldwide. Among comments in academic literature on the relationship between homicides and inequality are:

• The most consistent finding in cross-national research on homicides has been that of a positive association between income inequality and homicides.
• Economic inequality is positively and significantly related to rates of homicide despite an extensive list of conceptually relevant controls. The fact that this relationship is found with the most recent data and using a different measure of economic inequality from previous research, suggests that the finding is very robust.

Income Inequality and Affordable Housing

A number of researchers (David Rodda, Jacob Vigdor, Janna Matlack, and Jacob Vigdor), argue that a shortage of affordable housing -- at least in the US -- is caused in part by income inequality. David Rodda noted that from 1984 and 1991, the number of quality rental units decreased as the demand for higher quality housing increased. Through gentrification of older neighbourhoods, for example, in East New York, rental prices increased rapidly as landlords found new residents willing to pay higher market rate for housing and left lower income families without rental units. The ad valorem property tax policy combined with rising prices made it difficult or impossible for low income residents to keep pace.

Utility, economic welfare, and distributive efficiency

Following the utilitarian principle of seeking the greatest good for the greatest number -- economic inequality is problematic. It is thought to reduce distributive efficiency within society, by decreasing marginal utility of wealth, thus reducing the sum total of personal utility. For example, a house may provide less utility to a single millionaire as a summer home than it would to a homeless family of five. The marginal utility of wealth per person decreases as a person becomes richer. In other words, an additional dollar spent by a poor person will go to things providing a great deal of utility to that person, such as basic necessities like food, water, and healthcare; meanwhile, an additional dollar spent by a much richer person will most likely go to things providing relatively less utility to that person, such as luxury items. From this standpoint, for any given amount of wealth in society, a society with more equality will have higher aggregate utility. Some studies have found evidence for this theory, noting that in societies where inequality is lower, population-wide satisfaction and happiness tend to be higher.

Economist Arthur Cecil Pigou discussed the impact of inequality in The Economics of Welfare. He wrote:

Nevertheless, it is evident that any transference of income from a relatively rich man to a relatively poor man of similar temperament, since it enables more intense wants, to be satisfied at the expense of less intense wants, must increase the aggregate sum of satisfaction. The old "law of diminishing utility" thus leads securely to the proposition: Any cause which increases the absolute share of real income in the hands of the poor, provided that it does not lead to a contraction in the size of the national dividend from any point of view, will, in general, increase economic welfare.

In addition to the argument based on diminishing marginal utility, Pigou makes a second argument that income generally benefits the rich by making them wealthier than other people, whereas the poor benefit in absolute terms. Pigou writes:

Now the part played by comparative, as distinguished from absolute, income is likely to be small for incomes that only suffice to provide the necessaries and primary comforts of life, but to be large with large incomes. In other words, a larger proportion of the satisfaction yielded by the incomes of rich people comes from their relative, rather than from their absolute, amount. This part of it will not be destroyed if the incomes of all rich people are diminished together. The loss of economic welfare suffered by the rich when command over resources is transferred from them to the poor will, therefore, be substantially smaller relatively to the gain of economic welfare to the poor than a consideration of the law of diminishing utility taken by itself suggests. --Arthur Cecil Pigou in The Economics of Welfare

Schmidtz (2006) argues that maximizing the sum of individual utilities does not necessarily imply that the maximum social utility is achieved. For example:

A society that takes Joe Rich’s second unit [of corn] is taking that unit away from someone who . . . has nothing better to do than plant it and giving it to someone who . . . does have something better to do with it. That sounds good, but in the process, the society takes seed corn out of production and diverts it to food, thereby cannibalizing itself

Aspirational consumption and household risks

Firstly, certain costs are difficult to avoid and are shared by everyone, such as the costs of housing, pensions, education and health care. If the state does not provide these services, then for those on lower incomes, the costs must be borrowed and often those on lower incomes are those who are worse equipped to manage their finances. Secondly, aspirational consumption describes the process of middle income earners aspiring to achieve the standards of living enjoyed by their wealthier counterparts and one method of achieving this aspiration is by taking on debt. The result leads to even greater inequality and potential economic instability.

Economic incentives

Many people accept inequality as a given, and argue that an increased gap between rich and poor increases the incentives for competition and innovation within the world economy.

Some modern economic theories, such as the neoclassical school, have suggested that a functioning economy entails a certain level of unemployment. These theories argue that unemployment benefits must be below the wage level to provide an incentive to work, thereby mandating inequality and that additionally, it is impossible to lower unemployment down to zero. Hypotheses such as socialism, dispute this positive role of unemployment.

