Inequality, Policy

and Government

Economic Theory 1 A – Week 2

 2

Outline

1. Measuring the degree of inequality: the Lorenz curve and the

Gini coefficient
2. Inequality and policy interventions: Redistribution and
Predistribution
3. Global inequality: Between people and between nations
4. Accidents of birth, endowments and intergenerational inequality
5. Government’s role in the economy

Covering the following units in “The Economy” textbook

5.1 5.12 5.13 19.1 19.2 19.5 19.8 22.1
 3

Remember to use the Glossary section on www.core-econ.org

 https://core-econ.org/the-economy/book/text/50-02-glossary.html#glossary
endowment
 The facts about an individual that may affect his or her income, such as the
physical wealth a person has, either land, housing, or a portfolio of shares
(stocks). Also includes level and quality of schooling, special training, the
computer languages in which the individual can work, work experience in
internships, citizenship, whether the individual has a visa allowing
employment in a particular labour market…
human capital
 The stock of knowledge, skills, behavioural attributes, and personal
characteristics that determine the labour productivity or labour earnings of
an individual. Investment in this through education, training, and socialization
can increase the stock, and such investment is one of the sources of economic
growth….
 4

Measuring the degree of inequality

The Lorenz Curve and the Gini Coefficient
 5

By careful of averages…

 Which group is better off?

‒ Group A
10 people all receiving income of R5 000 a month
i.e. average income is R5 000 a month
‒ Group B
10 people with 5 receiving income of R10 000 a month and 5 receiving R500 a month
i.e. average income is R5 250 a month
((5 x R1000 + 5 x R500))/10 = R5250
 The average income for Group B is higher then for Group A
 But due to a high degree of inequality the average income measure does not accurately
describe welfare levels in these groups.
 This shows us that per capita GDP can’t tell us anything about how income is
distributed. It is the average income, but cannot indicate the variation in income within
the society.
 To measure income distribution we need tools such as the Lorenz curve and Gini
coefficient.
 6

Lorenz Curve

 Invented in 1905 by Max Lorenz (1876–1959), an American

economist (while he was still a student!)
 A graphical representation of inequality of some quantity such
as wealth or income.
 A useful tool for representing and comparing distributions of
income or wealth, and showing the extent of inequality
 How does the Lorenz work:
‒ The Lorenz curve shows the entire population lined up along
the horizontal axis from the poorest to the richest.
‒ The height of the curve at any point on the horizontal axis
indicates the cumulative fraction of total income received by
the fraction of the population up to that point on the
horizontal axis.
 7

Perfect equality
 For complete equality of income the
100
Lorenz curve is a straight line with a

Cumulative share of income (%)

slope of one (or 45 degrees). 90
 When there is complete equality of
income Perfect equality line
‒ the first 10% of the population
receives a cumulative 10% of 50
income
‒ the first 50% of the population
receives a cumulative 50% of Lorenz
curve
income, etc.
10
 The Lorenz curve allows us to see
how far income distribution departs
from this line of perfect equality. 10 50 90 100

 The extent to which the Lorenz curve Cumulative share of the

falls below this perfect equality line population from the lowest to
is a measure of the degree of the highest income(%)
inequality in a particular population.
 8

A Lorenz curve for wealth ownership

Landowners’ 100
share of land

Cumulative share of land (%)

 In a village of 100 people and 100ha
of land: e
lin
‒ 10 landowners owning 10 hectares y
a lit
each equ
‒ 90 farmer workers who own no e ct
rf
land. Pe

 The Lorenz curve is the blue line.

 Lining the population up in order of
land ownership, the first 90% of the
0
population own nothing, so the curve Cumulative share of the population from least
is flat. 0 to most land owned (%) 90 100

 The remaining 10% own 10 hectares

each, so the ‘curve’ rises in a straight 90 farmers 10 landowners
line to the point where 100% of
people own 100% of the land.
 9

Gini Coefficient
 The Lorenz curve provides a good graphical representation of inequality.
 But how can you summarise this information in one number?
 A coefficient that tells you the degree of inequality.
 The Gini coefficient (g) is 100
approximated with the 90
following formula:
80

Cumulative share of income (%)

g ≈ A / (A + B) 70
 Note that the Lorenz curve 60
contains more information than
50
the Gini
40
A
‒ The curve allows you to
observe the whole distribution 30
(which enables you to see
20
patterns of inequality – rich,
middle class and poor, etc) 10
B
‒ The Gini reduces this to one 0
number (which makes for 0 10 20 30 40 50 60 70 80 90 100
easier comparisons) Cumulative share of the population from lowest to highest income (%)
 10

