Chapter 22: Inequality and Poverty

Are equality and equity the same thing?

• Equality: Everyone receives the same resources, opportunities or treatment, regardless of their circumstances.

• Equity: Resources are distributed fairly according to people's different needs and circumstances to reduce disadvantages.

Economics example:

• Equality: Everyone receives the same amount of government financial support.

• Equity: Low-income households receive more financial support than high-income households because they need it more.

IB Economics key point: Equality focuses on treating everyone the same, whereas equity focuses on fairness. Equity may involve reducing income inequality through progressive taxation and welfare benefits.

How is income inequality measured?

Measuring Income Inequality

Lorenz Curve

• A graph showing the distribution of income among a population, with households ranked from poorest to richest.

• X-axis: Cumulative % of the population.

• Y-axis: Cumulative % of total income.

• The line of absolute equality represents perfectly equal income distribution (e.g. 20% of the population earns 20% of total income).

• The further the Lorenz curve is from the line of equality, the greater the income inequality.

• Used to compare income inequality between countries or within a country over time.

• Example: Brazil has greater inequality than Croatia.

Gini Index

• A numerical measure of income inequality derived from the Lorenz curve.

• Calculated as the area between the Lorenz curve and the line of equality divided by the total area under the line of equality.

• Higher Gini index = greater income inequality.

• Example: Bolivia has a high Gini index of 58.2, while Croatia has a lower index of 29.0.

Limitations of the Gini Index

• Income inequality does not directly indicate a country's level of development.

• There is no consistent relationship between a country's Human development index (HDI) and its Gini index.

• A highly developed country may have high inequality, while a less developed country may have lower inequality.

What about inequality of wealth?

Income Inequality vs Wealth Inequality

• Income: Money earned from wages, salaries, interest, dividends, rent and capital gains.

• Wealth (net worth): The total value of a person's assets minus liabilities.

  • Assets: Property, savings, investments and retirement funds.

  • Liabilities: Debts such as mortgages, student loans and credit card debt.

• Governments can collect income data relatively easily through tax records.

• Wealth is more unequally distributed than income.

• Example (Credit Suisse, 2018): The richest 10% own 85% of global wealth, while the poorest 50% own less than 1%.

How are inequality and poverty linked?

When there is a high level of income inequality, it means that a significant portion of the population is living in some form of poverty, and it is highly likely that this poverty will perpetuate the inequalities that exist.

Difference between absolute and relative poverty?

Poverty is a global problem and is a clear sign of a lack of equity

• Absolute poverty: Income is insufficient to meet basic needs. The poverty line is based on the cost of basic necessities (e.g. $1.90 per day PPP in the textbook).

• Relative poverty: Income is low compared with others in the same country, often defined as earning less than 50% of median income.

• Example: If median income is $50,000, anyone earning below $25,000 is considered to be in relative poverty.

• Key difference: Absolute poverty measures the ability to meet basic needs, while relative poverty measures living standards compared with the rest of society and is linked to income inequality.

• Developing countries: Absolute poverty is generally a more significant problem.

How is poverty measured?

Measuring Poverty

1. National Poverty Lines (Relative Poverty)

• Usually set at 50% of median income (OECD measure).

• Example: Australia had a poverty rate of 13.2% in 2015–16.

• Governments measure child and senior poverty to target support.

• Limitation: The threshold is somewhat arbitrary.

2. Minimum Income Standard

• Measures the minimum income needed to afford a basic but acceptable standard of living.

• Example: Canada calculates the cost of a basket of essential goods and services, with poverty lines varying by province due to different living costs.

• Limitation: What counts as an acceptable standard of living is subjective.

3. Multidimensional Poverty Index (MPI)

• Measures poverty through health, education and standard of living, rather than income alone.

• Indicators include nutrition, child mortality, years of schooling, clean water and sanitation.

• A person is multidimensionally poor if deprived in at least one-third of the weighted indicators.

• Advantage: Identifies specific deprivations, helping governments target policies effectively.

• Limitation: Requires detailed data and is more complex to calculate.

Key takeaway: Different measures reveal different aspects of poverty. Governments need to understand the specific causes of poverty to develop effective policies.

Difficulties in measuring poverty?

Problems with Measuring Poverty

• Different definitions: Poverty can be absolute, relative, income-based or multidimensional, and definitions vary between countries.

• Difficult to measure: Feelings of fear, insecurity and vulnerability are difficult to quantify, meaning income measures may not capture the full experience of poverty.

• Costly surveys: Poverty data often relies on household surveys, which require significant resources and may be unreliable in poorer countries.

