Distribution of Income and Wealth

Intro Study of the distribution of wealth and the distribution of income show a similar trend in the UK: of rising inequality between the richest and poorest households in the UK. Wealth and income not the same thing (although they are related). Wealth: the stock of financial and real assets e.g. property, savings in a bank/building society, ownership of land and rights to private pensions, equities, bonds etc. Income: the flow of factor incomes such as wages and earnings from work, rent from the ownership of land and interest and dividends from ownership savings and shares

Wealth The stock of financial and real assets. Marketable e.g. property, shares (can be sold) [approx 2/3 of household wealth] Wealth Non-marketable e.g. Life assurance, salaries, pensions (cant be sold). Wealth has tended to be more unequally distributed than income in the UK. 1% of the population own approx 1/5 of marketable wealth in the UK

Sources of Wealth Inheritance – “old money” – property accumulated over generations (is “self perpetuating”). Saving – accumulated through savings – (is easier for high income earners + older people who have been living longer). Entrepreneurship - people who are ‘self made’ – Bill Gates/Richard Branson etc. Chance – ‘Instant millionaires’/jackpot winners.

Causes of Wealth Inequality Inheritance – old money!! Properties, land passed down through generations. Marriage – wealthy people marry wealthy people – reinforcing concentration of wealth amongst a few people. Income inequality – high earners have higher savings ratio and can earn interest + invest in life assurance etc. Chance – Depends on random chance – e.g. competitor closing/winning probability competitions e.g. national lottery

Income the flow of factor incomes such as wages and earnings from work, rent from the ownership of land and interest and dividends from the ownership of shares. http://tutor2u.net/economics/revision-notes/a2-micro-distribution-of-income-and-wealth.html

Re-cap Wealth: the stock of financial and real assets. Income: the flow of factor incomes Wealth is marketable and non-marketable. Causes of wealth inequality: inheritance, savings, marriage, income inequality, chance.

Causes of Income Inequality Wealth inequality – some assets will lead to ‘unearned incomes’ e.g. property = rent, shares = dividends etc. Household composition – no. of people in household working. Level of skills and qualifications – life earnings of graduates are substantially higher than non graduates. Differences in earnings – full-time workers earn more than part-time workers, also jobs that have opportunities for over-time.

3. e.g. Lawyers Vs McDonalds Workers Number of McDonalds workers Supply is inelastic because of the qualifications required MRP of lawyers is high. If they are successful they can make firms a lot of revenue. Supply is elastic, because few skills and qualifications are required The MRP of a McDonalds worker is much lower because there is a limited profit to be made.

Some Facts UK National Income = 2.5 Trillion (US$) UK Population = 60million people

Distribution of household disposable income in the UK (% of national income) Quintile group 1979 2002/2003 2005/06 Bottom 20% 10 7 2nd 20% 14 12 3rd 20% 18 17 4th 20% 23 24 Top 20% 35 40

Homework Find out the difference between inequality and inequity.

Lorenz Curve Lorenz curve: a diagrammatic representation of the distribution of income See diagram

Gini Coefficient Pronounced “genie” or “guinea” Gini coefficient: a ratio showing the area between the 45 degree line and the Lorenz curve divided by the total area below the 45 degree line (see diagram) (a ÷ a + b). Ratio: 0 = perfect equality Ratio: 1 = perfect inequality

See handout

Uses and Limitations of GINI Coefficient Advantages is a more representative measure than GDP or GDP per head. used to indicate how the distribution of income has changed between different countries or over time. Can compare income distributions regionally e.g. North West vs South East, or between rural and urban areas. Is an ‘objective’ measure of inequality. Disadvantages Economies with similar Gini coefficients can still have very different income distributions. This is because the Lorenz curves can have different shapes and yet still yield the same Gini coefficient. It measures current income rather than lifetime income. Is only a statistic - only as accurate as the data used to calculate it. best to use in conjunction with other data such as poverty data

Analysis According to the gini coefficient, inequality in income distribution has been rising in the UK. Why?? Reduction in top rates of income tax benefited higher earners (although recent reversal of top rate of income tax from 40 to 50%). Increase in regressive taxes e.g. on cigarettes, alcohol, petrol way above inflation. Real wages have stagnated. Wages/average earnings have not kept up with inflation. Benefits, state pensions, JSA etc have not kept up with inflation ‘Inequality of opportunity’ exists – overwhelming proportion of ‘Oxbridge graduates’ still from privileged backgrounds – end up getting best paid jobs Percentage of single parent families – CLAIM BENEFITS and only work PART-TIME

Income Inequality by Geography UK Regions EU - Wide Region Income per head East Midlands 12,522 North East 11,356 South West 13,258 London 15,885 UK 13,279 Region Income per head (2006) Germany 114.3 Hungary 65.0 Portugal 74.6 UK 118.1 EU27 100 (index=100) Income inequality within UK e.g. North East compared to London Income inequality within each EU country itself e.g. east & west Germany Income inequality across Europe e.g. Hungary below average, UK above.