Approximating Gini from Lorenz Curve

 The degree of inequality rises as A / (A + B) rises

 Remember that the axes are percentages – so they range from zero to one (100% = 1)
 The area A represents the degree of deviation from perfect equality. The degree of
inequality rises as area A gets larger.
 Perfect inequality (one person receives all and
A fills the entire area under the line of perfect
equality)
A = 0.5 (because the area of a triangle = ½bh)
B=0
Gini = A / (A + B) = 0.5 / (0.5 + 0) = 1
 Perfect equality (each person receives and
equal share)
A = 0 (as the Lorenz curve is the perfect
equality line)
B = 0.5 (the entire area under the perfect
equality line = ½bh)
Gini = A / (A + B) = 0 / (0 + 0.5) = 0
 11

Approximating Gini from Lorenz Curve

For a high degree of inequality:

A = area of a triangle ½ b x h
= (0.5)(0.9)(1)
= 0.45

B = area of a triangle ½ b x h
= (0.5)(0.1)(1)
= 0.05

Gini = A / (A + B)
= 0.45 / (0.45 + 0.05)
= 0.45 / 0.5 = 0.9
 12

Four steps to Gini

 The graphical derivation of the Gini coefficient from the Lorenz curve is an
approximation (which is relatively close for large populations)
 More precisely, the Gini coefficient is defined as: half the relative mean
difference in income among all pairs of individuals in the population
 The Gini coefficient (g) is directly measured as a number between 0 and 1 as
follows:
1. Find the difference in income between every possible pair in the
population
2. Take the mean of these differences
3. Divide the mean of these difference by the mean income of the population
as a whole to get the relative mean difference
4. Divide the relative mean difference by 2 to get the Gini
 13

Example of measuring the Gini coefficient

 There are three people (a ,b and c) with incomes of R6 000 a month, R10 000 a
month and R12 000 a month respectively

 Step 1: Find the differences between every possible pair:

|a – b| = R10000 – R6000 = R4000
|a - c| = R12000 – R6000 = R6000
|b – c| = R12000 – R10000 = R2000

 Step 2: Mean of the differences

(R4000 + R6000 + R2000)/3 = R4000

 Step 3: Relative mean difference

Mean income of the population = 6000+10000+12000/3 = 9333
• then 4000/9333 = 0.429

 Step 4: Divide by 2
0.429/2 = 0.214
 Conclusion: Gini coefficient
g = 0.214
 14

Inequality and policy interventions

Redistribution and Pre-distribution
 15

Three dimensions of economic inequality

 Wealth
‒ The value of the assets owned by a household (net of their debts).
‒ This could include financial assets like shares in companies
‒ Or non-financial assets like a house or a farm
‒ Note that wealth is a stock
 Earnings or income
‒ Earnings is income from labour, including from wages, salaries, and self-employment
‒ Market income includes earnings and income from businesses owned by the
household or investments
‒ Note that income is a flow
 Disposable Income
‒ The income that a family can spend after paying taxes and receiving any cash
transfers from the government such a social grants.
 16

Inequality in the USA, Sweden and Japan

1.0
Wealth inequality
0.9
Earnings inequality (before taxes)
0.8
Disposable income inequality
0.7

0.6
Gini coefficient

0.5

0.4

0.3

0.2

0.1

0.0
United States Sweden Japan
 17

Dimensions of inequality

 Wealth is much more unequally distributed than earnings

 Earnings are much more unequally distributed than disposable income.
 The differences among the three measures are much smaller in Japan than in
Sweden and the US.
 Of the three, Sweden has:
‒ The highest inequality of wealth
‒ The lowest inequality of disposable income
 This is due to Sweden’s
1. Relatively high inequality of wealth
2. Its relatively modest inequality in earnings and
3. Its system of taxes and transfers which benefits the less well off.
 18

Impact of Government policy on inequality

 Governments influence the degree of inequality in the economy. They do this

in two ways:

 Redistribution (transfering market incomes from rich to poor)

‒ Taxes and transfers applied to market incomes that result in a distribution

of disposable income that differs from market income
‒ Expenditure that provides public services to households

 Pre-distribution (shaping patterns of market income for rich vs poor)

‒ Government affects the distribution of privately held wealth or the

distribution of market determined incomes
‒ By affecting the endowments that people have and the value of those
endowments leading to changes in the degree of inequality in market
income
 19

Redistribution

 Through tax and transfer policies government can foster a more equal
distribution of disposable income.

