Income Inequality and Poverty (Chapter 20 in Mankiw & Taylor; reading Chapter 19 will also help)

Transcription

1 Income Inequality and Poverty (Chapter 20 in Mankiw & Taylor; reading Chapter 19 will also help) Before turning to money and inflation, we backtrack - at least in terms of the textbook - to consider income inequality and taxation (Chapter 12) These are topics of interest to both micro- and macroeconomists

2 The invisible hand allocates resources efficiently, but not necessarily fairly Provides a rationale for government intervention? But in making the distribution of income more equitable the government distorts incentives, alters behaviour and makes the allocation of resources less efficient

3 Already discussed, why do people have different earnings? A person s wages depend on the supply and demand for their labour Which depends on their natural ability, human capital, compensating variations, discrimination etc. Labour earnings make up more than 50% of total income in the UK

4 Plan of lecture 1. How much inequality is there in our society? 2. Should the government alter the distribution of income? 3. Public policies to help society s poorest members

5 The Measurement of Inequality Questions of measurement: How much inequality is there in our society? How many people live in poverty? What problems arise in measuring the amount of inequality? How often do people move among income classes? 5

6 U.K. Income Inequality Distribution of income Align families by income Divide all families into five or ten equal groups Same number of families in each group Different incomes The bottom 20% of families recive 7.1% of income The top 20% received over 40% of all income Distribution of income is skewed with 65% of households have income below the national mean 6

7 Figure 1 The Distribution of Income in the UK: 2010 Source: IFS 7

8 13 years of New Labour 8

9 The income of the rich is correlated with growth in the financial sector Source: IFS 9

10 U.S. Income Inequality Trends in income distribution : more equal distribution : more unequal distribution Causes: Increase in international trade with low-wage countries Demand for skilled labour has increased; their wages have therefore risen in relative terms Changes in technology 10

11 Table 2 Income Inequality in the United States This table shows the percentage of total before-tax income received by families in each fifth of the income distribution and by those families in the top 5 percent. 11

12 Inequality Around the World Formal inequality measures 1. The Gini coefficient 2. The poverty rate Degree of inequality Varies substantially around the world and inequality can rise even as average incomes rise over time 12

13 Gini coefficient Gini coefficient = A/(A+B) = 0 when there s complete equality = 1 when one person earns all the income The Lorenz curve plots the proportion of the total income of the population (y axis) that is cumulatively earned by the bottom x% of the population

14 Figure 3: the Gini coefficient Inequality around the World: selected countries 14

15 Poverty rate The Poverty Rate Percentage of the population whose family income falls below an absolute level (the poverty line) Since poverty is a relative concept, we define the poverty line as an absolute level of income individuals do not have food, shelter and clothing (access to the basics of life) 15

16 Figure 4 The Poverty Rate by age group The poverty rate (after social transfers) shows the percentage of the population with incomes below an absolute level (in Europe often defined as less than 60% of median equivalised income) called the poverty line 16

17 Relative poverty is where some people s way of life and income is so much worse than the general standard of living in the country or region in which they live that they struggle to live a normal life and to participate in ordinary economic, social and cultural activities What this means will vary from country to country, depending on the standard of living enjoyed by the majority While not as extreme as absolute poverty, relative poverty is still serious and harmful 17

18 Table Who Is Poor in the US? This table shows that the poverty rate varies greatly among different groups within the population. 18

19 Problems in Measuring Inequality Data on income distribution & poverty rate Incomplete picture of inequality 1. People care about ability to maintain a good standard of living not incomes per se 2. Doesn t account for in-kind transfers 3. Normal life cycle pattern Causes inequality in the distribution of annual income May not represent true inequality in living standards as people save/dissave 19

20 Problems in Measuring Inequality Data on income distribution & poverty rate 4. Transitory vs. permanent income The distribution of permanent income is more relevant than that of annual (actual) income 20

21 Problems in Measuring Inequality In-kind transfers Transfers to the poor In the form of goods & services rather than cash Life-cycle Regular pattern of income variation over a person s life Empirically, we observe a hump shaped pattern, with income rising until someone is in their late 40s - then falling thereafter (with retirement at 65ish) 21

22 Life-cycle behaviour (cont.) People borrow and save to smooth out this variation in their income over their lifecycle Lifetime income is more relevant than annual incomes and tends to be more equally distributed across the population than annual incomes 22

