What is Income Inequality?

By | October 30, 2021

Income inequality is again in the spotlight. Earlier this year, The World Economic Forum (a gathering of political leaders and business leaders from around the world) stated that the growing gap between rich and poor is the biggest risk factor for the global economy in the years to come. In the media we can also hear that inequalities are constantly increasing. In this article, we will take a closer look at this very question. We will see that inequalities within most countries have increased in the last 30 years, at the same time as inequalities between countries (at least in a certain sense) have become somewhat smaller.

  • Why should we care about income inequality?
  • Are the differences getting bigger or smaller inland?
  • What are the consequences of increased income inequality?
  • Are poor countries approaching the rich?

2: Long-term, unique economic growth – at least in the West

The main source of today’s global income inequality can be traced back to a relatively modern phenomenon of success, namely economic growth. Today we have come to terms with the idea that each generation is richer than the last (just think about how your grandparents or great-grandparents grew up). Nevertheless, it is important to remember that this long-term growth in prosperity is actually quite new and historically unparalleled . Simplified, we can say that it started with the industrial revolution in the late 18th century. In the period that followed, the divide was created between the West and the “rest of the world” that we know well today – some countries ran away , while the rest were left in poverty.

3: Income is not the same as welfare

Income is not the same as welfare, which is what we should ultimately care about. High income in no way guarantees a good life. Why then is there such a strong focus on income inequality and not on other forms of inequality? One possible answer is that economists and others like to relate to a single goal , and income is after all relatively unproblematic to measure (at least in theory).

A somewhat better argument is that income is often linked to other dimensions of welfare: People with high incomes often also have good health, high education, great opportunities to participate in and shape society – generally good opportunities to live the life they may want . Economist Angus Deaton also shows that the higher their income, the higher their life satisfaction . In fact, this connection applies both within the country and across poor and rich countries. A one-sided focus on income is nevertheless a simplified approach to the question of inequality, although it can be a good start.

4: Different views on the value of income inequality

Why should we really care about income inequality? So: Should we care that people have different incomes? This is a question that is by no means fully agreed on the answer to, and we are happy to hear various arguments. Although many support the idea of ​​more equality, there is still great disagreement about exactly what should be leveled. Some people believe that income inequality in itself is unfair . Others believe that some degree of inequality may be necessary to achieve prosperity growth. If the authorities, for example, were to impose equal pay for everyone, many might have chosen to reduce the workload or work less efficiently (the pay is the same anyway) – which in the end can mean that everyone gets worse.

However, research shows that excessive differences often contribute to less trust and mutual understanding between social groups. Inequality can thus affect how people look at each other, something many would argue is a separate argument for caring about income inequality. Still others argue that we should strive for equality in opportunities rather than equality in outcome . This view works well in theory, but there are still many opinions about what we should concretely include in the concept of «equal opportunities».

There are thus different views on what is a fair degree of inequality, and on how we should judge this. Regardless of one’s view, it is nevertheless interesting to study the actual development in inequality. Global income inequality – ie inequality between all the citizens of the world – can be said to have two dimensions:

  • inequality within the country
  • inequality between countries

5: Inequality within Western countries

” Capital in the 21st Century “, written by French economist Thomas Piketty, is one of the most talked about book publications so far in 2014 – another proof that inequality is high on the news agenda. The book takes a very thorough look at how income inequality (and wealth inequality) has developed over a long period of time. The focus is primarily on inequality within western countries. Although the history is obviously not the same for all countries, the main trends over the last 100 years can be summarized as follows: Most western countries experienced reduced income inequality through the first half of the 20th century, after peak incomes fell due to wars, increased taxes ( emergence of welfare state) and inflation. Income inequality then began to rise from the mid-1970s. Slowly in some countries, very fast – almost explosive – in others.

The figure on page 1 illustrates these main trends by means of one measure of inequality, namely the proportion of countries’ incomes that accrue to the one per cent with the highest income. As we can see, this one percent of the population owns a very large share of the total income. The United States stands out clearly . In 2010, this group earned as much as 20 per cent of all income (somewhat higher figures in the years just before), 20 times more than what a completely even income distribution would indicate. In Sweden, the one percent highest paid get a considerably smaller share, but also here they take more than seven times as much as they would with a completely even income distribution. The figure does not include data for Norway. Research (Rolf Aaberge etc.) indicate that also Norway, like Sweden, has experienced increased income inequality since the late 1980s (the proportion that goes to the one percent with the highest income in Norway is probably somewhere between Sweden and Germany in the figure). More generally, the Anglo-Saxon countries (such as the United Kingdom, Canada and especially the United States) have experienced a sharp increase in inequality than continental Europe and Japan.