Market income Subtract direct taxes

Disposable
Income from wages,
salaries, self-employment, Add cash transfers income
business and investments

 Differences in inequality in disposable income across countries depends

(partly) on the effectiveness of these redistribution policies.
 20

Inequality in the Netherlands

 Market income:
‒ The poorest 10% of the population earns virtually 0% of income
‒ The poorest 50% of the population earns less than 20% of income
‒ The Gini coefficient for market income is 0.47
 Disposable income:
‒ The poorest 10% of the
population have about 4% of
total disposable income

Cumulative share of income

‒ The poorest 50% of the
population receive more than
30% of total disposable
income
‒ The Gini coefficient for
disposable income is 0.25
 Conclusion: The degree of
inequality is significantly reduced
by redistributive policies in the
Netherlands (with the Gini
coefficient falling from 0.47 to
0.25)

Cumulative share of the population (ranked by income)

 Gini coefficients
(various years, 1992-2013)

0.1
0.2
0.3
0.4
0.5
0.6
0.7

0
Sweden
Netherlands
Germany
France
Hungary
Ireland
Japan
Poland
South Korea
Canada
Taiwan
Greece
Disposable Gini

Italy
Comparing Market and Disposable Gini

Spain
Australia
United Kingdom
Market Gini

Russia
Israel
United States
Mexico
Uruguay
Brazil
Colombia
India
China
South Africa
21
 22
Comparing Market Gini and Disposable Gini across various countries

 Across countries there are greater differences in disposable income Gini

coefficients (red bars) than in market income Gini coefficients (blue bars)
 This indicates that there are income redistribution programmes in all countries,
but typically these programmes have a greater impact in high-income economies,
such as Sweden and Norway
 The income redistribution policies in countries like China and India have a very
small impact on reducing the relatively high degrees of market income inequality
in those countries
 Because of its history of racial dispossession, discrimination and exclusion South
Africa has very high market income and wealth inequality and even though it has
significant income redistribution policies, disposable income inequality remains
very high
 South Africa’s key income redistribution policies include:
‒ state old aged pensions (see slide) and child support transfers, and
‒ progressive taxation where high income earners pay a higher tax rate than low
income earners
 23

Concentration of revenue and expenditure in South Africa

Market income
90% 90%
PIT
VAT 87%
80% 80%
Direct transfers
In-kind transfers
70% 70%
72%

60% 60%
concentration share

59%
50% 54% 50%

40% 40%
39%
30% 34% 30%

27%
20% 20%

10% 13% 10%

7% 7.4%
0% 0%

Bottom 50% Middle 40% Top 10%

Households ranked by market income

Source data: Inchauste et al (2014) appendix table A3.4

 24

South Africa’s redistributive effort in context

Gini coefficients under different income concepts

World Bank (2014). "Fiscal Policy and Redistribution in an Unequal Society." South Africa Economic Update 6.
 25

Pre-distribution

 Governments can change the distribution of market income or

wealth by acting directly ex ante to change market outcomes.
 By changing the basic laws and institutional structure of the
economy – by defining and enforcing the legal framework in
which employers, banks, employees, unions, borrowers, and
other key economic actors interact, governments affect the
distribution of market income.
 There are many ways of doing this, including redistribution of
wealth, changes to property rights, regulation of private
contracts, education and a range of other social and economic
policies
 26

Pre-distribution

 Examples
‒ Increased education of the workforce: This changes the
endowments of employees, adding skills and other work relevant
capacities that will affect market incomes.
‒ Eliminating or reducing labour market
discrimination/segmentation: This – and other anti-discrimination
policies – will alter the prices (wages) that a person’s endowment
will be paid in the labour market. This raises the value of the
endowments of people who otherwise would suffer discrimination.
‒ Land reform: Undertaking land reform to give people increased
access to income generating land assets or a greater share of what
is produced from the land (see example from West Bengal, India)
 27
West Bengal: Addressing inequality through changes to property rights