• Government manipulation: Governments may change national poverty lines to reduce official poverty statistics without actually improving people's living standards.

Key point: Poverty statistics may not fully reflect the true extent of poverty or people's actual living conditions.

Causes of inequality and poverty

1. Inequality of Opportunities

• Children from wealthy families have better access to healthcare, education and employment, while poorer children face greater disadvantages.

• This creates a poverty cycle/trap, where disadvantages are passed between generations.

• Social mobility: The ability to move up or down the socioeconomic ladder.

  • Intragenerational: Changes in income within a person's lifetime.

  • Intergenerational: Changes in income compared with their parents.

• Greater inequality reduces social mobility, making it harder for disadvantaged people to improve their living standards.

2. Discrimination

• Unfair treatment based on gender, race, ethnicity, age or other characteristics creates unequal opportunities and outcomes.

• Wage discrimination occurs when workers in similar positions receive different wages for reasons unrelated to their skills or productivity.

3. Differences in Human Capital

• Workers with higher skills, qualifications and education generally earn higher wages due to greater productivity.

• Skilled workers' wages have risen faster than those of unskilled workers, increasing inequality.

• Weaker trade unions reduce the bargaining power and wage protection of low-skilled workers.

4. Globalisation and Technological Progress

• Globalisation allows firms to move production to countries with lower labour costs, reducing demand for manufacturing workers in developed economies.

• Automation replaces workers performing repetitive tasks, increasing technological unemployment.

• Demand for highly skilled workers rises, increasing their wages.

• This can cause the hollowing out of the middle class, with more people on low or high incomes and fewer earning middle incomes.

5. Market-Oriented Supply-Side Policies

• Deregulation of financial markets can increase investment returns for wealthy individuals.

• Weaker trade unions reduce workers' bargaining power, potentially lowering wages and job security.

• Growth in non-standard employment, such as temporary, part-time and zero-hours contracts, can lead to lower and less secure incomes.

6. Government Tax and Benefits Policies

• Lower top rates of income tax and relatively low taxes on dividends, capital gains and corporate profits can benefit wealthier individuals.

• Austerity involves reducing government spending to lower public debt.

• Cuts to welfare benefits and housing support disproportionately affect lower-income households, potentially increasing inequality.

What are the consequences of inequality and poverty for economic growth and living standards?

Consequences of Inequality and Poverty1. Economic Growth

Potential benefits of inequality:

• Encourages entrepreneurship, innovation and hard work by offering the incentive of higher incomes.

• Higher incomes may generate savings that can fund investment and economic growth.

Potential costs of inequality:

• Poorer people have less access to education and training, reducing human capital and productivity.

• Poverty can create a cycle of disadvantage, limiting future economic growth.

• Social and political instability can discourage investment and growth.

2. Lower Living Standards

• Poverty prevents people from affording basic necessities such as food, heating, housing and education.

• Low incomes create financial insecurity, stress and difficult spending choices.

• Poverty can lead to social exclusion and discrimination.

3. Regional Inequality

• Wealthy and poor communities may become concentrated in separate areas.

• Poorer areas often have worse schools, infrastructure and facilities.

• This limits opportunities and reinforces the poverty cycle.

4. Social Instability and Crime

• High inequality can create resentment and hostility between social groups.

• Limited job prospects, particularly for young people, may increase crime and gang activity.

• Crime and insecurity can threaten property and discourage investment.

5. Political Instability

• People experiencing poverty may view the economic and political system as unfair.

• This can reduce trust in government and participation in democracy.

• Tensions between low-income groups and those in power may increase.

What is the role of taxation in reducing poverty and income inequality?

1. Direct Taxes

• Paid directly by individuals or businesses to the government.

• Income tax: A progressive tax means higher-income earners pay a higher percentage of their income in tax, helping reduce income inequality.

• Wealth/property taxes: Tax wealth or property ownership to reduce wealth inequality and raise government revenue.

• Corporate tax: Tax on business profits. Multinational companies may use tax breaks to reduce their effective tax rates, reducing government revenue.

2. Indirect Taxes

• Taxes on spending on goods and services, such as VAT and excise duties.

• Can discourage consumption of goods with negative externalities, such as cigarettes, or protect domestic producers when imposed on imports.

• Regressive effect: Lower-income households often spend a greater proportion of their income on consumption, so indirect taxes can increase income inequality.

3. Wealth Taxes

• Property taxes: Tax property owners according to the value of their property.

• Wealth taxes: Tax individuals based on the value of their financial assets.

4. Purpose of Taxation

• Raise government revenue to fund public services.

• Redistribute income and reduce inequality.

