1. Inequality, Redistribution of income Michael Parkin ECONOMICS 5e

2. TM 17-2 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Describe the inequality in income and wealth Explain why wealth inequality is greater than income inequality Explain how economic inequality arises

3. TM 17-3 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives (cont.) Explain the effects of taxes and social security and welfare programs on economic inequality

4. TM 17-4 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Describe the inequality in income and wealth Explain why wealth inequality is greater than income inequality Explain how economic inequality arises

5. TM 17-5 Copyright © 1998 Addison Wesley Longman, Inc. Economic Inequality in the United States Should we look at the distribution of income or wealth? Income is the amount that is received in a given period of time.

6. TM 17-6 Copyright © 1998 Addison Wesley Longman, Inc. Economic Inequality Should we look at the distribution of income or wealth? Wealth is the value of the things it owns at a point in time. WEALTH = (1) real property + (2) financial assets – (3) debts

7. TM 17-7 Copyright © 1998 Addison Wesley Longman, Inc. Wealth Wealth is a person's net worth, expressed as: WEALTH = assets – liabilities The word "wealth" is often confused with “income". These two terms describe different but related things. Wealth consists of those items of economic value that an individual owns, while income is an inflow of items of economic value. The relation between wealth, income, and expenses is: change of wealth = income − expense

8. TM 17-8 Copyright © 1998 Addison Wesley Longman, Inc.

9. TM 17-9 Copyright © 1998 Addison Wesley Longman, Inc. Wealth levels across Countries global household wealth = o US$20,500 per person using official exchange rates o PPP$26,000 when adjusted for country price levels average wealth per capita = o $144,000 in USA o $181,000 in Japan o $1,400 in Indonesia o $1,100 in India

10. TM 17-10 Copyright © 1998 Addison Wesley Longman, Inc.

11. TM 17-11 Copyright © 1998 Addison Wesley Longman, Inc. Geographical spread of wealth wealth is heavily concentrated in North America, Europe, and high income Asia-Pacific countries - collectively own nearly 90% of world wealth North America has 6% of the world adult population, 34% of household wealth Europe and high income Asia-Pacific countries also own disproportionate amounts of wealth For Africa, China, India, and lower income Asian countries, share of wealth is considerably less than population share, sometimes by a factor of more than 10

12. TM 17-12 Copyright © 1998 Addison Wesley Longman, Inc.

13. TM 17-13 Copyright © 1998 Addison Wesley Longman, Inc. Wealth inequality is very high concentration of wealth within countries is generally high share of the top 10% around o 40% in China o 70% in the United States o higher still in other countries even higher for world as a whole o richest 2% of adults own more than half global wealth o global wealth Gini for adults is 89% (PPP: 80%) - same as group of 100 where 1 gets $900 and other 99 each get $1 o the between country Gini is 70% indicating that the between country inequality explains most of the global inequality wealth more unequally distributed than income across countries o high income countries have bigger share of world wealth than world GDP o reverse is true of middle- and low-income nations o exceptions include Nordic and Eastern Europe transition countries

14. TM 17-14 Copyright © 1998 Addison Wesley Longman, Inc. The global rich (exchange rate basis) $2,200 per adult to be in top half of world wealth ranking $61,000 to be in richest 10% of adults more than $500,000 to be in richest 1% of adults (group with 37 million members worldwide) richest 1% of adults owned 40% of global assets in 2005 richest 2% owned 51% richest 5% owned 71% richest 10% owned 85% bottom half owned barely 1%

15. TM 17-15 Copyright © 1998 Addison Wesley Longman, Inc.

16. TM 17-16 Copyright © 1998 Addison Wesley Longman, Inc.

17. TM 17-17 Copyright © 1998 Addison Wesley Longman, Inc.

18. TM 17-18 Copyright © 1998 Addison Wesley Longman, Inc. Millionaires and billionaires Wealth ($)Number above 1 million13 568 229 10 million451 809 100 million15 010 1 billion499

19. TM 17-19 Copyright © 1998 Addison Wesley Longman, Inc. Country differences in wealth > than in income World wealth inequality high Share of top 10% is 71% using PPP 85% using official exchange rate A study by the World Institute for Development Economics Research at UN University reports that the richest 1% of adults alone owned 40% of global assets in the year 2000, and that the richest 10% of adults accounted for 85% of the world total. The bottom half of the world adult population owned 1% of global wealth. [10] Moreover, another study found that the richest 2% own more than half of global household assets [10]