 Before 1973, land distribution in West Bengal was highly unequal. A few landowners (10% of the
population) owned all the land.
 The remaining 90% of the population worked the landlords land through a system of
sharecropping. There was a very high level of income inequality and 73% of rural people lived in
poverty.
 The tradition since the 1700’s was that sharecroppers (bargadars in Bengali) would give
landowners half (50%) of their crop in exchange for the right to use the land.
 In 1978, government introduced “Operation Barga”: the law was changed to say that:
‒ Bargadars could keep up to three-quarters (75%) of their crop
‒ Bargadars would be protected from eviction by landowners provided they gave landowners
25% of the crop
 The effect of this law was:
‒ The pie got larger: Agricultural output increased as bargadars had an incentive to work
harder: their reward was greater. Their property rights were more secure and they invested in
improving the land
‒ The poor got a bigger slice of the pie: The poorest people experienced rising share of the
income produced.
 28

Operation Barga illustrated on a (hypothetical) Lorenz Curve

 The figure shows a hypothetical Lorenz curve based on the description of the programme.
 Before the reform:
‒ Sharecroppers paid 50% of
their crops to landowners
‒ At point K: 90% of the
population is getting 50% of
the income
L
‒ The Gini coefficient was 0.4
 After the reform:
‒ Sharecroppers paid 25%,
retained 75% of the crop K
output
‒ At point L: 90% of the
population is getting 75% of
the income
‒ Gini coefficient was reduced
to 0.15
 29

A model of the sharecropping Gini

A fraction n are sharecroppers. The sharecroppers receive a share s of total output
The area of square is 1 1
A+B = 0.5 (where B = B1 + B2 + B3)
A = 0.5 – B
g = A/(A+B) = (0.5 - B)/0.5 = 1 – 2B
= 1 – 2(B1 + B2 + B3)
Calculating Areas
s
B1 triangle = ns/2
B2 rectangle = (1-n)s
B3 triangle = ((1-n)(1-s))/2
Calculating g
g = 1 – 2(B1 + B2 + B3)
= 1 – 2(ns/2 + (1-n)s + ((1-n)(1-s))/2)
= 1 – (ns + 2s – 2ns + 1 – s – n + ns) 0 n 1
= 1 – (1+ ns + ns – 2ns + 2s – s – n)
=n-s
 30

A model of the sharecropping : g = n - s

Conclusion
 The Gini coefficient (g) will decrease (and inequality will fall) if:
‒ n falls (meaning that the fraction of sharecroppers falls and
more are landowners)
‒ s rises (meaning the sharecroppers get a larger share of
output)
 The Gini coefficient (g) will increase (and inequality will rise) if:
‒ n rises (meaning that the fraction of sharecroppers rises and
there are u)
‒ s falls (meaning the sharecroppers get a smaller share of
output)
 31

Minimum wages

 Another important example of pre-distribution by limiting the

kinds of contracts that are allowed is a statutory minimum wage.
 The intention of a minimum wage is to guarantee living standards
for the low-paid. Many countries, including the UK and the US,
(and in SA since 1 January 2019) enforce this with legislation.
 Minimum wages:
‒ positively affect the value of a worker’s endowment of labour,
but
‒ negatively effect workers if they reduces the likelihood that
workers will be able to find a job. The costs of the minimum
wage could be fewer jobs.
 32

Potential impact of minimum wages

 The precise impact of minimum wages on workers (positive or negative)

depends on the circumstances of the policy’s implementation.
 For example, raising the minimum wage will have little negative impact on
employment and will increase the income of poor workers on average, if:
‒ Firms will be able to adjust to the minimum wage by increasing prices.
‒ Demand for goods remains strong
 But employment is likely to fall if:
‒ If demand is highly sensitive to prices, or
‒ Firms are likely to respond to the minimum wage by reducing employment
levels in order to contain costs e.g. via mechanisation
 33

Global inequality
Between people and between nations
 34

Income deciles and the 90/10 ratio (again)

 A handy measure of inequality in a Average income

country is called the 90/10 ratio, (2005 USD PPP)
which we define here as the average 1st Decile 10th Decile 90/10 ratio
Botswana 169 24 523 145.1
income of the richest 10% divided by
Mozambique 45 3 403 75.6
the average income of the poorest South Africa 253 18 421 72.8
10%. Malawi 38 2 583 68.0
 It is more commonly defined as the Colombia 293 13 238 45.2
Ghana 193 8 345 43.2
income of the 90th percentile China 448 18 689 41.7
divided by that of the 10th Mexico 331 13 474 40.7
percentile. Brazil 604 17 363 28.7
Chile 1 122 26 649 23.8
 The 90/10 ratio is high even in
Nigeria 203 4 449 21.9
relatively equal countries. Turkey 866 18 559 21.4
India 223 4 446 19.9
Find out where you fit into the Malaysia 1 142 21 683 19.0
distribution of income at this Venezuela 619 10 665 17.2
United States 3 778 60 418 16.0
link:
Korea, Rep. 3 821 35 323 9.2
https://www.saldru.uct.ac.za Australia 5 269 47 167 9.0
/income-comparison-tool/ Japan 4 194 33 102 7.9
Norway 8 325 45 302 5.4
 35

