In this essay I will be discussing why income inequality is an inevitable consequence of economic development

February 23, 2019 0 Comment

In this essay I will be discussing why income inequality is an inevitable consequence of economic development. In order to analyse why it is inevitable I will look at specific instances of economic growth in history and look at how the distribution of this new wealth will always spread unevenly throughout society. I shall also be analysing the ninety to ten ratio specifically in regard to income distribution. This essentially highlights why it is impossible for even distribution of income within society to support my argument.
I will also present an analysis of Pareto’s principle in reference to Thomas Pikettys work to highlight the distribution ratio in income inequality to emphasize that income inequality is inevitable and will always follow a certain distribution. I will also refer to the idea of a ‘multiplicative productivity theory’ that essentially underlines the reasoning behind a certain proportion of society having higher earnings than others.
Another idea I intend to discuss is the fact that income inequality is socially engineered and a hierarchy of earnings and attributes will always exist within society as those in power will obtain higher earnings.

I will start this essay by defining income inequality and the basic measuring mechanisms used to quantify it. Inequality is defined in the Cambridge English dictionary as an “unfair situation in society when some people have more opportunities than others”. Inequality has always prevailed through society as wealth is impossible to distribute equally and efficiently.
As society and the human race develops and unfolds itself there is always a certain ‘elite’ group who gain more from the development than others and become wealthier than others. In order to understand the extent of economic resources it is crucial to differentiate between income and wealth. While wealth measures general savings and long term well-being, income is a more accurate measure of financial state as it entails the day-to-day income of society. However, the measurement of income is challenging as a multitude of factors must be taken into account. Whilst the Gini co-efficient is a good measuring mechanism of income inequality it doesn’t take into account important factors such as basic resources and general levels of poverty. As the global economy becomes more integrated and globalisation spreads income inequality is on the rise. According to the Brian Keeley, author of the book OECD, a quarter of a century ago the average disposable income of the richest 10 per cent in OECD countries was roughly seven times higher than that of the poorest ten percent. Income inequality is inevitable and will continue to be due to a multitude of different factors including technological developments and globalisation.

Guillermo Calvo and Stanislaw Wellisz discussed the concept of an existing ladder of “income hierarchy “which allows income distribution to be skewed (The Journal of Political Economy 1979,The University of Chicago Press). The idea behind their writings was that there are always more abled individuals within society who are assigned to higher supervisory levels, and as the optimal inter-level wage differentials are higher than the inherent skills differentials, the income distribution will be more skewed than the distribution of skills and ability. It implies that there is a ‘multiplicative productivity’ effort meanings that if a worker is less efficient it will reflect the workers below him. This allows them to generate the basic reasoning that more productive workers or special skilled workers will be assigned to the higher-level jobs offering higher wage levels.

This study of hierarchic organisations was previously discussed by Simon(1957) and Lydall (1968).They generated assumptions that demonstrated the Pareto wage level but never discussed the issue of internal wages. Calvo and Wellisz combated this issue by highlighting that some individuals prefer to be self-employed and therefore there is no correlation between wage hierarchies being endogenously generated and the empirical observation that high earners are not organisational. Therefore, income inequality can be perceived as an inevitable consequence of efficiency and skill of individuals as those who are on the higher end of the income distribution are more effective and generate economic growth.

Vilfredo Pareto along with Simon Kuznets first reviewed income inequality by observing household surveys. Thomas Piketty later revived this research by taking income account tax data rather than subjective surveys. Piketty’s findings focus on the top income levels than the broader distributional studies that would have been more directed at general measures of inequality like Gini or the Theil entropy index. These only statistics summarised income inequality into one single number. However, Piketty does not focus on the median incomes but focuses on the top one percent of society. To portray how income inequality is inevitable and is a reoccurring cycle in history, Piketty observes growing income inequality using SOI data that estimates the share of income received by top earnings from 1913 through 1998. One of the key empirical factors that connects his data and theory is the Pareto distribution. There is a close connections between the share of income to the top one percent and they key parameter of the Pareto distribution. A key to understanding the facts is the way in which the top percentile of earners take form of this distribution. Piketty’s mathematical growth model assigns r to g which gives arise to a relationship between r-g to and inequality . This relationship is the fundamental factor driving top wealth inequality. Pareto first discussed income heterogeneity in his paper in 1896 in which the power law explains that “the fraction of people with income greater than some cut off is proportional to the cut off raised to some power” (Pareto 1896?).