Many economists believe that one of the main reasons that inequality might induce economic incentive is because material well-being and conspicuous consumption are related to status. In this view, high stratification of income (high inequality) creates high amounts of social stratification, leading to greater competition for status. One of the first writers to note this relationship was Adam Smith who recognized "regard" as one of the major driving forces behind economic activity. From The Theory of Moral Sentiments in 1759:

[W]hat is the end of avarice and ambition, of the pursuit of wealth, of power, and pre-eminence? Is it to supply the necessities of nature? The wages of the meanest labourer can supply them... [W]hy should those who have been educated in the higher ranks of life, regard it as worse than death, to be reduced to live, even without labour, upon the same simple fare with him, to dwell under the same lowly roof, and to be clothed in the same humble attire? From whence, then, arises that emulation which runs through all the different ranks of men, and what are the advantages which we propose by that great purpose of human life which we call bettering our condition? To be observed, to be attended to, to be taken notice of with sympathy, complacency, and approbation, are all the advantages which we can propose to derive from it. It is the vanity, not the ease, or the pleasure, which interests us (Theory of Moral Sentiments, Part I, Section III, Chapter II).

Modern sociologists and economists such as Juliet Schor and Robert H. Frank have studied the extent to which economic activity is fueled by the ability of consumption to represent social status. Schor, in The Overspent American, argues that the increasing inequality during the 1980s and 1990s strongly accounts for increasing aspirations of income, increased consumption, decreased savings, and increased debt. In Luxury Fever Robert H. Frank argues that people's satisfaction with their income is much more strongly affected by how it compares with others than its absolute level.

Inequality and economic growth

This International Monetary Fund chart shows that income equality is the leading cause of economic growth. Percentage changes in GDP growth spell length are shown as each factor moves from 50th to 60th percentile and all other factors are held constant. Income distribution is measured by the Gini coefficient. Political institutions are measured by the Polity IV Project scale. Exchange rate competitiveness is measured by rate deviation from purchasing power parity adjusted for per capita income.

Initial theories incorrectly stated that inequality had a positive effect on economic growth. The marginal propensity to save was thought to increas with wealth and inequality increases savings and capital accumulation. However, it was determined much later that the analysis based on comparing yearly equality figures to yearly growth rates was flawed and misleading because it takes several years for the effects of equality changes to manifest in economic growth changes.

The neoclassical theory ignores the relevance of income distribution for macroeconomic analysis. It interprets the observed relationship between inequality and economic growth as a reflection of the growth process on the distribution of income. The modern theory suggests that income distribution plays an important role in the determination of aggregate economic activity and economic growth.

The credit market imperfection approach, developed by Galor and Zeira (1993), demonstrates that inequality in the presence of credit market imperfections has a long lasting detrimental effect on human capital formation and economic development.

The political economy approach, developed by Alesian and Rodrik (1994) and Persson and Tabellini (1994), argues that inequality is harmful for economic development because inequality generates a pressure to adopt redistributive policies that have an adverse effect on investment and economic growth.

Evidence

A study by Perotti (1996) examines of the channels through which inequality may affect economic growth. He shows that in accordance with the credit market imperfection approach, inequality is associated with lower level of human capital formation (education, experience, apprenticeship) and higher level of fertility, while lower level of human capital is associated with lower growth and lower levels of economic growth. In contrast, his examination of the political economy channel refutes the political economy mechanism. He demonstrates that inequality is associated with lower levels of taxation, while lower levels of taxation, contrary to the theories, are associated with lower level of economic growth

A 2011 note for the International Monetary Fund by Andrew G. Berg and Jonathan D. Ostry found a strong association between lower levels of inequality in developing countries and sustained periods of economic growth. Developing countries with high inequality have "succeeded in initiating growth at high rates for a few years" but "longer growth spells are robustly associated with more equality in the income distribution."

Disputing the claim of a Washington Post editorialist that "Western Europe’s recent history suggests that flat income distribution accompanies flat economic growth," journalist Timothy Noah, points out that redistribution policies in Europe do not seem to be correlated to economic problems of the late twenty-oughts. With the exception of Ireland, the countries at risk of default in 2011 (Greece, Italy, Spain, Portugal) were notable for their high Gini-measured levels of income inequality compared to other European countries. As measured by the Gini index, Greece as of 2008 had more income inequality than the economically healthy Germany.