Average income by decile in 2014

Botswana Japan Mozambique
Nigeria Norway South Africa
40 960 United States

20 480
10 240
5 120
2005 USD PPP

2 560
1 280
640
320
160
80
40
Decile Decile Decile Decile Decile Decile Decile Decile Decile Decile
1 2 3 4 5 6 7 8 9 10
 36

Share of the 1%

 Inequality can also be measured by focussing on the share of the very rich, say, what fraction
of total income or wealth belongs to the richest 1% or 10% of the population?
 This indicator has the advantage that it can be measured over hundreds of years, because the
very rich have long been required to pay taxes, and hence we have reasonably good inform­
ation on their incomes and wealth.
 There are three distinct periods:
‒ the eighteenth and nineteenth centuries up to about 1910 show increasing wealth
inequality (excepting Norway and Denmark),
‒ the twentieth century until 1980 shows decreasing wealth inequality, and
‒ the period since 1980 shows a modest increase in wealth inequality
 There are cross-country differences in the level of inequality. The US is much more unequal
than China, India, the UK and Germany
 But there are also common trends: there was a fall in income inequality across almost all
countries form 1920 to 1980, followed by an increase in income inequality in many countries
since about 1980
 Countries differed greatly in what happened after 1980 though
‒ In many countries there was a sharp U-turn towards greater inequality after 1980
‒ In other countries inequality remained at historically modest levels.
 37

The inequality U-turn in some countries

 38

… but not others

 39
A closer look at South Africa:
The market income share of the top 1% (1910 – 2015)

25 United States
South Africa
United Kingdom
Income share of the top 1%

20 China

15

10

0
1955

2015
1910
1915
1920
1925
1930
1935
1940
1945
1950

1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
 40

Inequalities between and within nations

 The ‘great divergence’ resulted because the upward tick in the hockey stick for
per capita income came early for some countries (Britain, Italy, and Japan), later
for others (China and India), and has not yet occurred for others (Nigeria and
Argentina)
 The result of the uneven timing of the capitalist revolution around the world
was a widening of inequalities among the people of the world, which occurred
over the nineteenth and twentieth centuries until very recently.
 Even the poor in North America and Europe became richer than the rich
elsewhere.
 So, how do we measure global inequality?
 There are two methods:
‒ Measuring global inequality between people (people are the basic unit of
comparison)
‒ Measuring inequality between countries (countries are the basic unit of
comparison, and we implicitly assume that every person in a country earns
the average income of that country)
 41

Measuring global inequality

Red line: Gini coefficient of nations (a Lorenz curve of average per capita incomes per country)
Blue line: Gini coefficient for the world population (a Lorenz curve of all individuals)

Inequality between individuals

0.70

0.60
Inequality between countries

0.50
Gini coefficient

0.40
• Since 1980, among countries inequality fell
0.30 rapidly,
• Inequality among all the world’s people has also
0.20 declined
• But within many countries inequality has
0.10
increased.

0.00
1945

1950

1955

1960

1965

1975

1980

1985

1990

1995

2000

2005

2010
1970

2015
 42

Inequality across countries

 The red line focuses on the income differences across countries.

 Imagine that everyone in each country earned the average income for that country. In
this thought experiment, everyone in South Africa would earn exactly South Africa’s
average income, whereas everyone in China would earn exactly the Chinese average
income.
 The red line shows the result of performing this calculation, where the only source of
inequality in the world would be inequality between countries.
 Measured in this way, inequality is reduced, but substantial inequal­ities still exist due
to the vast differences in income between countries.
 The reason that across country inequality declined (red line from early 1990’s) was
because of accelerated growth in decline in the world’s largest poor countries, China
and India.
 But inequality within China and India, increased over this period
 43

