where people lack an incentive to take up a low-paying job because they would be worse off than when on benefits. 4. **Age** * The young and the old tend to earn less. * Younger workers have to work their way up the pay scale. * Older workers are retired. * Older workers who have accumulated wealth are not as affected by a lower income in retirement. 5. **Gender** * Families and workplaces disadvantage women. * Women disproportionately take time out of careers to care for children. * They tend to choose lower-paying professions with more flexibility and are less able to advance their careers. * Over their lifetime, women earn less than men on average (gender pay gap). * There may also be gender discrimination in hiring and promotion. ### Causes of Wealth Inequality 1. **Savings** * High-income earners can save more because they do not need to spend most of their income on necessities. * Poorer households accumulate less wealth. 2. **Property** * The purchase of property leads to income for its owners, as prices usually rise over time. * Poorer households do not own property and thus do not accumulate wealth. 3. **Inheritance** * Some families can pass on considerable wealth to their children, while the poor have no assets to pass on. * Wealth inequality continues through more than one generation. 4. **Enterprise** * Some people build up wealth through their own enterprise. * Those who do not have entrepreneurship skills are less likely to accumulate wealth. ## Consequences of Poverty & Inequality * Some inequality is inevitable in a free market. * Equality of opportunity underpins much of UK government policy in healthcare and education. * Key costs of significant levels of inequality: * Poor living conditions. * Poor health. * Inequality of opportunity. * Poverty and deprivation. * These factors overall may limit economic growth. * A common issue in development economics is the poverty trap. ### Detailed Consequences 1. **Poor living conditions** * Lower-income households may have to rent accommodations of a poor standard. * This can lead to health issues. * Problem is worse in developing countries where the poor might live in overcrowded slums. 2. **Poor health** * The poorest in society are likely to have lower life expectancy. * They may suffer more ill health than the general population, due to a less healthy diet and lifestyle. * Infant mortality is also likely to be high among the poorest. 3. **Inequality of opportunity** * The poorest often live in areas that are likely to have a lower standard of education. * In developing countries, the provision of education to poorest rural areas may be lacking. 4. **Poverty and deprivation** * Some households will not be able to afford most things. * In developing countries, inequality may lead to absolute poverty and deprivation. ### Evaluation Points 1. The consequences of inequality may be less severe if the economy is growing steadily and real wages are increasing for poorer households. 2. When comparing two or more countries, inequality measures such as the Gini coefficient may not reflect the actual shape of the income distribution. 3. Depends on whether the poor have access to safety nets. ### Kuznets Curve * Simon Kuznets argued that there is an expected relationship between the degree of income inequality and the level of development a country has achieved. * In the early stages of development, income is fairly evenly distributed. * As development accelerates, some households will be at the forefront of enterprise, with their incomes rising more rapidly. * At a later stage of development, society can afford to redistribute income to protect the poor. ## Policies to Reduce Inequality 1. **Invest in education and training for low-income earners** * Help low-income earners gain more skills and greater occupational mobility. * Reduce structural unemployment and reduce the gap between high- and low-income earners. 2. **Redistribution of income and wealth through taxation and benefits** * Raising income tax could reduce income inequality by reducing the disposable income of high-income earners. * Increasing benefits and/or increasing the tax-free threshold would help increase the income of the lowest income earners. 3. **Increase the national minimum wage** * Increase the incomes of the lowest-paid earners and help reduce the gap between low- and high-income earners.

Income Distribution and Welfare

Introduction

• Imagine being on the tournament committee for Wimbledon.
• The tournament includes 128 players in a knockout format over 7 rounds.
• Rounds: R1 (128 players), R2 (64), R3 (32), R4 (16), Quarter-Final (8), Semi-Final (4), Final (2).
• Total prize fund: £1 million.
• The committee must decide how to distribute the prize fund based on players' progress.
• Task: Decide prize fund distribution among the 128 players based on the round reached, ensuring total outgoings do not exceed £1 million.
• Identify key factors influencing decision-making during the distribution process.