• Influence aggregate demand to achieve macroeconomic objectives.

• Correct market failures and protect domestic industries.

Key takeaway: Progressive direct taxes can reduce inequality, whereas indirect taxes may worsen it because they take a larger proportion of income from poorer households.

How is progressive tax calculated?

A progressive tax is calculated by charging higher rates of tax on higher levels of income. The key thing to remember is that higher tax rates only apply to the income within each tax band, not to all your income.

Example

Imagine a country has these income tax bands:

Annual income	Tax rate
First £10,000	0%
Next £20,000	20%
Income above £30,000	40%

If someone earns £40,000, their tax is calculated as follows:

First £10,000

£10,000 × 0% = £0 tax

£0

Next £20,000

£20,000 × 20% = £4,000 tax

£4,000

Remaining £10,000

£10,000 × 40% = £4,000 tax

£4,000

Total tax paid

£8,000

Calculate the average tax rate

The average tax rate is the total tax paid divided by total income, multiplied by 100.

Average tax rate = 8,000 / 40,000 x 100

Average tax rate = 20%

Notice that although the highest tax band is 40%, the person pays only 20% of their total income in tax.

IB Economics exam tip: Progressive taxation helps redistribute income because higher-income earners pay a greater proportion of their income in tax.

Further policies to reduce inequality and poverty?

1. Transfer Payments (Welfare Payments)

• Government payments that redistribute income from some groups to others to improve living standards.

• Examples: child benefits, pensions, housing allowances and fuel allowances.

• Universal payments: Given to everyone who meets a broad category, e.g. all parents.

• Means-tested payments: Given to people below a certain income level or who meet specific eligibility criteria.

• Help reduce poverty and income inequality.

2. Improving Education and Healthcare

• Universal healthcare: Ensures everyone can access medical treatment.

• Early-years support: Subsidised childcare, preschool and pre/post-natal care improve children's development.

• School meals: Provide nutritious food to help disadvantaged children learn effectively.

• Better education: More resources, quality teachers, tutoring and support for struggling students reduce educational inequality.

• Apprenticeships and training: Improve skills and employability.

• Higher education support: Financial assistance helps low-income students attend university.

• Adult training and work experience: Help unemployed adults return to work.

• These policies improve human capital, productivity and social mobility, helping break the poverty cycle.

3. Conditional Cash Transfers (CCTs)

• Payments to low-income families conditional on meeting requirements related to children's health or education.

• Examples include ensuring children attend school or receive vaccinations.

• Reduce current poverty by providing income and future poverty by improving children's human capital.

4. Policies to Reduce Discrimination

• Equal pay laws: Ensure equal pay for work of equal value.

• Anti-discrimination legislation: Makes unfair treatment in employment, education and housing illegal.

• Positive action/affirmative action: Encourages opportunities for groups previously disadvantaged.

• Diversity quotas: Require a minimum representation of certain groups in workplaces or leadership.

• Accessibility requirements: Prevent people with disabilities from being excluded.

• These policies improve equal opportunities and reduce inequality based on gender, race and disability.

What is universal basic income?

Problems with Welfare Systems

• Welfare programmes provide transfer payments (e.g. unemployment benefits) to reduce poverty.

• They can be costly and complex to administer.

• They may create a poverty trap:

  • People can lose benefits when they start working.

  • This may discourage them from accepting low-paid jobs.

Universal Basic Income (UBI)

• A UBI is a regular payment given to every citizen regardless of income or employment.

• Often called "free money for everyone."

• Supported by economists such as Friedrich von Hayek and Milton Friedman.

Advantages of UBI

• Removes poverty traps and improves work incentives.

• Reduces administrative costs and bureaucracy.

• Guarantees a minimum income and helps reduce poverty.

• May help people affected by automation and job losses.
  
  Evaluation

• Could reduce poverty and inequality more effectively than some welfare systems.

• However, it may be very expensive to fund.

• Success depends on the size of payments and government finances.

Arguments against UBI and counterarguments

• Reduces incentive to work: People may become lazy or stop seeking jobs. However, UBI only covers basic needs, so people may still work to earn more. It can also allow people to study, care for relatives or start businesses.

• Too expensive: UBI requires significant government spending. However, removing existing conditional welfare payments could help fund it, alongside higher taxes on the wealthy.

• Why pay the rich? Wealthy people do not need financial support. However, UBI should be universal to reduce poverty and inequality for society as a whole. Progressive taxes can help redistribute income from the rich.

• Avoids administrative costs: A universal payment requires fewer eligibility checks than means-tested benefits, reducing administration costs.