Inequality among people

 Think about the Lorenz curve constructed by lining up all the individuals in the world
from lowest to highest income, irrespective of the country people live in.
 The poorest 20%—the part of the Lorenz curve extending from zero to 0.20 on the
horizontal axis—would be very flat: this would represent most of the populations of
Liberia and Nigeria, and middle and lower income people in Indonesia and India
 If we construct the entire Lorenz curve, we can calculate the Gini coefficient for the
whole world.
 For example, on the blue line in the figure, in 2003 the worldwide Gini coefficient was
0.69.
 Measured in this way, inequality among the world’s individuals is high but has fallen
very recently.
 44
Interpretation is that most inequality of income is accounted for by inequality
across countries

 You can see that the Gini coefficient for all individuals in the world in 1988 (the
beginning of the blue line) was 0.69
 This number would have been 0.60 had there been perfect equality within each
country (the red line is based on the assumption that everyone in a particular country
earns that country’s average income).
 This can be interpreted as follows:
‒ In 2003, we could argue that 87% of global inequality in income is accounted for by
inequality across countries, because 0.60/0.69 = 0.87, or 87%
‒ By 2013 across country inequality only accounted for 76% of global inequality
(0.47/0.62 = 0.76)
 45

In Summary

 Fact 1
Most of the inequality in the world is between individuals in different countries (the red
series is a large proportion of the blue series) and is not between individuals in the same
country
 Fact 2:
But this is changing: The world’s two largest and once very poor economies—India and
China—raised their average incomes more rapidly than the richer countries, reducing
between-country inequality, and because inequalities across individuals in these
countries and many other large nations became greater, this has resulted in increasing
within-country inequality.
 Fact 3:
Inequality between individuals is declining: The net result of these opposite trends (1)
across country inequality falling and (2) within country inequality rising is that inequality
among the individuals of the world has started to decline.
 Overall:
as more people experience rising incomes in countries like India and China inequality
rises in those countries and this has resulted in less inequality across the world as a
whole (comparing the individuals across the world to each other)
Accidents of birth, endowments and
intergenerational inequality
 47

Taking a chance: what do you choose?

2014

om es
inc cil
e
of n de
te
 Suppose that all you care about is income, and you can choose either:
‒ The income decile you are in, but the country you are born in will be decided by chance (The Risk: if you
choose top decile you may land up in Nigeria’s top decile which means you will be less well off than if you
had chosen to be in a country like Norway, even if you land up in a lower decline in Norway)
‒ The country you are born in, but the income decile will be decided by chance (The Risk: if you choose to
be born in Norway you may be in the lowest decline which means you will be less well off than if you had
chosen China or Botswana and you landed up in a high decile in one of those countries)
 48

Accidents of birth

 Much of the inequality in the world today can be traced to differences among people
in things over which they have virtually no control, such as their race, sex, nation, or
parents.
 These differences are known-as ‘accidents of birth’.
 Inequality can be as result of the place where you are born and live.
 Inequality can be as the result of your gender, race or other category
 Inequalities based on one’s ethnic identity or caste are examples of categorical i.e.
Inequality between particular social groups (identified, for instance, by a category such
as race, nation, caste, gender or religion).
 49

Gender inequality

 The most common form of categorical inequality is that between men and
women.
 There are many economic differences between men and women on average.
 This is surprising because men and women have similar parents, similar
schools (in most countries), similar genetic inheritance on matters affecting
intellectual skills and so on.
 But it is clear that the society treats men and women differently, and this is
reflected in economic outcomes. This is much more true in some countries
than in others, but it is true for all countries.
 Income disparities between men and women among otherwise similar
individuals are one measure of this inequality.
 50

Gender inequality in the USA

 The figure shows the expected lifetime earnings (labour income) of men and women in the US,
who work full time from the time they leave school until retirement.
 Any differences in the figure are not due to women having more time out of the labour force (on
average) because of child rearing. Nor, are they due to difference in access to education (see
following figure).
4.5

4.0 Male Female 0.75

0.82
3.5
0.74
Expected lifetime earnings ($m)

3.0
0.75
2.5
Ratio of female to male earnings

2.0 0.74
0.74
1.5
0.72
1.0

0.5

0.0
Less than Secondary Some post- Bachelor's Master's Doctoral Professional
secondary school secondary/no degree degree degree (law, medicine,
school degree etc)
 51

Ratio of girls to boys schooling

1.2

1.1

1.0
Ratio of girls' to boys' years of schooling

0.9

0.8

0.7

0.6

0.5
Brazil France
0.4 United States Indonesia
China Tanzania
0.3
India
0.2
1970 1975 1980 1985 1990 1995 2000 2005 2010
 52

Intergenerational inequality

 In addition to categorical differences such as nation, gender, race, or ethnic

group, a second source of economic inequality within a nation is inherited.
You may be rich or poor simply because your parents were rich or poor.