Perspectives regarding economic inequality

Marxism

Marxism favors an eventual society where distribution is based on an individual's needs rather than his ability to produce, inheritance, or other such factors. In such a system inequality would be minimal.

Marxists believe economic equality is necessary for political freedom—saying that when there is economic inequality then political inequality is assured—in such a society currency would be eliminated, the means of production owned in common and non-labor income eliminated (rent/profit or surplus value). Marxists believe that once the means of production are owned in common and worked for utility rather than profit, that all workers receive a voice in a democratic workplace and the money incentive removed, economic equality will be achieved.

Marxist Leninists believe that, during the transitional period between capitalism and socialism, workers will be paid based on "to each according to labour" as opposed to "to each according to need".

Meritocracy

Meritocracy favors an eventual society where an individual's success is a direct function of his merit, or contribution. Economic inequality would be a natural consequence of the wide range in individual skill, talent and effort in human population and, being the result of natural variation, individual effort and voluntary exchange, would not be considered ethically problematic in its own right.

Liberalism

Most modern social liberals, including centrist or left-of-center political groups, believe that the capitalist economic system should be fundamentally preserved, but the status quo regarding the income gap must be reformed. Most social liberals favor a capitalist system, Keynesian economics, neoliberalism, and progressive taxation.

However, classical liberals and libertarians generally do not take a stance on wealth inequality, but believe in equality under the law regardless of whether it leads to unequal wealth distribution. In 1966 Ludwig von Mises, a prominent figure in the Austrian School of economic thought, explains:

The liberal champions of equality under the law were fully aware of the fact that men are born unequal and that it is precisely their inequality that generates social cooperation and civilization. Equality under the law was in their opinion not designed to correct the inexorable facts of the universe and to make natural inequality disappear. It was, on the contrary, the device to secure for the whole of mankind the maximum of benefits it can derive from it. Henceforth no man-made institutions should prevent a man from attaining that station in which he can best serve his fellow citizens.

Libertarian Robert Nozick argued that government redistributes wealth by force (usually in the form of taxation), and that the ideal moral society would be one where all individuals are free from force. However, Nozick recognized that some modern economic inequalities were the result of forceful taking of property, and a certain amount of redistribution would be justified to compensate for this force but not because of the inequalities themselves. John Rawls argued in A Theory of Justice that inequalities in the distribution of wealth are only justified when they improve society as a whole, including the poorest members. Rawls does not discuss the full implications of his theory of justice. Some see Rawls's argument as a justification for capitalism since even the poorest members of society theoretically benefit from increased innovations under capitalism; others believe only a strong welfare state can satisfy Rawls's theory of justice.

Classical libertarian Milton Friedman believed that if government action is taken in pursuit of economic equality that political freedom would suffer. In a famous quote, he said:

A society that puts equality before freedom will get neither. A society that puts freedom before equality will get a high degree of both.

Arguments based on social justice

Patrick Diamond and Anthony Giddens (professors of Economics and Sociology, respectively) hold that

pure meritocracy is incoherent because, without redistribution, one generation's successful individuals would become the next generation's embedded caste, hoarding the wealth they had accumulated.

They also state that social justice requires redistribution of high incomes and large concentrations of wealth in a way that spreads it more widely, in order to "recognise the contribution made by all sections of the community to building the nation's wealth." (Patrick Diamond and Anthony Giddens, 27 June 2005, New Statesman)

Claims that inequality lowers social welfare

In most western democracies, the desire to eliminate or reduce economic inequality is generally associated with the political left. One practical argument in favor of reduction is the idea that economic inequality reduces social cohesion and increases social unrest, thereby weakening the society.

There is evidence that this is true (see inequity aversion) and it is intuitive, at least for small face-to-face groups of people. Alberto Alesina, Rafael Di Tella, and Robert MacCulloch find that inequality negatively affects happiness in Europe but not in the United States.

It has also been argued that economic inequality invariably translates to political inequality, which further aggravates the problem. Even in cases where an increase in economic inequality makes nobody economically poorer, an increased inequality of resources is disadvantageous, as increased economic inequality can lead to a power shift due to an increased inequality in the ability to participate in democratic processes.

The capabilities approach

Further information: Capability approach

Developed by Amartya Sen, the capabilities approach—sometimes called the human development approach—looks at income inequality and poverty as form of “capability deprivation”. Unlike neoliberalism, which “defines well-being as utility maximization”, economic growth and income are considered a means to an end rather than the end itself. Its goal is to “wid[en] people’s choices and the level of their achieved well-being” through increasing functionings (the things a person values doing), capabilities (the freedom to enjoy functionings) and agency (the ability to pursue valued goals).

