One of the themes of last year’s Occupy protest was income inequality, focusing especially on how much wealth the top 1% of income earners controlled. Income inequality has always been of interest in discussing what makes a fair society but economists also refer to income inequality when discussing what makes an efficient society. An economy without income inequality is also an economy without incentives.
One of the measures of inequality is called the Gini coefficient. It goes from 1 in a society where one person controls all the wealth to 0 in a society where everybody earns exactly the same income. You can see some of the pitfalls in both such extremes – from the envy and tension of a god-king ruling every aspect of life to the drab uniformity of life where everyone gets the same reward no matter how much they contribute or how hard they try. My subject for today is what are the factors that lead to the income inequality demonstrated for a given society?
The most obvious factor is political philosophy. There is an instructive graph on the Wikipedia site for the Gini coefficient. It shows a 54% increase in inequality in the United Kingdom from 1979-2000 during the reign of Margaret Thatcher, John Major and the first few years of Tony Blair. This is interesting because the index had been stable and low (greater equality) for the previous 30 years. Something similar happened in the US during the conservative administrations of Reagan and Bush Sr. (1981-1993), with inequality increasing by a more modest 17%. It was relatively stable before and after. The graph also shows a big shift towards inequality in Bulgaria and Poland as they transitioned out of communism in 1989. That said, it is difficult to predict how fair the income distribution of a country is by their brand of politics. Poor countries tend to have high inequality even when their politics is more socialist.
In fact, affluence is one of the better predictors of inequality:
This needs a little explaining. Inequality (the Gini coefficient) decreases from left to right as the average income of the country increases along the bottom axis. Richer countries are more generous! In any case their income is more evenly distributed. To get a closer look at these countries, let’s look at the same graph with some names attached:
South American countries stand out as being poor and unfair while Scandinavia comes out as rich and fair. The USA has higher inequality than would be predicted on the basis of average income. France, United Kingdom and their associated countries (Belgium, Canada, Australia and New Zealand) all cluster around the same level of wealth and inequality.
One final factor, education, explains some of the departures from the prediction line in these graphs. The percentage of population going on to post secondary studies (including vocational schools and community colleges) is negatively related to inequality. That is, generally speaking, countries with more training have a more equal income distribution. Though only a little more than a quarter of the variation in the Gini coefficient is explained by affluence and education, this is much better than can be done with a measure of political philosophy (for example, The Economist magazine’s economic freedom index).
Though politicians appear to be able to adjust inequality in their societies within a decade or less, the history and fundamental values of the society seem to be more important in determining how fair the distribution of wealth will be. Next time we will look at the consequences of income inequality.