Regional inequality in UK exists because of: Differences in industrial structure i.e. many manufacturing industries based in the ‘north’ whilst service sector industries based in the south. Higher unemployment rates in the north – structural unemployment due to declining industries. Lack of investment including FDI (Foreign Direct Investment) in certain regions. Region International firms in UK East Midlands 4.66% North East 2.19% South West 9.18% London 21.69% UK 100% *Note: some regions are not included in table so will not total 100

Methods of Intervention to reduce Inequality of Income 2. Taxation – increase progressive taxes e.g. income tax and reduce regressive taxes e.g. VAT. 3. Monetary benefits – ‘means tested’ benefits – get cash benefit if your income is below certain level e.g. WFTC. Universal benefit – child benefit – everybody gets it irrespective of income 4. Direct provision of goods and services. – free state education, NHS, free school meals 5. Legislation and labour market policy – minimum wage, equal pay, anti-discrimination, equal opportunities policy. Also provide training to low skilled.

Increase progressive taxes -Disincentive to work Advantages (Interventionists) Disadvantages (Free market Economists) Increase progressive taxes -Raises revenue -Can be spent on low income earners -Disincentive to work -less labour supply – potential output falls -total tax revenue may fall - Monetary Benefits - Direct financial help to people - Reduces poverty -Reduces social problems Disincentive for people on benefits to actively seek work. Large spending commitments of government Opportunity cost

Direct State Provision - Equal access to merit goods - Positive externalities for wider economy. Boosts potential growth - -- Large spending commitments of government Opportunity cost Bureaucratic/less efficient than private sector Legislation and Labour Market Policy - Ensures protection for workers on low incomes Ensures equality of opportunity Reduces discrimination Raises costs for firms Unemployment in P.C. lab mkt. Reduces overall international competitiveness of economy – less attractive to MNC’s

Equity vs. Efficiency Equity = fairness. Horizontal equity: no discrimination on the grounds such as race / gender / different types of work. Vertical equity: people with higher incomes should pay more tax. Interventionists argue: Competitive labour markets lead to market failure i.e. uneven dist. of income. It is fair that the government intervenes to ‘correct’ this market failure – by redistributing income for poorest households, alleviating poverty, crime and other social problems. Efficiency = optimal allocation of scare resources. Free market advocates argue: Intervention causes government failure. Differences in wages reflect different MRP’s. By raising taxes on high earners and increasing benefits for low earners, this adversely affects ‘incentives’ – distorting the labour market . Damages efficiency and potential growth

Continued…. Legislation on equal pay and discrimination is required to provide equal opportunities to people from all walks of society and protect the most vulnerable e.g. people with disabilities. Minimum wages ensure that people (especially low skilled and youth workers) are paid a 'fair wage' that is not eroded by inflation and also raises employment (see monopsony diagram) Cash benefits create a disincentive for those dependent on state assistance to improve their skills and seek work leading to a higher inactivity rate. Spending on health and education (free at the point of use) - means that government spending as a proportion of GDP is higher than necessary, leading to higher tax burdens than would otherwise have been necessary.

Since people on high incomes benefit most from the market economy, it is equitable for them to pay a higher proportion of their income on tax so it can be redistributed to the least well off in society. Cash benefits are necessary to protect those on the lowest incomes e.g. pensioners, single parents from poverty. Use supply side policies to: Reduce marginal tax rates - it will boost incentives to work, boosting tax revenue and economic growth (see laffer curve). policies to increase mobility i.e. skills training so people can find it easier to move between jobs. Policies to increase labour market flexibility and competitiveness - e.g. reducing trade union power, employment protection (easier to make workers redundant), reducing employment costs.

Gross Vs. Disposable Income After tax and benefit system Gross Income % Disposable income Bottom 20% 7 8 2nd 20% 11 12 3rd 20% 16 17 4th 20% 23 Top 20% 43 41 Data to show the redistribution of income from high income earners to low income earners

Types of labour market failure are: Monopsony (imperfectly competitive lab. Mkt.) Immobility (geographical and occupational) ‘Traps’ (Poverty and unemployment trap) Discrimination (negative and positive) Inequality in income and wealth distribution Poverty

Poverty

Poverty Is a consequence of the unequal distribution of income. Absolute Poverty Relative

Measuring Poverty

Causes of Poverty Unemployment (primary cause) Low wages (due to demand and supply influences i.e. “McDonalds worker diagram” Sickness and disability – dependence on benefits Issue of incentives – poverty trap. When working, if given pay rise, no better off as taxable income increases and benefits withdrawn. Imperfect information – low take up rate