The Possible Economic Causes and Consequences of an Increase in Income Inequality for a Developed Economy - Essay Example

INCOME INEQUALITY Affiliation Introduction Income inequality can be defined as the magnitude to which income in among a group of people or country is unevenly distributed or in other words it is the measure of how the income is equally divided among all society members. It is representation of how relative income among the poor in a community is as compared to the income of the rich thus it can also be defined as the measure of how the income pie is equally divided between all members in the society. The main goals of this paper are to study and assess the meaning and measurement methods of income inequality in a developed country, which in this case is the United Kingdom. It also aims at critically discussing the possible economic causes and consequences of a rise in income inequality in the United Kingdom using relevant evidence gathered from research and other available sources. As discussed above, income inequality is the extent to which income is unevenly distributed among a group of people. Based on the definition, there should be defined methods and techniques used to measure inequality. Currently, there exists three commonly used measurement methods for income inequality where the choice of the method used does not change the value of view of the income inequality in a society. Income inequality measurement methods The Gini coefficient This is the most common way of measuring income inequality based on the Lorenz curve. The horizontal axis of the graph represents the proportion of the population in order of their income from lowest to highest. The vertical axis represents the income proportion from 0 – 100%. A 45o line represents a equality where the every person in the society receives the same income. The Gini coefficient is computed by dividing the shaded area in by the area under the line of perfect equality. The Gini coefficient varies from 0 (‘perfect’ equality) to 1(‘perfect’ inequality). The Gini coefficient works by measuring inequality across the entire society other than comparing diverse income groups. The Gini coefficient reveals that when all the income is acquired by a single individual referred to as the maximum inequality while everyone received nothing the Gini coefficient is 1 but it the income is equally distributed among everyone the Gini would be 0. Thus the higher the Gini coefficient value is the less equal income is distributed among the society. Currently, the United Kingdom’s Gini coefficient is 0.34 while the country with the lowest has a Gini coefficient is 0.24. The Gini coefficient is favoured because it can offer measurement if income inequality before and after tax deductions and housing costs thus the coefficients change depending on the time of measurement . Robin Hood index This is defined as the share of income that is required to be redistributed from individual to individual above the average income to those people below the average income in order to achieve ‘perfect’ equality. The Robin Hood index is the highest vertical distance achieved between the line of ‘perfect’ equality and the Lorenz curve. Cause of income inequality Income inequality in any society is caused by numerous factors but this paper will dwell on a few major causes of income inequality that are considered as the most influential (Shin 2012). The top reason of income inequality in most economically developed countries such as the United Kingdom is because most of the households in these countries possesses the same characteristic which is that they have two workers, the husband and the wife are both employed. Consequently, the households with only one income source or one breadwinner, are mostly in the category of low income households but this does not mean that all household in these category are poor. Additionally, upper and lower class people are known to marry people of the same class (Oishi et al. 2011). Based on this, married couples are mostly in the same class thus if both are of the upper class they will have two high income workers thus the income in the household will increased the country’s Gini coefficient because the lower class people will also marry each other consequently having two low income workers. Moreover, single parent families are considered as an important cause of poverty that leads to income inequality particularly when family economic pillar is only a woman. Based on the later statement, a new issue arises that places gender as another cause of income inequality. This is backed up by research carries out in the USA stating that for every dollar a man makes a woman make 20% less between the ages of 18 and 44 while those between the age of 45 and 54 make 27% less (Shin 2012). Education is considered as one of the most influential causes of income inequality. Each new generation of people in the UK appear possess a better education level as compared to the previous generation meaning that the young generation is always ahead of the old people in terms of education. Currently, it is obvious that university or college graduates receive a better paid which is by far much higher than what most high school graduate workers receive thus more and more people are aiming at achieving a higher education level in order to acquire better qualification to get that well-paying job (McCall & Percheski 2010). This situation has pushed the current generation to seek better education to receive a better pay thus more and more unqualified people are being laid off and better educated people are being employed at a higher wage thus increasing the income equality level of the country. Advances in technology is widening the gap between the poor and the rich thus increasing the income inequality because it