23 Permanent income A person s normal income. It is this that affects their ability to buy goods/services Income varies not just over the life-cycle but due to random and transitory forces Crop failure; recession People can again borrow/lend to smooth out transitory variation in income Transitory changes - need not affect standard of living 23

24 Economic mobility Economic Mobility Movement of people among income classes Some reflects transitory variation in income Some reflects more persistent changes in income Many of those below the poverty line are there only temporarily 24

25 Economic Mobility Persistence of economic success from generation to generation Above-average income carries over from parents to children Millionaires Four of five millionaires made their money on their own One in five millionaires inherited their fortunes 25

26 Political Philosophy What should the government do about economic inequality? Contrasting political philosophies of redistributing income: Utilitarianism Liberalism Libertarianism 26

27 Utilitarianism Political philosophy Utilitarianism The government should choose policies to maximise the total utility of everyone in society Utility Measure of happiness or satisfaction 27

28 Utilitarianism Utilitarian case for redistributing income Based on diminishing marginal utility One extra dollar of income More utility to poor person than to rich person Government: redistribution of income From rich to poor to increase total utility Balance the gains from greater equality against the losses from distorted incentives Maximise total utility Stops short of making society fully egalitarian 28

29 Liberalism Liberalism Another way of thinking about inequality The government should choose policies deemed just As evaluated by an impartial observer behind a veil of ignorance Society s institutions, laws, and policies Should be just 29

30 Maximin criterion Liberalism Government - aim to maximise the wellbeing of the worst-off person (not total utilility) in society Justifies public policies aimed at equalising the distribution of income Transfers income from the rich to the poor Society raises the well-being of the least fortunate Wouldn't lead to a completely egalitarian society 30

31 Liberalism Redistribution of income A form of social insurance Social insurance Government policy Aimed at protecting people against the risk of adverse events Maximise the minimum utility 31

32 Libertarianism Political philosophy Libertarianism The government should punish crimes and enforce voluntary agreements Society itself earns no income Only individual members of society earn income The government should not redistribute income 32

33 Libertarianism Libertarianism Don t evaluate economic outcomes Evaluate the process by which these outcomes arise As long as the process determining the distribution of income is just The resulting distribution is fair, no matter how unequal Equality of opportunities is more important than equality of incomes 33

34 Government Policies to Reduce Poverty Should provide a safety net to prevent people from falling too far into poverty Poverty Associated with various economic and social ills 34

35 Policies to Reduce Poverty Policies to reduce number of people living in poverty Minimum-wage laws Social Security Negative income tax In-kind transfers Anti-poverty policies and work incentives 35

36 Policies to Reduce Poverty Minimum-wage laws Workers who remain employed Benefit from higher wage Higher unemployment Workers who might have been employed at a lower wage - worse off The magnitude of these effects Depends on the elasticity of demand When inelastic (esp. for unskilled labour) employment is only depressed slightly 36

37 Social Security Policies to Reduce Poverty Government programmes that supplement the incomes of the needy To qualify: Low income and some additional need Income Support and Jobseeker s Allowance 37

38 Policies to Reduce Poverty Criticism of welfare programs Creates incentives for people to become needy May encourage families to break up May encourage illegitimate births Exacerbate the very problems they are supposed to cure? 38

39 Policies to Reduce Poverty Negative income tax If your income is below a threshold you get a subsidy Collects revenue from high-income households and gives subsidies to low-income households Poor families receive financial assistance without having to demonstrate need Based only on income Subsidise not only the unfortunate but also those who are simply lazy 39

40 In-kind transfers Policies to Reduce Poverty Provide poor people directly with some of the goods and services they need to raise their living standards Free school meals, housing benefit, free dental care etc. Is it better simply to give the poor people cash? Let them decide what maximises their utility Or avoid them wasting the money on drink/drugs 40

41 Policies to Reduce Poverty Antipoverty programmes and work incentives Many policies aimed at helping the poor have unintended effects Discourage the poor from escaping poverty on their own Very high effective marginal tax rates Discourage families from working 41

42 Policies to Reduce Poverty Antipoverty programmes and work incentives Solution: reduce benefits more gradually as incomes rise Higher cost of antipoverty programmes Trade-off Burdening the poor with high effective marginal tax rates Burdening taxpayers with costly programmes to reduce poverty 42

43 Policies to Reduce Poverty Other ways to reduce the work disincentive of antipoverty programmes: Provide benefits for only a limited period of time, as with Jobseeker s Allowance 43