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How Can We Reduce High Income Inequality?

Augusto Lopez-Claros's picture
Also available in: Español

There are many ways to think about income inequality. One can, for instance, look at it within the boundaries of a particular country and ask how is income distributed today among Brazil’s 198 million citizens? It is also possible to look at the average income per capita of all the countries in the world (or a region of the world) and ask: how unequal are income differences across countries at a particular moment in time? We can think of this as international inequality. One can also abstract from national boundaries and concepts of citizenship, view the world as one human family, and ask: how is income distributed among its 7 billion people? Call this global income inequality.



 

One of the more interesting—and surprising—results that fall out of the data on international income inequality is that although Gini coefficients have risen steadily since 1950 (see the chart above, for a group of 130 countries accounting for the lion’s share of the world’s population), when one looks at the high income (largely OECD) countries, Gini coefficients have actually come down rapidly and are, today, about half of their levels in the early 1950s. In other words, there has been a massive process of convergence among the rich countries. Indeed, there is empirical evidence that suggests that this convergence probably goes back to at least the 1870s, if not earlier. This convergence is highly significant given that these are the countries that have been at the center of global capitalism and that have spearheaded the process of globalization. These are the countries that have made the most progress in opening up their economies to each other. Indeed, much of the post-war trade liberalization that took place in the context of the GATT was of an intra-OECD nature, of which the opening up which took place as a result of the expansion of the EU is perhaps the most salient example; freer trade and higher incomes is at the heart of these countries’ post-war evolution. It is also likely that at least in regard to the EU, income inequalities among its members have narrowed because these countries have put in place mechanisms to reduce intraregional income disparities through a generous system of cash transfers from the richer to the poorer countries; during the early years of EU membership Spain and Portugal received the equivalent of 5 percent of GDP in annual transfers.

Two other features of the data shown in the chart worth noting: (i) the very high level of global income inequality, for which we have a few discrete observations showing sky-high Gini coefficients, hovering around 0.70; and (ii) international inequality has improved over the past decade, reflecting the impact of high economic growth rates in China and, to lesser extent, India.

What is the problem, from a development perspective, with large income gaps? First, the larger the gap, the more difficult it is to make the jump. If catching up is perceived as “highly unlikely within my lifetime” then incentives emerge to make another sort of jump, leading to migration (legal or otherwise), brain drain and the permanent loss of native talent. Furthermore, being far behind creates a difficult context for the implementation of sound policies. The populations of poor countries can readily estimate—due to the power of communications technologies—how far back they are vis-à-vis the rest of the world, particularly the rich economies of the industrial world. This is likely to create unrealistic expectations of catch up and, in turn, force governments to favor a populist path, instead of the deliberate, gradual and at times difficult path chosen by the few successful cases of upward income mobility. “Lateness is the parent of bad government” is how Harvard’s David Landes puts it, where he uses the noun “late” to mean late entry into the development process, captured by a low per capita income.

At least part of our serious inequality problem would appear to reflect gross misallocation of resources. We have close to 800 million illiterates in the world, 530 million of them women; a large segment of the world’s population has thus limited access to the most essential tools to open the road to prosperity: knowledge and broad access to information. But we spend close to US$2 trillion annually subsidizing the driving habits of the global middle classes; a full 61 percent of the benefits of gasoline subsidies go to the richest segment of the population, making these among the most regressive policies on the planet. Indeed, these subsidies are so sizeable that they also contribute tangibly to accelerate climate change.

Contrast this, for instance, with investing in girls’ education, a powerful engine of women’s advancement, with multiple beneficial development impacts. Reallocating the resources which now go to energy subsidies to teaching 800 million illiterates to read and write would free up some $2,400 per person per year—an embarrassment of riches.

Sadly, it would appear that in many countries high illiteracy rates are not necessarily a consequence of poverty or resource constraints. No. They are a policy choice governments have made, with perturbing implications for income distribution and opportunity.

There is much hand-wringing in the world today about high income inequality and the associated societal dysfunctions. There is broad international consensus that we should do something about it. The numbers quoted above suggest at least one clear path open to begin to deal with this problem in an effective way. As is often the case, there is no shortage of sensible solutions, given the political will to do the right thing.
 

Comments

Submitted by Dr Leslie Taylor on

Hi Augusto,
Many thanks for your thoughts and this important issue. The rule of law is a vital component of an enabling environment in which individuals are freed to make informed choices is large part of the cure. This requires significant investment in education and especially amongst the rural population that facilitate their transition from low wage traditional sectors such as agriculture to the modern high skilled and high wage sectors.
This is my background- I lived in a rural agricultural community--no books and little schooling until my relocation from the West Indies at the age of 11yrs.