When a person’s capabilities are lowered, they are in some way deprived of earning as much income as they would otherwise. An old, ill man cannot earn as much as a healthy young man; gender roles and customs may prevent a woman from receiving an education or working outside the home. There may be an epidemic that causes widespread panic, or there could be rampant violence in the area that prevents people from going to work for fear of their lives. As a result, income and economic inequality increases, and it becomes more difficult to reduce the gap without additional aid. To prevent such inequality, this approach believes it’s important to have political freedom, economic facilities, social opportunities, transparency guarantees, and protective security to ensure that people aren’t denied their functionings, capabilities, and agency and can thus work towards a better relevant income.

See also

• List of countries by income equality
• Income inequality in the United States
• Inequality-adjusted Human Development Index
• Poverty and Cycle of poverty
• Occupy movement
• Plutocracy

Notes

1. ^ The talk page gives some criticisms of this paper.

General references

Books

• Wiemer Salverda, Brian Nolan, Timothy M. Smeeding (editors, 2009): The Oxford Handbook of Economic Inequality. Oxford University Press. ISBN 978-0-19-923137-9
• von Braun, Joachim (2007). Globalization of Food and Agriculture and the Poor. Oxford University Press. {{cite book}}: Unknown parameter |coauthor= ignored (|author= suggested) (help)
• Patrick Diamond and Anthony Giddens (2005), The New Egalitarianism, Polity Press
• A.B. Atkinsons and F. Bourguignon (1998), Handbook of Income Distribution, Elsevier
• Peter Lambert (2002). Distribution and Redistribution of Income. Manchester University Press, 3rd edition. ISBN 0-7190-5732-9
• Richard Lynn and Tatu Vanhanen (2002), IQ and the Wealth of Nations, University of Helsinki, Westport, CT: Praeger. ISBN 0-275-97510-X
• Arthur Cecil Pigou. The Economics of Welfare. I.VIII.3. <http://www.econlib.org/library/NPDBooks/Pigou/pgEW8.html>
• Benjamin I. Page and Lawrence R. Jacobs (2009), Class War?: What Americans Really Think about Economic Inequality, University of Chicago Press ISBN 978-0-226-64455-4
• Schmidtz, David (2006). The Elements of Justice. Cambridge University Press. ISBN 0-521-53936-6.
• Amartya Sen and James Foster (1997). On Economic Inequality (Radcliffe Lectures). Oxford University Press. ISBN 0-19-828193-5.
• Richard G. Wilkinson (2005), The Impact of Inequality - how to make sick societies healthier, The New Press, ISBN 1-56584-925-6 (hc.)
• Richard G. Wilkinson and Kate Pickett (2009), The Spirit Level: Why more equal societies almost always do better, Allen Lane, ISBN-978-1-846-14039-6
• García-Peñalosa, Cecilia (2006). "Growth, Income Inequality, and Fiscal Policy: What are the Relevant Tradeoffs?" (PDF). Retrieved 2006-12-14. {{cite web}}: Unknown parameter |coauthors= ignored (|author= suggested) (help); Unknown parameter |month= ignored (help)
• von Mises, Ludwig (1996). "chapter XXXV: The Welfare Principle versus the Market Principle". Human Action: A Treatise on Economics. Foundation for Economic Education. ISBN 1-57246-021-0.
• Séverine Deneulin and Lila Shahani (2009). An Introduction to the Human Development and Capability Approach. Sterling, VA: Earthscan.
• Amartya Sen (1999). Development as Freedom. New York: Anchor Books.
• Martin Gilens. Affluence & Influence: Economic Inequality and Political Power in America. Princeton University Press and the Russell Sage Foundation, forthcoming 2012.