Lack of data material makes it difficult to study the development of non-western countries. Nevertheless, there are many indications that inequality has risen in recent decades in this part of the world as well . It is difficult to give a complete explanation of why income inequality has increased so sharply in almost all western countries in the last 30-40 years. Globalization can probably explain something. Closer relations and more trade between countries have undoubtedly opened up new opportunities, especially for people with the right skills. Others, especially those with little education who work in what were already low-paid occupations, have had to deal with tough competition from low-cost countries such as China. This has led to a weak, and at times negative wage development for these groups.

Another phenomenon, related to globalization, is something Piketty refers to as the emergence of a new group of ” super leaders ” , often with great bargaining power. These are leaders (often in English-speaking countries) of large international corporations, which in recent decades have achieved a star status previously reserved only for music artists, athletes and actors. As indicated in the figure, wage developments have been accordingly.

6: New political course

Also political changes will be highlighted as a possible cause of the increased inequality. In collaboration with Emmanuel Saez, Piketty has shown, among other things, that the OECD countries with the largest increase in inequality are the same countries that have cut the most in taxes for high-wage earners.. Politics is not formed in a vacuum. Several studies have shown how voting in the US Congress is affected by money-rich interest groups. Many even claim that policy changes in favor of the rich must take much of the blame for the increased income inequality in the United States. Even if these notions are only partially correct, they still open up frightening perspectives. If the richest and most powerful in society are really able to turn politics in their favor, we can also envision a self-reinforcing effect: Politics makes the rich even a little richer, which increases their ability to influence politicians further.

Increased inequalities can at least affect public spending in an indirect way. Research (Erling Barth and Kalle Moene) shows that societies with relatively small income differences before tax (such as Norway) generally – through the tax system – redistribute more of their resources compared to societies with large differences before tax (such as the USA). This is quite strange, since it is the countries with the greatest inequality that basically have the greatest need for redistribution over the tax bill. Barth and Moene explain the paradox by saying that increased inequality often leads the middle class to distance itself from low-income groups. They may thus be less willing to pay high taxes to finance a welfare state they themselves have less need for. Here, too, we see the contours of one self-reinforcing effect : Large inequalities can create a political majority for less redistribution, which could increase inequalities further.

7: Inequality between countries

What about the second dimension of global inequality – the evolution of inequality between country? Have the poor countries of the world approached the rich in income? Simple economic logic should indicate a clear “yes” to this question. With globalization, one would expect ideas and technology to spread rapidly from country to country. Poor countries should thus be able to benefit from the progress and technology developed in rich countries. Since it is much easier, and faster, to copy technology than it is to develop new technology yourself, globalization should therefore lead to smaller differences between countries. And many formerly poor countries have clearly benefited from the spread of ideas and technology. Some examples are the so-called Asian tigers (Hong Kong, Singapore, South Korea and Taiwan, according to politicsezine.com) in the 1960s, China from the late 1970s and India somewhat later.

In light of all the focus on these “growth miracles”, and in light of simple economic theory, it is then surprising that the countries of the world as a whole show no signs of approaching each other. At first glance , the differences between countries in average income per capita are not visible at all appears to be smaller – on the contrary. For every sunshine story about countries growing out of poverty, there are two or three others, about countries falling deeper into poverty – often as a result of wars and / or lack of political institutions. While the population of many formerly poor countries has multiplied incomes over the last 50 years, the average incomes in the Central African Republic, the Democratic Republic of Congo, Haiti and Nicaragua (to name a few) were actually lower in 2010 than 50 years earlier. The benefits of new technology and new production methods have definitely not benefited everyone.
On closer inspection, however, we see that a common feature of the countries that have experienced strongly growing living standards is that they are often very populous . For example, the populations of China and India alone make up more than a third of the earth’s population. Because growth in these two very populous countries (especially in China) has been significantly higher than the global average, we can thus still claim that the differences in average income between countries have decreased in recent decades.

Finally: What can we say about developments in global inequality? Has income inequality between individuals, regardless of place of residence, increased or decreased in the last 50 years? On the one hand, we have already seen that income inequality has increased within most western countries , and probably in most other countries . On the other hand, it has sunk between countries – at least if we take into account population size, and allow populous countries to weigh heavier than others.

The two dimensions of inequality thus pull in different directions. How global inequality has developed thus has no obvious answer . In addition, the uncertainty associated with the income figures from a number of countries is too great (uncertain figures from China contribute significantly to this uncertainty). But one thing economists quite agree on: the differences in average income between the countries of the world are greater than the inequality within most countries.

What is Income Inequality