Policy Objectives

• Main macroeconomic objectives of a government:
  • Positive, stable, and sustainable economic growth.
  • Low and stable rate of inflation.
  • Low level and rate of unemployment, coupled with a high level and rate of employment.
  • A surplus (or balance) on the current account of the balance of payments.
• In a market economy, resource allocation is determined by market forces and government intervention.
• Individuals differ in skills and property ownership, leading to unequal market outcomes.
• If society desires equitable income distribution, a key policy objective is ‘a fair distribution of income’.

Definitions

• Income: All payments received by an individual or household over time, such as wages, salary, bonuses, rent, interest, and dividends; a flow variable.
• Net income (disposable income): Gross income adjusted for direct taxes (income tax) and benefits.
• Wealth: The market value of total assets owned by an individual or household at a specific point in time, such as property, financial assets, and savings.
• Wealth can be negative (e.g., owing more than assets are worth).
• Some types of wealth generate a flow of income.
• Income distribution: Measures how national income is distributed among the population, usually shown as the share of national income going to different groups.
• Income inequality: The extent to which national income is unevenly distributed across the population.
• Wealth inequality: The extent to which total wealth is unevenly distributed among the population.

Objective of a More Even Distribution of Income

• Reasons why society and government should care about achieving a more even distribution of income:
  • Vulnerability of households or individuals with low income or wealth.
  • Potential for social unrest.
  • Possible link between income inequality and macroeconomic growth.
• Overly focusing on redistributing income may have costs.
  • Heavy taxation on the rich may affect incentives for high-paid workers.
  • Redistributing income may divert resources from other priorities.
• Concept of an ‘optimal’ level of income inequality:
  • Balancing meeting the needs of the poor without significantly impacting the incentives of the rich to work.
• The UK government affects income distribution through taxation and transfer payments.

Measuring Income and Inequality

• Factor incomes: Wages (largest share of income), rent, interest, and profit.
• State benefits: Transfer payments that represent income for the recipient but do not represent output produced (e.g., JSA, housing benefit, child benefit, state pension).
• The ONS uses the Household Finances Survey (17,000 households) to measure household income in the UK.

Income and Wealth Distribution in the UK

• Income Distribution:
  • Top fifth: 40%
  • Bottom fifth: 8%
  • Second fifth: 13%
  • Third fifth: 17%
  • Fourth fifth: 23%
• Wealth Distribution:
  • Richest 10th: 45%
  • Poorest segments hold very small shares (0% for poorest 10th, 0% for 2nd, 1% for 3rd, 3% for 4th, etc.)
• Wealth is distributed more unequally in the UK than income.

Equivalised Income

• A measure of household income that accounts for differences in household size and composition.
• Calculated using the OECD equivalence scale:
  • 1. 0 for the first adult
  • 2. 5 for the second adult and each subsequent person aged 14 and above
  • 3. 3 for each child aged under 14
• Equivalent size: Sum of the weights given to all members of a household.
• Equivalised income: Total household income divided by its equivalent size.

Rising Inequality in the UK

• Inequality measured by the Gini coefficient from 1979 to 2010-11 shows an increasing trend.

Measures of Inequality

• Gini Coefficient: Compares income distribution in a society to a society where everyone earns the same amount.
  • Ranges from 0 (perfect equality) to 1 (all income earned by one person).
  • UK's Gini coefficient for income (2019): Approximately 0.36.
  • UK’s Gini coefficient for wealth: Around 0.73.
• Gini Index: Gini coefficient multiplied by 100.

Lorenz Curve

• A way of showing income or wealth distribution in an economy, developed by Max Lorenz in 1905.
• Shows the cumulative share of income held by different sections of the economy.
• Perfect equality: the poorest 20% of the population holds 20% of the income, and so on.

Example

• Poorest 20% hold 5% of the total income.
• Poorest 90% hold 55% of the total income, meaning the richest 10% hold 45% of the total income.

Shift in the Lorenz Curve

• A shift towards greater equality means the poorest segments hold a larger share of the income.

Gini Coefficient Calculation

• Gini = RAC{A}{A + B}
• Where A is the area between the line of perfect equality and the Lorenz curve, and B is the area under the Lorenz curve.
• The closer the Lorenz Curve is to the 45-degree line, the smaller the area of A, and the smaller the Gini coefficient, indicating less inequality.

Wealth Inequality and the Lorenz Curve

• The bottom 38% of the UK population have zero property wealth.
• The bottom 65% of the population have negative financial wealth.