reduces employment opportunities for the poor people in factory jobs since technology is much faster and more effective. Although the more complex machinery require skilled operators to work them, the employment opportunities created by the technology only benefit the middle class and not the poor in the society. This has been the lead cause and explanation to explain the rapid increase in the Gini coefficient worldwide since the industrialization period in the early 1980s (Babones 2008). Technology has, is and will continuously get more advanced thus the demand for skilled labour will be on the rise as the layoff of the non-skilled labourers will continue rising since machined will replace them. Consequences. Income inequality leads to unemployment which leads to other consequences including social and political unrest and an increase in the crime rate in a country because the unemployed people have to find alternative ways to sustain themselves. This effects is also backed up by Wilkinson & Pickett (2009) who conducted a crime-inequality nexus study in the UK where he stated that by reducing income inequality, a country is in a better chance of minimizing crime rates compared to provision of better education or the implementation of policies promoting growth. Therefore, income inequality has cyclical effects on an economy in a destructive way. Cooper McCausland & Theodossiou (2013) reveals that societies experiencing a high income inequality level are more probable to adopt policies that do not promote long term growth potential mostly due to the conflicts experienced between holders of political power and economic power. This move creates a destabilizing influence depending on the strategy. Moreover, high income inequality tend to increase competition between high and low income earners with the later constantly under pressure to ask for loans in order to maintain themselves. This eventually leads to an increase in inflationary pressures, debts and macro-economic instability which were regarded to as some as the causes of the great recession. With the presence of unequal income distribution in any economy, the majority of the population is usually poor which makes it harder for them to invest their human capital thus tending to weaken the growth of the economy and thus leading to a low human capital formation gap. It is difficult for capital markets to bypass this trap due to the information on the future income growth because human capital information is scarce. Income inequality has also been identified to cause inefficiencies in an economy by distortive taxation. This is applicable in economies possessing more intense wide gaps in distributional conflicts and income distribution. Higher income inequality levels lead to build up of political pressure on the government meaning that it is forced to increase the taxation rates on capital (Ravallion 2014). The increase in taxation rates has diverse effects on the economy because the capital accumulation if vital for growth thus a higher taxation on capital would in turn affect the incentive to accumulate capital thus the economy is bound to grow at a sluggish rate. These will also cause an effect on investment because economic uncertainly is bound to scares away investors. The increase in income inequality will also affect the borrowing rate of the poor majority in that they will not be in a position to request to loans to aid in the acquisition of capital so that they can get capital to finance investments. On the other hand, higher inequality levels will give influence to the rich groups who will selectively lobby to receive preferential tax treatment thus leading to over-investments in certain areas and consequently reducing the growth in other areas. The World Development Report (2006) reported that high levels of income inequality in any country could result in the emergence and growth of racial and gender discrimination in the labour that would in turn discourage the participation of the discriminated group hence reducing the labour supply. This reduction in economy labour supply would inevitably lead to a reduction in production thus affecting the economy negatively by reducing its growth and production. In conclusion, the different ways used to measure inequality often return similar trends although they have their differences because they use different income distributions to measure the income inequality. But in all cases, the inequality measures are usually closely correlated. The causes and consequences of income inequality are also similar in developed economies because they possess the same type of problems and issues. Generally, income inequality in the United Kingdom has over the years increased drastically mainly because of the increased top wage incomes. Reference list Babones, S.J., 2008. Income inequality and population health: Correlation and causality. Social Science and Medicine, 66, pp.1614–1626. Cooper, D, McCausland, W, & Theodossiou, I 2013, Income Inequality and Wellbeing: The Plight of the Poor and the Curse of Permanent Inequality, Journal Of Economic Issues (M.E. Sharpe Inc.), 47, 4, pp. 939-958, Business Source Premier, EBSCOhost, viewed 18 March 2015. McCall, L. & Percheski, C., 2010. Income Inequality: New Trends and Research Directions. Annual Review of Sociology, 36, pp.329–347. Oishi, S., Kesebir, S. & Diener, E., 2011. Income inequality and happiness. Psychological science : a journal of the American Psychological Society / APS, 22, pp.1095–1100. Ravallion, M., 2014. Income inequality in the developing world. Science, 344, pp.851–855. Shin, I., 2012. Income inequality and economic growth. Economic Modelling, 29, pp.2049–2057. Wilkinson, R.G. & Pickett, K.E., 2009. Income Inequality and Social Dysfunction. Annual Review of Sociology, 35, pp.493–511. Read More