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Articles for the ‘Economics 8e: Ch 10’ Category

More and more zeros

In a post last August we looked at the rising number of workers employed on ‘zero-hours’ contracts. These are contracts where there are no guaranteed minimum hours. Such contracts give employers the flexibility to employ workers as much or as little as suits the business. Sometimes it benefits workers, who might be given the flexibility to request the hours that suit them, but usually workers simply have to take the hours on offer.

Latest figures published by the Office for National Statistics show that zero-hours contracts are on the increase. In 2014 quarter 4, 697,000 workers were recorded as being on zero-hours contracts. This represents 2.3% of people in employment. Ten years ago (2004, Q4) the figures were 108,000 or 0.4%: see chart. (Click here for a PowerPoint of the chart.)

Around one third of the 697,000 people on zero-hours contracts wanted more work if they could get it and most wanted it in their current job rather than having to move jobs. These people wanting more work can be classed as underemployed. They also include those not on a zero-hours contract who would like to work more if they could.

According to the ONS:

‘People on zero-hours contracts are more likely to be women, in full-time education or in young or older age groups when compared with other people in employment. On average, someone on a zero-hours contract usually works 25 hours a week.’ (See section 4 of the report for more details.)

As we saw in the earlier post, many public- and private-sector employers use such contracts, including many small and medium-sized enterprises and many well-known large companies, such as Sports Direct, Amazon, JD Wetherspoon and Cineworld. It gives them the flexibility to adjust the hours they employ people. It allows them to keep people in employment when demand is low. It also makes them more willing to take on staff when demand rises, as it removes the fear of being over-staffed if demand then falls back.

As we also saw, zero-hours contracts are not the only form of flexible working. Other examples include: ‘self-employed’ workers, contracted separately for each job they do for a company; people paid largely or wholly on commission; on-call working; part-time working, where the hours are specified in advance, but where these are periodically re-negotiated; overtime; people producing a product or service for a company (perhaps at home), where the company varies the amount paid per unit according to market conditions.

The extent of zero-hours contracts varies dramatically from one sector of the economy to another. Only 0.6% of workers in the Information, Finance and Professional sectors were on zero-hours contracts in 2014 Q4, whereas 10% in the Accommodation and Food sectors were.

The flexibility that such contracts give employers may make them more willing to keep on workers when demand is low – they can reduce workers’ hours rather than laying them off. It also may make them more willing to take on workers (or increase their hours) when demand is expanding, not having to worry about being over staffed later on.

However, many workers on such contracts find it hard to budget when their hours are not guaranteed and can vary significantly from week to week.

Articles
lmost 700,000 people in UK have zero-hours contract as main job The Guardian, Phillip Inman (25/2/15)
UK firms use 1.8m zero-hours contracts, says ONS BBC News (25/1/15)
Zero-hours contracts jump in UK Financial Times, Emily Cadman (25/2/15)
Zero-hours contracts ‘disturbingly’ hit 1.8 million in 2014 International Business Times, Ian Silvera (25/2/15)
Zero-hours contracts a reality for almost 700,000 UK workers, ONS figures show Independent, Antonia Molloy (25/1/15)

Data
Contracts with No Guaranteed Hours, Zero Hour Contracts, 2014 ONS Release (25/1/15)
Supplementary LFS data on zero hours contracts – October to December 2014 ONS dataset (25/2/15)
Analysis of Employee Contracts that do not Guarantee a Minimum Number of Hours ONS Report (25/1/15)

Questions

  1. Distinguish between open unemployment, disguised unemployment and underemployment?
  2. Distinguish between functional, numerical and financial flexibility? Which type or types of flexibility do zero-hours contracts give the firm?
  3. In a ‘flexible’ labour market, what forms can that flexibility take?
  4. Why does the Accommodation and Food sector have a relatively high proportion of people employed on zero-hours contracts?
  5. What are the benefits and costs to employers of using zero-hours contracts?
  6. If a company introduces a system of zero-hours contracts, is this in accordance with the marginal productivity theory of profit maximisation from employment?
  7. What are the benefits and costs to employees of working on zero-hours contracts?
  8. Why has the use of zero-hours contracts risen so rapidly?
  9. Using the ONS data, find out how the use of zero-hours contracts varies by occupation and explain why.
  10. Identify what forms of flexible contracts are used for staff in your university or educational establishment. Do they benefit (a) staff; (b) students?
  11. Consider the arguments for and against (a) banning and (b) regulating zero-hours contracts.
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Keeping it in the family

An article in the February 2015 issue of the Economic Journal, ‘Intergenerational Wealth Mobility in England, 1858–2012: Surnames and Social Mobility’ by Gregory Clark and Neil Cummins, looks at the persistence of wealth within British families across the generations. The article shows, ‘using rare surnames to track families, that wealth is much more persistent than standard one-generation estimates would suggest. There is still a significant correlation between the wealth of families five generations apart’.

It concludes that down the generations the main determinant of wealth is inheritance, despite all efforts to improve social mobility. The intergenerational elasticity of wealth inheritance is found to be 0.70–0.75 throughout the years 1858–2012. In other words, people’s wealth on average will be between 70% and 75% of that of their parents. Thus a large proportion of each person’s wealth depends on the wealth of their parents and a relatively small amount depends on other factors. As Clark and Cummins conclude:

The implications of this model are that wealth will be surprisingly persistent in families across multiple generations. This is what allows rich rare surnames to still remain rich on average even four generations later. It also implies that wealth differences between racial, religious and ethnic groups will also be highly persistent across generations.