PrIncome > y=Y to the power of minus 1 divided by N
This distribution can be referred in the Piketty ad Saez (2003) top share numerical results. The fraction of earnings assigned to the top p percentiles equates to (100/p) to the power of n-1. An increase in n leads to a rise of top income shares therefore the parameter is called a measure of Pareto inequality as the share of income going to the top 1 is 10 percent. The same theory applies to wealth distribution. In the case of wealth inequality the exponential growth is dependent on the interest rate ( R) in a normal asset calculation equation. The growth in an individual’s wealth occurs whilst the economy experiences an overall growth which is described at average wealth per person (G). Therefore the standard rate of growth of wealth for an individual is the rate R-G following the Pareto distribution function again. Picketty’s findings demonstrate that income inequality will always follow the Pareto distribution as the endogenous factors make income inequality inevitable. Piketty’s prediction of rising wealth and income inequality have provided the key to understanding the force driving top income inequality.

The ninety to ten income inequality ratio highlights the idea that income will always be unevenly distributed throughout society. Michael Thompson (2012) refers to this by observing income inequality in the United States in a recent period of economic growth between 2001 and 2007,using wage data from the Current Population Survey (USA). Morris and Western had previously documented U.S income inequality between the early 1970s which demonstrated that earnings for those in the 70th percentile or lower had declining earnings while those near the top of the income distribution prospered immensely.

In Figure 1, Thompson puts forward the conclusion that workers at the 10th percentile saw a huge decline in their earnings at roughly $16,500 dollar per annum between the years 2001 and 2007.For this low wage bracket, on average , the states saw a major decline in the 10th percentile income levels which resulted in a drop from $17,100 in real value in 2005 to $16,751 in 2007.

In Figure 2, the upper quartile of the income distribution earnings in the 90th percentile saw improvements in their wage levels. Throughout the period of 2001 to 2007 , these workers earned 82,800 per year and ended in 84,500. The average 90th percentile level increased between this period from 77,900 to 79,700. Despite the described increase in wage for earners at the top 90th percentile across the US, their incomes averaged at five time the amount received by workers at the 10th percentile demonstrating that income inequality is on the rise.

These statistics demonstrate that the benefits accruing to the top ten percent of American society are always in increasing at a faster rate than the lower percentiles, causing a greater differential in wages earner between the upper and lower quartile overtime. This illustrates that income inequality is inevitable and on the rise in America as the higher earners will continue to prosper a result of economic growth and low wage earners will continue to suffer.

Even though there is a general growth in income inequality in this period, Thompson highlights that the states began this period with an average 90 to 10 income inequality ratio of 4.56 which then grew to 4.76. Research conducted by Hasanov and Izraeli revealed that the relationship between income inequality and economic growth should effect all of society equally however this is seen as otherwise from the data shown above. The issue of income inequality has persisted for as long as a free market economy has existed and will continue to do so as an innate talent exists in the work force.

It is worth observing Irish economy too to demonstrate this point. For example the benefits of economic prosperity in the late eighteenth century were not evenly spread throughout Irish society. Landowners were economically dominant in Irish society and as a result those below them, the large rural proletariat compromised of unskilled labourers and farmhands, suffered. Rent levels grew to double the level of exports and was almost the same amount of national income. The proletariat paid “tithes” to the Church of Ireland and the surplus from the rent financed the country. A hierarchical ladder existed as farmers rented land from Landlords who then in return rented land to cottiers. These cottiers would then in return offer their labour to pay for the rent which stopped then from achieving economic independence and prospering. To demonstrate the extent of the oppression that was placed on Cottiers, they did not even receive their own plot of land. The Penal Laws put restrictions on Catholics stopping them from purchasing land, to vote and barred them from political affairs in general.
Another instance of uneven distribution of wealth is Pre-Famine Ireland. According to the 1841 census, 63 per cent of the population had access to less than five acres of land, and were “without land without capital”. A small three percent of society were at the top of the rich elite which included 10,000 proprietors. This made up 0.12 per cent of the population who owned 100 acres of land. Rent accounted for nearly a fifth of National Income of 80 million pounds
The division between religious groups and land ownership stopped the lower quartile of the population from feeling any effects of economic growth while the rich Landowners took advantage of their weakness and prospered. Income inequality is socially engineered and a hierarchy of earnings and attributes will always exist within society as those in power will obtain higher earnings.

Whilst income inequality is inevitable it cannot be denied that it is a problem within society that cannot be terminated but must be controlled by governmental policies to try and stop it from further dividing and destroying society.