Inequality: Factors and effect of Economic inequality.

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1 International International Multidisciplinary Multidisciplinary e-journal e Journal / Dr. Venkatarao Palati ( ) ISSN Inequality: Factors and effect of Economic inequality. Dr. Venkatarao Palati M.A. M.Ed. M.Phil. Ph.D. Principal, Noor College of Education, Bidar (Karnataka) Paper Received on: 20/01/2014 Paper Reviewed on: 19/01/2014 Paper Accepted on: 23/01/2014 Abstract: Emerging countries are playing a growing role in the world economy. It is a role that is expected to be even greater in the future. It is important, therefore, that any comprehensive assessment of inequality trends worldwide considers the emerging economies. This chapter discusses inequality patterns and related issues in the biggest emerging economies. It begins with a brief overview of Inequalities, economic inequality, factors impacting economic inequality and Effects of inequality. Keywords: Economic inequality. 1. Introduction: Equity is probably one of the most fundamental values common to all people in a society. Equity can be elusive, however. It is usually defined in terms of how equals are treated by government policies and the legal system, and how we decide who these equals are. The concept of equality is multifaceted; the literature on theories of equality is immense and the application of these theories is complex. Nevertheless, the great philosophical and legal minds of our time recognize that a comprehensive investigation of equality, and its measurement, is vital in the quest for justice. In this essay, I consider some of the major theories of equality as defined by various players in the literature, each of whom attempts to answer the question, `What type of equality will promote equity in society? Vol-III, Issue-I, Jan Page

2 Economic inequality is the difference between individuals or populations in the distribution of their assets, wealth, or income. 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 involves equity, equality of outcome, equality of opportunity, and life expectancy. Opinions differ on the utility of inequality and its effects. Recent studies consider it beneficial, while others considered it a growing social problem. While some inequality promotes investment, too much inequality is destructive. Income inequality can hinder long term growth. Statistical studies comparing inequality to year-over-year economic growth have been inconclusive; however in 2011, researchers from the International Monetary Fund published that income equality was more determinate of the duration of countries' growth spells than free trade, low government corruption, foreign investment, or low foreign debt. Economic inequality varies between societies, historical periods, economic structures and systems (for example, capitalism or socialism), and between individuals' abilities to create wealth. The term can refer to cross sectional descriptions of the income or wealth at any particular period, and to the lifetime income and wealth over longer periods of time. There are various numerical indices for measuring economic inequality. A prominent one is the Gini coefficient, but there are also many other methods. 2. Factors impacting economic inequality: There are many reasons for economic inequality within societies. Common factors thought to impact economic inequality include: labor market outcomes Globalization technological changes policy reforms more regressive taxation computerization and increased technology Vol-III, Issue-I, Jan Page

3 racial discrimination gender discrimination variation in natural ability 2.1.The labor market: A major cause of economic inequality within modern market economies is the determination of wages by the market. Some small part of economic inequality is caused by the differences in the supply and demand for different types of work. However, where competition is imperfect; information unevenly distributed; opportunities to acquire education and skills unequal; and since many such imperfect conditions exist in virtually every market, there is in fact little presumption that markets are in general efficient. This means that there is an enormous potential role for government to correct these market failures. 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. "On the other hand, markets can also concentrate wealth; pass environmental costs on to society, and abuse workers and consumers." "Markets, by themselves, even when they are stable, often lead to high levels of inequality, outcomes that are widely viewed as unfair." 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 Vol-III, Issue-I, Jan Page

4 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. Polarization of wages does not explain the accumulation of wealth and very high incomes among the 1%. Joseph Stiglitz believes that "It is plain that markets must be tamed and tempered to make sure they work to the benefit of most citizens." 2.2. 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, provided that income does not change as a result of the change in tax regime. Additionally, a steeper progressivity results in a more equal distribution of income across the board 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 however, increases in education first increase and then decrease growth as well as income inequality. As a result, those who are unable to afford an education, or choose not to pursue optional education, generally receive much lower wages. The justification for this is that a lack of education leads directly to lower incomes, and thus lower aggregate savings and investment. In particular, the increase in family income and wealth inequality leads to greater dispersion of educational attainment, primarily because those at the bottom of the educational distribution have fallen further below the average level Vol-III, Issue-I, Jan Page

5 of education. Conversely, education raises incomes and promotes growth because it helps to unleash the productive potential of the poor. During the mass high school education movement from , 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. Education is very important for the growth of the economy, however educational inequality in gender also influence towards the economy. Lagerlof and Galor stated that gender inequality in education can result to low economic growth, and continued gender inequality in education, thus creating a poverty trap. It is suggested that a large gap in male and female education may indicate backwardness and so may be associated with lower economic growth, which can explain why there is economic inequality between countries. More of Barro studies also find that female secondary education is positively associated with growth. His findings show that countries with low female education; increasing it has little effect on economic growth, however in countries with high female education, increasing it significantly boosts economic growth. More and better education is a prerequisite for rapid economic development around the world. Education stimulates economic growth and improves people's lives through many channels. By increasing the efficiency of the labour force it create better conditions for good governance, improving health and enhancing equality. Labor market success is linked to schooling achievement, the consequences of widening disparities in schooling is likely to be further increases in earnings inequality Views on 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. Lawrence Katz estimates that trade has only accounted for 5-15% of rising income inequality. Robert Lawrence argues that technological Vol-III, Issue-I, Jan Page

