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Income Inequality: How Scared Should We Be?

There is no doubt that we are constantly being surrounded by articles that emphasizes how polarized the income distribution of the world as it is now. Just last week, a report released by a group of politicians, business leaders and trade unions warned us that about two-third of global wealth would be possessed by just 1 percent of individuals in 2030. In January, before the annually-held economic conference in Davos, a group of researchers released on increasing global inequality that raised even more eyebrows: 42 richest individuals in the entire world are holding as much wealth as the bottom 3.7 billion individuals. And yes, while it is extremely important to recognize the importance of increasing global inequality, are we over-emphasizing the severity of theproblem?

The overview of inequality

Before 1970, income inequality in the world was mostly driven by cross-country inequality due to centuries of colonization by the Europeans and its offshoots. After the conclusion of World War II, income inequality between countries narrowed modestly while domestic income inequality decreased due to the work of reconstruction after the war. However, after 1970, the global income inequality has mostly been caused by within-country inequality – many developing economies are rapidly catching up to the standard of living of the Western society.

The Gini coefficient measure is the most widely-used measure of income inequality. The construction of the Gini formula is extremely straightforward and easy to undertsand. At each cummulative income share, the corresponding population share will be determined based on the collected data, and the calculation will proceed from there. The Gini coefficient ranges from 0 to 1, in which 0 implies perfect equality and 1 describes perfect inequality (i.e. all income is concentrated on one individual). Right now, the global Gini coefficient is around 0.64, which implies that there is still a lot of income inequality. However, if we compare this number to what was the case at the beginning of this century (2003: 0.68), in an overall sense, we have indeed made some progress in tackling this problem.

Macro studies

In the renowned work of Thomas Piketty, he measured that income inequality has increased dramatically over the years, with the increasing share of the 10% wealthiest increasing from just more than 30 percent in 1960 to almost 50 percent fifty years later. However, another research proposed by Gerald Auten and David Splinter only measured that the increasing share of income to the wealthiest individuals is only increasing modestly, and it is not significant as closely as the figures that were posted by Piketty and his colleagues.

As you might have guessed, the difference in the results is due to the methodologies that different authors use. Auten and Splinter argued that the tax-based measure that Piketty and his colleagues use is highly biased. This method that they use could overestimate the inequality measure significantly. Piketty also measures the capital gains of individuals, which is probably the main reason that is attributed to the increase of income inequality. When some of the causes of biases and government transfers are accounted for in the measurement, the after-tax income share of wealth of the top 10% is virtually insignificant. However, we can see that there is limited public (and maybe academic) attention to this research. It might be the case that the work of Piketty and his colleagues are more highly touted in the public only because of the significance in the results.

Micro findings

In terms of relative importance, the United States is probably where income inequality is the most debated economic and societal issues. Its domestic income equality progress is behind 70% countries all over the world. To understand the severity of income inequality in the US, the top 1% percent of individuals own 22% percent of the country’s wealth, while the top 0.01% owns 5%. The ratio between the income of the 10% wealthiest individuals compared to 10% of the poorest individuals in the United States is 18.5. To put it in perspective, that of the Netherlands is considerably lower, at 9.2.

However, the implication is that income inequality cannot be put in the same token as fairness, as economist Angus Deaton argues. The “fair” aspect of inequality is instinctively the motivation for the economy to move forward, with the increasing influence of globalization and the emergence of new technology which aids productivity level. However, sources of unfairness of income equality must be addressed. While inequality can be justified somewhat, Deaton also tackles at the flaws of the US domestic policy itself to allow the inequality to be ridiculously excessive in the economy. The unfair practice of healthcare financing, (too low) minimum wage, and labor contracts reform are the driving causes of increasing income inequality. Because of these policies, the wages of the bottom-end individuals are kept constantly low for many years, while the average prices of products and services increase. His view also echoes on the Nobel-prize winning economist Joseph Stiglitz, that inequality is not due to capitalism but the policies that are built around it.

The key takeaway here, that is, inequality does need to exist in our society, but whether the extent to which inequality is justified. Of course, it is extremely difficult to evaluate if that is the case. The end is, if there is any unjustified inequality, as long as that contributes to the overall welfare of the society (by taxes and/or income transfers), income inequality should not be what we should be too concerned about. However, there is still a slight tendency towards wealth being increasingly more concentrated towards the group of richest individuals, even when we take account of after-tax income.

I do not yet have a concrete answer to the question about whether we should be scared of the problem. Although income inequality can be measured quantitatively through income measures, there is not yet a consensus between academics and politicians of how to understand income inequality and how it is directly related to our society. Having seen how income inequality has changed in recent years, it would be down to the economic policies that will effectively address the issue.


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