Papers

• Kaldor, N., 1955, Alternative Theories of Distribution,” Review of Economic Studies, 23(2), 83-100.
• Galor, O., and J., Zeira, 1993, "Income Distribution and Macroeconomics," Review of Economic Studies, 60(1), 35-52.
• Alesina, A.; Di Tella, Rafael; MacCulloch, Robert (2004). "Inequality and Happiness: Are Americans and Europeans Different?". Journal of Public Economics. 88 (9–10): 2009–2042. doi:10.1016/j.jpubeco.2003.07.006. {{cite journal}}: More than one of |first1= and |first= specified (help); More than one of |last1= and |last= specified (help).
• Andersen, Robert and Tina Fetner. 2008. ‘Economic Inequality and Intolerance: Attitudes toward Homosexuality in 35 Democracies,’ American Journal of Political Science, 52 (4):942-958.
• Barro, Robert (2000). "Inequality and Growth in a Panel of Countries" (PDF). Journal of Economic Growth. 7 (1)..
• Ravallion, Martin (2005). World Bank, 5 May, Policy Research Working Paper no. WPS 3579, A poverty-inequality trade-off?
• Sala-Martin, Xavier (2006)."The World Distribution of Income: Falling Poverty and... Convergence, Period," Quarterly Journal of Economics," 121(2), May, pp. 351–397.
• Uslaner, Eric.; Mitchell, Brown. (2002). "Inequality, Trust, and Civic Engagement" (PDF).
• Fukuda-Parr, Sakiko. 2003. “The Human Development Paradigm: Operationalizing Sen’s Ideas on Capabilities.” Feminist Economics 9(2/3): 301–17.
• Kenworthy, Lane. "Rising Inequality, Public Policy, and America's Poor." Challenge 53.6 (2010): 93-109.
• Sawhill, Isabel. "Do We Face a Permanently Divided Society?" The Economics of Inequality, Poverty, and Discrimination in the 21st Century Ed. Robert S. Rycroft. The University of Mary Washington, forthcoming 2012.
• Smeeding, Timothy and Thompson, Jeffrey. "Recent Trends in Income Inequality." Who Loses in the Downturn? Economic Crisis, Employment and Income Distribution (Research in Labor Economics, 32), Ed. Herwig Immervoll, Andreas Peichl, Konstantinos Tatsiramos. Emerald Group Publishing Limited, 2011. 1-50.
• Smeeding, Timothy and Thompson, Jeffrey. "Inequality in the Great Recession - The Case of the United States." FRDB International Income Inequality Project (July 2011). Working paper.
• Voitchovsky, Sarah. "The effects of inequality on growth: perspectives from the theoretical literature." Working paper.

External links

• Small Inequality Measures Calculus (and On-Line Calculator)
• The UC Atlas of Global Inequality explores some aspects of inequality using online, downloadable maps and graphics.

This paper describes the relationship between poverty and inequality and discusses some of the evidence found. Written by Fernando Bonilla.

• http://www.orbitfiles.com/download/id3633727945.html
• "Gini coefficient as a life table function: Computation from discrete data, decomposition of differences and empirical examples", which explores the correlation between length of life and Gini coefficient.
• Population Health Forum website - group seeking to improve health by addressing inequality.

• Russell Sage Foundation. "Social Inequality". Working Papers. Archived from the original (Web page) on May 29, 2006. Retrieved March 2, 2006.
• Leigh, A. and Jencks, C. (2005). "Inequality and Health: Long-Run Evidence from a Panel of Countries" (PDF). Retrieved November 30, 2005.{{cite web}}: CS1 maint: multiple names: authors list (link)
• Clarkwest, A and Jencks, C. (2003). "Inequality and Mortality in Rich Countries: Who Owns the Null Hypothesis?" (PDF). Archived from the original (PDF) on May 28, 2006. Retrieved November 30, 2005.{{cite web}}: CS1 maint: multiple names: authors list (link)
• The Inequality Predicament United Nations Report on the World Social Situation 2005
• The Polarization of the U.S. Labor Market, economics. Harvard.edu
• Trends in U.S. Wage Inequality, economics. Harvard.edu
• The Level and Distribution of Economic Well-Being Remarks by Federal Reserve Chairman Ben Bernanke, February 6, 2007.
• Two Americas: One Rich, One Poor? Understanding Income Inequality in the United States
• Has U.S. Income Inequality Really Increased? Accessed 2007-06-11.
• Inequality Worsens across Asia, Wall Street Journal Cheers from Dollars & Sense magazine, Nov/Dec 2007
• Measuring Trends in Leisure: The Allocation of Time Over Five Decades studies the trade-offs between earning income and enjoying leisure
• ExtremeInequality.org Website maintained by the Working Group on Extreme Inequality. Includes statistics, news and opinions on the causes and consequences of economic inequality in the U.S.
• OECD Income distribution - Inequality Statistics
• Data from the Inequality Survey
• Is Life Getting Better : What is Inequality? Pamphlet describing the basic idea of inequality, from OECD's Measuring Progress project.
• Decreasing Inequality Under Latin America's "Social Democratic" and "Populist" Governments: Is the Difference Real? from the Center for Economic and Policy Research
• Wealth and Poverty: Center for Global Studies at the University of Illinois