Transcript Summary Inequality

Income Inequality
Jimmy Norström
Erik Nilsson
Why should we study income
inequality?
• It’s relationship to poverty.
- If income is distributed more unequally,
more people will live in poverty for any level
of average income.
• Effects on economic growth.
- Hypothesis states that income inequality will
be good for growth in rich countries and bad
for growth in poor countries.
How do we measure income
inequality?
• Two commons ways to look at income
inequality.
1.Divide the population into several equal-sized
groups and measure how much each group
earns.
How do we measure income
inequality?
2. Divide income into equal-sized groups and
measure how much of the population falls
into each group.
The Gini coefficient
• Takes on a value between 0 and 1 and tells the
degree of income inequality in a country.
• To construct the Gini coefficient one first
calculates what fraction of the total income
the poorest 1 % of households earn. Then the
same fraction for the poorest 2 % of
households, and so on, up to 100 %.
The Gini coefficient
• When then graph these values we get a
Lorenz curve.
• The
Lorenz curve
is curved
because of
inequality.
The Gini coefficient
• If there was no inequality the Lorenz curve
would be a straight line (Line of perfect
equality).
• The Gini coefficient is the area between the
“Line of perfect equality” and the Lorenz
curve divided by the total area under the “Line
of perfect equality.
• The Gini coefficient is between 0 and 1. The
higher the coefficient the higher the degree of
inequality.
Kuznets Curve
• Kuznets hypothesized that as a country
developed, inequality would first rise then
later fall.
• The theory implies that if we graph the Gini
coefficient as a function of GDP per capita, the
data would show an inverted-U shape. This is
the Kuznets curve.
Sources of income inequality
• People in an economy differ from each other
in ways that are relevant to their income.
- Human capital (both education and health)
- Geography (city or countryside, provinces)
- Ownership of capital
- Luck
Effect of income inequality on
economic growth
• Four channels through which inequality affect
economic growth has been hypothesized.
1.The accumulation of physical capital
2.The accumulation of human capital
3.Government redistribution policy
4.Sociopolitical instability
Effect on the accumulation of
physical capital
• Saving rates tend to rise with income
• The higher the level of income inequality
- that is, the higher the fraction of total
income earned by rich people the higher the total savings will be.
• Through this channel, inequality have a
positive effect on economic growth.
Effect on the accumulation of
human capital
• Poor households tend to forego human-capital
investments that offer relatively high rates of
return. In this case, a distortionfree
redistribution of assets and incomes from rich
to poor tends to raise the quantity and
average productivity of investment.
• Through this channel, inequality have a
negative effect on economic growth.
Effect on government redistribution
policy
• A greater degree of inequality—measured, for example, by
the ratio of mean to median income—motivates more
redistribution through the political process. Typically, the
transfer payments and the associated tax finance will distort
economic decisions.
• For example, means-tested welfare payments and levies on
labor income discourage work effort. In this case, a greater
amount of redistribution creates more distortions and tends,
therefore, to reduce investment (in the transition to the
steady state)
Effect on government redistribution
policy
• The rich may prevent redistributive policies through
lobbying and buying of votes of legislators.
• The lobbying activities would consume resources and
promote official corruption and tend accordingly to
hamper economic performance.
• Therefore, inequality can have a negative effect on
growth through the political channel even if no
redistribution of income takes place in equilibrium.
Effect on sociopolitical instability
• The threats to property rights deter
investment. (revolution)
• The participation of the poor in crime and
other antisocial actions represents a direct
waste of productive efforts.
• Through this channel, inequality have a
negative effect on economic growth.