6 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 Impact of gender: 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. A U.S. Census's report stated that in US once other factors are accounted for there is still a difference in earnings between women and men. Gender inequality and discrimination is argued to cause and perpetuate poverty and vulnerability in society as a whole Diversity of preferences: Related to cultural issues, diversity of preferences within a society may contribute 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 may choose different strategies. 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: Wealth concentration is a theoretical process by which, under certain conditions, newly created wealth concentrates in the possession of already-wealthy individuals or entities. Vol-III, Issue-I, Jan Page

7 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 Rent-seeking: Economist Joseph Stiglitz argues that rather than explaining concentrations of wealth and income, market forces should serve as a brake on such concentration, which may better be explained by the non-market force known as "rent-seeking". While the market will bid up compensation for rare and desired skills to reward wealth creation, greater productivity, etc., it will also prevent successful entrepreneurs from earning excess profits by fostering competition to cut prices, profits and large compensation. A better explainer of growing inequality, according to Stiglitz, is the use of political power generated by wealth by certain groups to shape government policies financially beneficial to them. This process, known to economists as rent-seeking, brings income not from creation of wealth but from "grabbing a larger share of the wealth that would otherwise have been produced without their effort" 2.9. 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 if the change in taxation does not cause changes in income. Minimum wage legislation: raising the income of the poorest workers (for the ones that don't lose their jobs due to the minimum wage) Vol-III, Issue-I, Jan Page

8 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. 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. 3. Effects of inequality: Among the effects of inequality researchers have found include higher rates of health and social problems, and lower rates of social goods, a lower level of economic utility in society from resources devoted on high-end consumption, and even a lower level of economic growth when human capital is neglected for high-end consumption. 3.1.Health and social cohesion: 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. 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. Vol-III, Issue-I, Jan Page

9 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 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 Crime: Crime rate has also been shown to be correlated with inequality in society. 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. 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 Social, cultural, and civic participation: Higher income inequality led to less of all forms of social, cultural, and civic participation among the less wealthy. When inequality is higher the poor do not shift to less expensive forms of participation Utility, economic welfare, and distributive efficiency: Vol-III, Issue-I, Jan Page

10 Following the utilitarian principle of seeking the greatest good for the greatest number economic inequality is problematic. A house that provides less utility to a millionaire as a summer home than it would to a homeless family of five, is an example of reduced "distributive efficiency" within society, that decreases marginal utility of wealth and thus the sum total of personal utility. 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; while, an additional dollar spent by a much richer person will very likely go to luxury items providing relatively less utility to that person. Thus, the marginal utility of wealth per person ("the additional dollar") decreases as a person becomes richer. 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. The pressure to have bigger ones than your rivals leads to an arms race that consumes resources that could have been used more efficiently for other things, such as fighting off disease. As a result, every male ends up with a cumbersome and expensive pair of antlers, and "life is more miserable for bull elk as a group." 3.6. 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. 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 Vol-III, Issue-I, Jan Page

11 this relationship was Adam Smith who recognized "regard" as one of the major driving forces behind economic activity Inequality and economic growth: In the 1960s, economist Arthur Melvin Okun argued that pursuing equality could reduce efficiency (the total output produced with given resources) by reducing incentives to work, save, and invest and through the leaky bucket of wasteful government efforts to redistribute (such as a progressive tax code and minimum wages). Some resources will simply disappear in transit, so the poor will not receive all the money that is taken from the rich. Along the same lines, earlier writers had argued that wealthier individuals save proportionally more of their incomes, so that more inequality would lead to higher overall savings and thus capital accumulation and growth Cross-country evidence: Many authors have empirically examined the relationship between economic growth and income inequality in a large group of countries. Following the broader economic growth literature, the typical approach was to relate countries' real GDP per capita growth over a long period of time (e.g., 1965 through 1990) to the income distribution at the start of the period, simultaneously taking into account other standard determinants such as the initial level of real GDP per capita. A typical conclusion was that more unequal countries tend to grow slower though the evidence was contested. Berg and Ostry postulate that high levels of inequality might damage long term growth by amplifying the potential for financial crisis, discouraging investment because of political instability, making it more difficult for governments to make difficult choices (such as raising taxes or cutting public expenditure) in the face of shocks, or by discouraging investment in education and health for the poor. References: 1. Alvaredo, F. and A.B. Atkinson (2010), Colonial Rule, Apartheid and Natural Resources: Top Incomes in South Africa , OxCarre Research Paper, No. 46/ Banerjee, A. and T. Piketty (2005), Top Indian Incomes, , World Bank Economic Review, No. 19, Washington, DC. Vol-III, Issue-I, Jan Page

12 3. Barros, R. and C.H. Corseuil (2004), The Impact of Regulations on Brazilian Labor Market Performance, Law and Employment: Lessons from Latin American and the Caribbean, NBER, University of Chicago Press, Chicago, pp Brys, B., Matthews S. and J. Owens (2011), Tax Reform Trends in OECD Countries, OECD Taxation Working Papers, No. 1, forthcoming. 5. Chakraborty, P. (2007), Implementation of the National Rural Employment Guarantee Act in India: Spatial Dimensions and Fiscal Implications, Economics Working Paper, No. 505, Levy Economics Institute, New York. Vol-III, Issue-I, Jan Page