Limitations of the Gini Coefficient

• Subject to sample bias and data inaccuracies, ignoring subsistence/informal economy.
• Not very sensitive to changes at the very top or very bottom of the income distribution.
• Two countries with the same Gini may have different standards of living.
• Different Lorenz curves can generate the same Gini coefficient (curves can cross).
• Does not look at changes in income distribution over time.
• Does not tell us how inequality varies by other social dimensions.

Ratio Measures of Inequality

• Compare how much people at one level of the income distribution have compared to people at another level.
  • 80:20 ratio: compares the average income of the richest 20% to the poorest 20%.
  • 90:50 ratio: describes inequality between the top 10% and the poorest 50%.
  • 99:90 ratio: describes inequality between the top 1% and the bottom 90%.

Palma Ratio

• The ratio of the income share of the top 10% of the population compared to that of the bottom 40%.
• In more equal societies, this ratio will be one or below.
• Addresses the Gini index's over-sensitivity to changes in the middle of the distribution and insensitivity to changes at the top and bottom.
• Developed by Cobham and Sumner (2013) and named after Chilean economist Palma who noticed the middle class takes in around half the national income in most countries.

Gini vs. Palma

• Redistributing income from the lowest 40% to the highest 10% changes the Gini coefficient very little, but the Palma ratio is much more sensitive to these changes.

Exercise Example

• Calculate the ratios of top decile income to bottom decile income and of top quintile income to bottom quintile income for Belarus and South Africa using provided data.
• Draw Lorenz curves for the two countries and compare the inequalities.

Poverty

Absolute Poverty

• People living in poverty lack the resources to purchase goods and services considered necessary for an acceptable living standard.
• Where household income is insufficient to purchase the minimum bundle of goods and services needed for survival.
• International poverty line (September 2022): $2.15 per day, using 2017 prices.
• Headcount ratio: The percentage of a country’s population living below the poverty line.

Relative Poverty

• In the UK, poverty is defined in relative terms.
• Where household income is below 60% of the median adjusted household income in a country.
• Persistent poverty: Where a household is currently in relative income poverty and has been in this state for at least 2 of the preceding 3 years.

Limitations of the Poverty Line

• The percentage of the population falling below the poverty line is not a totally reliable measure.
• The ‘income gap’ (the distance between household income and the poverty line) is useful to measure the intensity of poverty.

Poverty in the UK

• People in relative low income: living in households with income below 60% of the median income in that year.
• People in absolute low income: living in households with income below 60% of median income in 2010/11, adjusted for inflation.
• Income can be measured before or after housing costs are deducted.

Trends in the UK

• Absolute low income in the UK in 2019/20: 9.2 million people (14%) BHC and 11.7 million AHC (18%).
• Relative low income in the UK in 2019/20: 11.7 million people (18%) BHC and 14.5 million AHC (22%), including 3.2 million children (23%) BHC and 4.3 million AHC (31%).
• Longer-term trends: Absolute poverty has fallen, but relative poverty has increased amongst working-age adults and families with children.
• Significant variation in relative poverty by region and ethnicity.
• Poverty can be overestimated due to under-reporting of benefits by recipients.

Causes of Inequality

• Causes of poverty are similar to the causes of inequality – unemployment and economic inactivity are major reasons why some people are poor.
• Factors that determine whether someone will remain poor over time.

Causes of Income and Wealth Inequality

• Income:
  • Difference in Wages
  • Unearned income from wealth
  • Reliance on Benefits
  • Age
  • Gender
• Wealth:
  • Savings
  • Inheritance
  • Property ownership
  • Enterprise

Detailed Causes of Income Inequality

1. Difference in wages
   • Set by supply and demand in labor markets.
   • Low-skilled workers: large supply, but not necessarily high demand.
   • Highly-skilled workers: low supply, but high demand.
   • The rise of part-time work and the shift from low-skilled manufacturing to high-skilled service jobs exacerbate wage differences.
2. Unearned income from wealth
   • Workers who do not own assets will only earn a wage, but not interest, rent, or profit.
   • A society with large wealth inequality will also see income inequality.
3. Reliance on benefits
   • Benefits are typically lower than wages.
   • Groups relying on benefits will have lower incomes.