I am now Associate Prof Economics in a Major Chinese University with PhD.
I believe many of my class mates would probably have achieved more but did not have the opportunity I had: relocation to the UK and access to a good education system.

Kind regards

Leslie

Dr Leslie Taylor FRSA MCMI

Dear Leslie,
Many thanks for your message. Your case very nicely illustrates how, given the opportunities for training and education, individuals can make impressive progress in personal empowerment. All people have wonderful latent capacities when they are born and education can release these talents into the open and transform them into useful engines of economic growth and innovation. The difference between a poor illiterate farmer on the edge of hunger and a prosperous medical professional in an urban metropolis is nothing more than a few years of education. Countries that have understood this early on in the development process have made the jump from low to high income in a generation. The development benefits of a more effective use of budgetary resources (doing away with energy subsidies and spending more to educate the young, particularly girls for instance) are huge. We just need to get started!

-Augusto

Submitted by Octavio Gonzalez on

Mr. Lopez-Claroz

Very respectfuly I partially agree with your position, since the very basic concept of the cost of the energy, and the consequences of its utilization, should be somehow represented in its value, on one hand, and the resources employed by our countries in subsidizing fuels, can be used more efficiently, to solve fundamental problems and reduce that gap represented by Gini coefficient. Nevertheless, I think this is a matter very hard to generalize, since the energetic scenario of each country is very particular, and I'm saying this with some knowledge on the matter, both professionally and from a citizen point of view, coming from Venezuela, the country with the most impressive contrasts in the subject of energy. Having the cheapest gasoline in the world I must say that it represents an unbearable economic distortion and an ecologic deep negative impact. Moreover, I'm sure that a big amount of this subside is benefiting precisely the higher income sector of the population, happy to fill their big SUVs tanks with gasoline cheaper than water. Nonetheless, precisely Venezuela had a Gini coefficient of 0,41 in 2013, if I recall well, and we were declared free of illiterates some years ago. This demonstrates that the inequity and the access of opportunities is a matter of a wider picture that have to be assumed with the right policies by the sovereign states. For example, we can ask ourselves and our governments, why not reduce the military expenses as well, and invest more in education?
Don't misunderstand me, I agree with you, the citizen has to know what is the cost of energy and bear it, and the governments should use the resources more efficiently, buy I believe in the equilibrium, through a proper subside policy for fuels, pointing to reduce the gap of the inequity and, again, that allows and guarantee the less benefited, as well as the bigger incomers, to access both the energy and the education (to mention only two aspects), under similar conditions.

Regards,

Octavio G.

Submitted by Anonymous on

Dear Octavio,

There are instances in which some subsidies may make sense from an income distribution perspective. For instance, to protect vulnerable groups in the population, providing them with access to food at lower prices or event energy products, for instance, in the middle of a cold winter. Targeting subsidies to the appropriate income groups is important and is also a sign of social solidarity. What does not make sense is to extent blanket subsidies to the entire population irrespective of the level of income. These are regressive; that is, they worsen income distribution and have a high opportunity cost. Money that goes to subsidize the driving habits of the middle class is money that is not spent in education or in boosting innovation capacity in the country. And, yes, you are right; we spent far too much money in the maintenance of military establishments, reflecting the absence of effective mechanisms of collective security. Adding up energy subsidies with total global defense spending gives you a good sense of what heavy costs we are paying, from a development perspective, through misguided public policies.

Augusto

The pillar of current bank regulations are capital (equity) requirements for banks based on the perceived risk of the borrower or the asset. As the perceived risk is cleared for in other ways, for instance in the interest rate and the amount of exposure, this only causes the banks to overdose on perceived risk.

And the result is that it will increase the gap between “The infallible” the haves and “The Risky” the not haves.

And the result is that banks will not finance the risky future only refinance the safer past

And on this odious and dumb regulatory discrimination the World Bank keeps mum.

http://subprimeregulations.blogspot.com/2013/10/who-are-rent-extractors-and-rent-payers.html

Submitted by Dr Leslie Taylor on

Hi Augusto,
The danger in all of this is an over statement of the importance of government. Beyond obvious need for government provide a conducive environment in which individuals can exercise choice on the basis of real opportunity and pursue their own self-interest, most of the really important knowledge production was by individual often in opposition to the state and religious institutions.
So I come back to my earlier comments, in the end education is the principal issue that determines income and welfare.

The convergence of the European countries is due largely to the fact that they all share in the development of knowledge-convergence of knowledge which subsequently fuelled the industrial and economic development of the early 19th century.