 Two hundred years ago, in most countries it was taken for granted that
somebody would expect a life of poverty simply because her parents had
been poor.

 But this has changed with the spread of public education and, in many
countries, with the decline in discrimination against poor people due to their
race, religion, or simply their humble origins.

 In some countries, the economic status of one’s parents matters a great deal
for the economic success of their children; in other countries, differences
among parents are only weakly transmitted to their offspring.
 53

Intergenerational inequality

 The expression intergenerational transmission of economic difference is the

processes by which the economic status of the adult sons and daughters
comes to resemble the economic status of the parents

 Intergenerational inequality: The extent to which differences in parental

generations are passed on to the next generation.
 The transmission process takes many forms:
‒ Children inherit the wealth of their parents.
‒ Through parental influence in child rearing, parents and children tend to
share similar preferences, social norms, and knowledge, skills and social
connections acquired outside formal schooling.
 54

Measuring intergenerational inequality

 The figure is based on labour earnings (wages or salaries). The tall bar on the left in the US panel
means that among those whose fathers were in the bottom fifth of the earnings distribution, 40%
were themselves in the poorest fifth, while 7% ended up in the top fifth of the earnings
distribution.
 By contrast, 36% of those born to the richest fifth were themselves in the richest fifth—the tall
purple bar on the right.
 55

Comparing intergenerational inequality in the US and Denmark

 The earnings of parents and their children appear to be similar in the US,
partly because children of well-off parents receive more, higher-quality,
schooling.
 They also benefit from the networks and connections of their parents, which
improve access to the labour market.
 The data from Denmark in the right panel suggests a more level playing field.
‒ Only 25% of those born to parents in the poorest fifth of the population end
up in the poorest fifth themselves, compared to 40% in the US.
‒ This suggests that those born to relatively poor parents are less
disadvantaged in Denmark.
‒ Similarly, 33% of those born to parents in the richest fifth end up in the
richest fifth themselves, compared to 36% in the US
 Based on this data, we would conclude that intergenerational inequality is
lower in Denmark than in the US, though it still does not appear to be a
completely level playing field.
 56

Intergenerational elasticity

 The intergenerational elasticity measures how much richer the child of the well
off father will be than the child of the poorer father.

 An elasticity of 0.5, for example, means that if one father is 10% richer, then his
child, when grown up, will be on average 5% richer than the other child.

 An elasticity of 2, for example, means that if one father is 10% richer, then his
child, when grown up, will be on average 20% richer than the other child.

 The higher the intergenerational elasticity,

‒ the greater the degree of intergenerational transmission of economic status

and

‒ the greater the level of intergenerational inequality.

 In a society with a high intergenerational elasticity intergenerational mobility is

slow.
 57

Factors influencing endowments and inequality

 Intergenerational inequality is likely to be greater where:

‒ inheritances are not heavily taxed
‒ education policies allow the wealthy to acquire more and better education for their
children.
‒ marriage customs result in spouses having similar levels of wealth—called ‘positive
assortment’—this will contribute to inequalities in endowments.
‒ elite universities, for example, contribute to positive assortment because like
exclusive social clubs, they provide meeting and matching oppor­tunities for the sons
and daughters of the wealthy.
‒ If the economy operates on winner-take-all forms of competition. In this setting, a
few people—the winners—will end up with substantial endowments in the form of
valuable financial or real assets, while the rest end up with little.
 58

Government’s role in the economy

 59

Government as an actor in the economy

 Government is the only entity within a territory that can dictate what people must
do/not do. It can legitimately use force and restraints on an individual’s freedom to
achieve that end.
 The government is different from other economic actors:
‒ Much larger – size of most governments have grown over time.
‒ Engage in activities that can improve quality of life for citizens
 Unlike private firms, government has an obligation to citizens
‒ To realize these obligations, governments use tax funds to provide services such as
national defence, police protection, and schooling.
‒ It can use coercion to force people to pay taxes.
‒ These services are often provided without restrictions to those who use them, and
without charging a price.
‒ People differ in the taxes they pay in line with their income and wealth, but because
they are citizens, they are equally entitled to many of the services of the
government.
 60

Britain: Taxation as a share of GDP

40  The rise of capitalism has been associated with a sustained
increased in the size of government
35  As per capita incomes rise, the size of 1945 Hitler defeated,
Atlee elected
government has increased.
Total tax revenue (% of GDP)