20. TM 17-20 Copyright © 1998 Addison Wesley Longman, Inc. Wealth dominated by Real Assets in low income countries Financial Assets more important in high income countries Large differences in wealth composition for countries at similar income

21. TM 17-21 Copyright © 1998 Addison Wesley Longman, Inc. Wealth condensation : is a theoretical process by which, in certain conditions, newly-created wealth tends to become concentrated in the possession of already-wealthy individuals or entities, a form of preferential attachment. According to this theory, those who already hold wealth have the means to invest in new sources and structure thus creating more wealth or to otherwise leverage the accumulation of wealth, thus are the beneficiaries of the new wealth

22. TM 17-22 Copyright © 1998 Addison Wesley Longman, Inc. Economic Inequality Lorenz Curves A Lorenz curve graphs the cumulative percentage of income against the cumulative percentage of families.

23. TM 17-23 Copyright © 1998 Addison Wesley Longman, Inc. Lorenz Curves for Income and Wealth Families Income Wealth CumulativeCumulativeCumulative PercentagePercentagePercentagePercentagePercentagePercentage aLowest 20203.73.700 bSecond 20409.112.800 cThird 206015.228.044 dFourth 208023.351.31115 e Highest 2010048.7100.085100

24. TM 17-24 Copyright © 1998 Addison Wesley Longman, Inc. Cumulative % of families 40 20 40 60 80 Lorenz Curves for Income and Wealth 020 6080100 Cumulative % of income & wealth 100 Line of equality Income Wealth b c d e a

25. TM 17-25 Copyright © 1998 Addison Wesley Longman, Inc. Trends in the Distribution of Income: 1950–1998

26. TM 17-26 Copyright © 1998 Addison Wesley Longman, Inc. GINI Coefficient Invented by the Italian statistitian Corado Gini, is a number between zero and one that measures the degree of inequality in the distribution of something. The coefficient would register zero (0.0 = minimum inequality) for a society in which each member received exactly the same amount. A coefficient of one (1.0 = maximum inequality) would mean one member got everything and the rest got nothing.

27. TM 17-27 Copyright © 1998 Addison Wesley Longman, Inc. Economic Inequality in the United States Who Are the Rich and the Poor? The poorest household is likely to be: a black woman over 65 years of age lives in the South has fewer than eight years of education

28. TM 17-28 Copyright © 1998 Addison Wesley Longman, Inc. Economic Inequality in the United States Who Are the Rich and the Poor? The wealthiest household is likely to be: a college-educated white married couple between 45 and 54 years of age has two children lives in the Northeast

29. TM 17-29 Copyright © 1998 Addison Wesley Longman, Inc. The Distribution of Income by Selected Family Characteristics in USA

30. TM 17-30 Copyright © 1998 Addison Wesley Longman, Inc. Economic Inequality in the United States Poverty Poverty is a state in which a family’s income is too low to be able to buy the quantities of food, shelter, and clothing that are deemed necessary. Poverty is a relative concept. The distribution of poverty by race is unequal: 12 percent of white families 31 percent of Hispanic-origin families 33 percent of black families

31. TM 17-31 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Describe the inequality in income and wealth in the United States Explain why wealth inequality is greater than income inequality Explain how economic inequality arises

32. TM 17-32 Copyright © 1998 Addison Wesley Longman, Inc. Comparing Like with Like How do we measure a person’s economic situation? Measure their income? Measure their wealth? Long period of time? Short period of time?

33. TM 17-33 Copyright © 1998 Addison Wesley Longman, Inc. Comparing Like with Like Wealth Versus Income Wealth is a stock of assets. Income is a flow of earnings that results from the stock of wealth. Wealth data measures tangible assets and exclude human capital. Income data measures income from both tangible assets and human capital.

34. TM 17-34 Copyright © 1998 Addison Wesley Longman, Inc. Capital, Wealth, and Income Lee Peter WealthIncomeWealthIncome Human Capital200,00010,000499,00024,950 Nonhuman Capital800,00040,0001,00050 Total$1,000,000$50,000$500,000$25,000

35. TM 17-35 Copyright © 1998 Addison Wesley Longman, Inc. Comparing Like with Like Annual or Lifetime Income and Wealth? Incomes vary with age. Some inequality results from differences in peoples' stage of the life cycle. Therefore, inequality of annual incomes overstates the degree of lifetime inequality.