The development of ideas and the freedom of the individual to both contribute to the national process of knowledge and technological advance is the real achievement of the Europeans. But I do not see that individual governments had much to do with this until the 20th century when conflict and war between nation states turned from ideology to actual war.

War enhanced the need to exploit new technologies and develop weapons of war. So a large part of our technology and knowledge comes from or resulted from the race between nations and the result of physical conflict, war. This no where more true than for Europe.

One thing is true of many developing countries, they have learned to use the instruments of war without acquiring any of its technology for peaceful and productive purposes.
Think of the total knowledge content of the world and the share of it i.e. contribution made by the developed and developing countries and how this relate to the share of global income. This will probably explain the income gap between the said.

regards
Leslie

Submitted by Augusto on

Dear Leslie,

I agree we must not overemphasize the importance of government, particularly in the context of a globalized economy and international interdependence. Most global problems we face today (e.g., climate change, nuclear proliferation, drug trafficking, terrorism, poverty, income disparities) cannot be solved outside of frameworks of considerably stronger international cooperation involving not only government, but also the business community and civil society. Where government matters is in the area of public policy and how they go about making the rules that underpin the activities of the private sector. Here, they go from the sensible, transparent and coherent, to the inefficient (not to say macabre) and this makes a difference in terms of human welfare. Best,

Augusto

Submitted by Octavio Gonzalez on

Mr. Lopez-Claroz

Very respectfuly I partially agree with your position, since the very basic concept of the cost of the energy, and the consequences of its utilization, should be somehow represented in its value, on one hand, and the resources employed by our countries in subsidizing fuels, can be used more efficiently, to solve fundamental problems and reduce that gap represented by Gini coefficient. Nevertheless, I think this is a matter very hard to generalize, since the energetic scenario of each country is very particular, and I'm saying this with some knowledge on the matter, both professionally and from a citizen point of view, coming from Venezuela, the country with the most impressive contrasts in the subject of energy. Having the cheapest gasoline in the world I must say that it represents an unbearable economic distortion and an ecologic deep negative impact. Moreover, I'm sure that a big amount of this subside is benefiting precisely the higher income sector of the population, happy to fill their big SUVs tanks with gasoline cheaper than water. Nonetheless, precisely Venezuela had a Gini coefficient of 0,41 in 2013, if I recall well, and we were declared free of illiterates some years ago. This demonstrates that the inequity and the access of opportunities is a matter of a wider picture that have to be assumed with the right policies by the sovereign states. For example, we can ask ourselves and our governments, why not reduce the military expenses as well, and invest more in education?
Don't misunderstand me, I agree with you, the citizen has to know what is the cost of energy and bear it, and the governments should use the resources more efficiently, buy I believe in the equilibrium, through a proper subside policy for fuels, pointing to reduce the gap of the inequity and, again, that allows and guarantee the less benefited, as well as the bigger incomers, to access both the energy and the education (to mention only two aspects), under similar conditions.

Regards,

Octavio G.

Submitted by Brenth Howard on

Income inequality is sometimes linked to low wages issue because as you observe a person having a higher degree of Education has the higher wage compared to those people who achieved a lower degree of Education. A brand new report from the economic Policy Institute states that the rate of low-end careers in the U.S. economy is not going to decrease in the next ten years, even if the economy rebounds. The study says that 28 percent of American employees are in low-wage careers, and the trend will not change. Learn more about low wages at https://personalmoneynetwork.com

Submitted by fred jansen on

According to Larry Summers "Raising taxes on the rich would "play a major role" in reducing income inequality" In my opinion Wealth resulting from financial transactions is what is and has been creating the wealthiest Americans for some time. Slashing taxes to those job creators is proving to be a dismal failure.These tycoons bank their windfall. Either here or in an offshore post office box. What was once used as hedges against greed and corruption has been changed into a casino where lax tax codes fail to account for gaming in extreme numbers. While the fight will always rage against taxing to continue development of our societies infrastructure. There must be some form of remittance if our country is to survive in any form. Having to pay here to play here is an American tradition that should be extended to taxation as much as it is to private enterprize. The reason we had more equality of income back in the 1950's through the 1970's is that the 1% couldn't keep the money they gave themselves. When high earner's income went into the 70% margin rate (or the 91% rate under Ike), source: http://bank-i-danmark.dk/ they were simply paying more taxes. No board of directors would okay increases in CEO wages because most of it would go to the IRS. Cap gains rates were also higher. Paying yourself a big salary or bonus was worthless if you couldn't keep it. read more here: http://www.laan-info.dk/

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