30  Other factors that have influenced the size

of government include: 1815 1979
‒ War Treaty of Paris Thatcher
25 elected
‒ Democracy and universal suffrage
‒ Aging populations
20 1939
WW2

1799 1919 Treaty

15 of Versailles
Napoleon's Coup

1914
10 WW1
1899
Anglo Boer war
5
1688
The "Glorious Revolution"
0
1500 1550 1600 1650 1700 1750 1800 1850 1900 1950 2000
 61

USA: Government spending as a share of GDP

45
WW2
Even in the USA – generally
40
regarded as the most “free market”
35
society – government now accounts
for 40% of GDP
30

Vietnam
Percent of GDP

WW1
25

20

Civil War
15

10 War of
1812

0
1800
1810
1820
1830
1840
1850
1860
1870
1880
1890
1900
1910
1920
1930
1940
1950
1960
1970
1980
1990
2000
2010
Source data : Mauro et al (2013)
 62

India: Government Spending as a share of GDP

30

25

20
1947
Percent of GDP

15 Indo-Pak War

10
1939
WW2
5
1914 1947
WW1 Independence/democracy
0
1870

1880

1890

1900

1910

1920

1930

1940

1950

1960

1970

1980

1990

2000

2010
 63

South Africa: Government spending as a share of GDP

35
1994
Democracy
30
1976
Soweto
25 uprising

20
Percent of GDP

15 1939 1985 First State of

WW2 emergency and
debt standstill
10

0
1914

1924

1934

1944

1954

1964

1974

1984

1994

2004
Source data : Mauro et al
 64

Government policies as part of the solution

 Governments may adopt the twin objectives:

‒ ensuring that the mutual gains possible through our economic interactions are as
large as possible and are fully realized
‒ sharing these gains in a fair manner
 Examples of policies to address market failures and unfairness include:
‒ Public provision of healthcare or compulsory insurance.
‒ Minimum wage laws: That prohibit contracts that pay below a stated minimum.
‒ Competition policies: To reduce the price-setting powers of monopolies.
‒ Environmental policies: To reduce emissions of pollutants.
 65

Government as part of the problem

 To accomplish these valuable policies, governments must have

extraordinary powers to acquire information and to compel compliance.
 This creates a dilemma. For the government to be a successful problem-
solver, it must also be powerful enough to potentially be a problem itself.
 Examples from history, and today’s news, show governments using their
monopoly on the use of force to silence opposition and to acquire huge
personal wealth for their officials and leaders (“corruption”).
 Well-governed societies have devised ways to limit the damage that the
use of government powers can inflict without undermining the
government’s capacity to solve society’s problems. These have generally
included a combination of:
‒ Democratic elections
‒ Institutional checks and balances
 66

Main points again

 67

Inequality, Policy and Government

 The Measure of GDP per capita is an average which does not give a
sense of the degree of inequality in a society
 The Lorenz curve and Gini coefficient are measure which give a
clearer picture of the degree of inequality
 Government ex post redistribution policies and ex ante
predistribution policies can assist in reducing inequalities of income
and wealth, as well as categorical inequality (such as inequality
based on race and gender) and inter-generational inequality
 Globally, as more people experience rising incomes in countries like
India and China inequality rises in those countries and this has
resulted in less inequality across the world as a whole
 68

Inequality, Policy and Government

 A government allows people to do things together that they could not do individually, notably
going to war. But governments in a mixed economy also engage in activities that vastly
improve living standards and the quality of life for their citizens.
 Examples include:
‒ Poverty: Fifty years ago, even in rich countries, many retired or elderly people were trapped
in poverty. For example, in 1966, 28.5% of US citizens aged 65 and over were classed as
‘poor’. Government transfers in many countries have virtually eliminated serious economic
deprivation among the elderly. In 2012 just 9.1% of elderly people in the US were poor.
‒ Economic security: The increased size of government spending, as well as the policy lessons
from the Great Depression and the golden age of capitalism, have reduced economic
insecurity by making the business cycle less volatile. See Diagram.
‒ Increased life expectancy and the dramatic reduction in child mortality in many countries:
When these occurred in the late nineteenth and early twentieth century, they were not
primarily the result of advances in medicine, most of which came later. They followed
government policies that improved sanitation and water supply.
 In some senses government is part of the solution and in some senses government is part of
the problem