36. TM 17-36 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives Describe the inequality in income and wealth in the United States Explain why wealth inequality is greater than income inequality Explain how economic inequality arises

37. TM 17-37 Copyright © 1998 Addison Wesley Longman, Inc. Resource Prices, Endowment, and Choices Family income depends upon: Resource prices Resource endowments Choices

38. TM 17-38 Copyright © 1998 Addison Wesley Longman, Inc. Resource Prices, Endowment, and Choices Resource Prices Individuals with different skill levels earn different incomes. Resource Endowments Individuals have different family endowments in capital and human abilities. Distribution of income and wealth is non- normally distributed.

39. TM 17-39 Copyright © 1998 Addison Wesley Longman, Inc. Income (thousands of dollars per year) Price (dollars per chip) 10 2 4 6 8 The Distribution of Income 2030405060 0 Mode income Median income $31,241 Mode Income $44,938

40. TM 17-40 Copyright © 1998 Addison Wesley Longman, Inc. Resource Prices, Endowment, and Choices Choices Wages and the Supply of Labor People who earn higher wage rates tend to work more hours. Savings and Bequests Debts Cannot Be Bequeathed Assortative Mating

41. TM 17-41 Copyright © 1998 Addison Wesley Longman, Inc. Learning Objectives (cont.) Explain the effects of taxes and social security and welfare programs on economic inequality Explain the effects of health-care reform on economic inequality

42. TM 17-42 Copyright © 1998 Addison Wesley Longman, Inc. The Scale of Income Redistribution Market income is a family’s income in the absence of government redistribution. Redistribution reduces the inequality of incomes.

43. TM 17-43 Copyright © 1998 Addison Wesley Longman, Inc. Cumulative % of families 40 20 40 60 80 Income Redistribution 020 6080100 Cumulative % of income & wealth 100 Line of equality Distribution after taxes and benefits Redistribution Market distribution

44. TM 17-44 Copyright © 1998 Addison Wesley Longman, Inc. Income Redistribution The Big Tradeoff Income redistribution creates a big tradeoff: Uses scarce resources Weakens incentives

45. TM 17-45 Copyright © 1998 Addison Wesley Longman, Inc. Negative Income Tax Negative Income Tax gives every family a guaranteed minimum annual income and taxes all income above the guaranteed minimum at a fixed marginal rate.

46. TM 17-46 Copyright © 1998 Addison Wesley Longman, Inc. Market Income Income after redistribution G Comparing Traditional Programs and a Negative Income Tax (USA) 0AC TaxesWelfare trap No distribution Benefits Current programs and taxes Current redistribution arrangements

47. TM 17-47 Copyright © 1998 Addison Wesley Longman, Inc. Market Income Income after redistribution G Comparing Traditional Programs and a Negative Income Tax (USA) 0B Higher taxes A negative income tax Current programs and taxes Break-even income Higher benefits No distribution Negative income tax

48. TM 17-48 Copyright © 1998 Addison Wesley Longman, Inc. History of redistribution of income and wealth In many societies, attempts have been made, through property redistribution, taxation, or regulation, to redistribute wealth, sometimes in support of the upper class, and sometimes to diminish extreme inequality. Examples of this practice go back at least to the Roman republic in the third century B.C., when laws were passed limiting the amount of wealth or land that could be owned by any one family. Motivations for such limitations on wealth include the desire for equality of opportunity, a fear that great wealth leads to political corruption, to the belief that limiting wealth will gain the political favor of a voting bloc, or fear that extreme concentration of wealth results in rebellion.

49. TM 17-49 Copyright © 1998 Addison Wesley Longman, Inc. History of redistribution of income and wealth During the Age of Reason, Francis Bacon wrote "Above all things good policy is to be used so that the treasures and monies in a state be not gathered into a few hands... Money is like muck, not good except it be spread. Socialism arose as a reaction to a distribution of wealth in which a few lived in luxury while the masses lived in extreme poverty. In the Communist Manifesto Marx and Engels wrote "From each according to his ability, to each according to his need.” While the ideas of Marx have been embraced by various states (Russia and China in the 20th century), Marxism has seldom if ever worked in practice.” On the other hand, the combination of labor movements, technology, and social liberailsm has diminished extreme poverty in the developed world today, though extremes of wealth and poverty continue in the Third World.