So it is just inherited wealth in terms of money or property that gets passed from generation to generation? Or are their other factors, such as education, social class and social contacts, that cause people’s wealth to depend heavily on that of their parents? Clark and Cummins consider this question.

What is the latent variable that underlies the inheritance of wealth? Evidence in other work we have done on the inheritance of education status in England suggests that families can be conceived of as having an underlying social competence, which is highly persistent across generations. This social competence generates their outcomes on all dimensions of social status but with random components on each one. In this case, social mobility between generations measured on any single aspect of status will be much greater than mobility on a more general ranking of families’ overall social status, that averages earnings, wealth, occupation, education, health and longevity.

So does this mean that attempts to create greater social mobility and greater equality are futile? The authors maintain that although it is difficult to achieve greater social mobility, income and wealth can nevertheless be redistributed through the tax and benefits system.

News articles
Inheritance: how Britain’s wealthy still keep it in the family The Observer, Jamie Doward (1/2/15)
How the rich stay rich: social status is more inheritable than height ZME Science (25/11/14)
This is the proof that the 1% have been running the show for 800 years Quartz (23/11/14)

Journal article
Intergenerational Wealth Mobility in England, 1858–2012: Surnames and Social Mobility The Economic Journal, Gregory Clark and Neil Cummins (February 2015) (To read this article you will need to log in via Shibboleth using your university username and password.)

Questions

  1. What would be the implication of an intergenerational wealth elasticity (a) of 1; (b) of 0; (c) >1; (d) <0?
  2. For what reasons might there be a high intergenerational wealth elasticity?
  3. What is the likely relationship between the intergenerational distribution of wealth and the intergenerational distribution of income?
  4. What difficulties are there is using rare surnames as a means of establishing the intergenerational distribution of wealth?
  5. Discuss the advantages and disadvantages of (a) a much higher rate of inheritance tax (in the UK it’s currently 40% on the value of a person’s estate above £325,000 when they die); (b) capping the amount that can be left to any individual from an estate, with anything above this taxed at 100%; (c) capping the total amount that can be left (other than to charity), with the rest taxed at 100%.
  6. What measures could be adopted to increase social mobility?
  7. What problems would arise from using the tax and benefit system to reduce inequality? (In 2012/13 the gini coefficient of original income was 0.52 and that of both gross income (i.e. income after benefits but before tax) and post-tax-and-benefit income in the UK was 0.37: see Table 27 of The Effects of Taxes and Benefits on Household Income, 2012/13.)
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The rich discuss poverty

The World Economic Forum has been holding its annual meeting in the up-market Swiss ski resort of Davos. Many of the world’s richest and most powerful people attend these meetings, including political leaders, business leaders and representatives of various interest groups.

This year, one of the major topics has been the growth in inequality across the globe and how to reverse it. According to a report by Oxfam, Wealth: Having it all and wanting more:

The richest 1 per cent have seen their share of global wealth increase from 44 per cent in 2009 to 48 per cent in 2014 and at this rate will be more than 50 per cent in 2016. Members of this global elite had an average wealth of $2.7m per adult in 2014.

Of the remaining 52 per cent of global wealth, almost all (46 per cent) is owned by the rest of the richest fifth of the world’s population. The other 80 per cent share just 5.5 per cent and had an average wealth of $3851 per adult – that’s 1/700th of the average wealth of the 1 per cent.

Currently, the richest 85 people in the world have the same amount of wealth as the poorest 50% of the world’s population. It might seem odd that those with the wealth are talking about the problem of inequality. Indeed, some of those 85 richest people were at the conference: a conference that boasts extremely luxurious conditions. What is more, many delegates flew into the conference in private jets (at least 850 jets) to discuss not just poverty but also climate change!

Yet if the problem of global inequality is to be tackled, much of the power to do so lies in the hands of these rich and powerful people. They are largely the ones who will have to implement policies that will help to raise living standards of the poor.

But why should they want to? Part of the reason is a genuine concern to address the issues of increasingly divided societies. But part is the growing evidence that greater inequality reduces economic growth by reducing the development of skills of the lower income groups and reducing social mobility. We discussed this topic in the blog, Inequality and economic growth.

So what policies could be adopted to tackle the problem. Oxfam identifies a seven-point plan:

Clamp down on tax dodging by corporations and rich individuals;
Invest in universal, free public services such as health and education;
Share the tax burden fairly, shifting taxation from labour and consumption towards capital and wealth;
Introduce minimum wages and move towards a living wage for all workers;
Ensure adequate safety-nets for the poorest, including a minimum income guarantee;
Introduce equal pay legislation and promote economic policies to give women a fair deal;
Agree a global goal to tackle inequality.

But how realistic are these policies? Is it really in the interests of governments to reduce inequality? Indeed, some of the policies that have been adopted since 2008, such as bailing out the banks and quantitative easing, have had the effect of worsening inequality. QE drives up asset prices, particularly bond, share and property prices. This has provided a windfall to the rich: the more of such assets you own, the greater the absolute gain.

The following videos and articles look at the problem of growing inequality and how realistic it is to expect leaders to do anything significant about it.

Videos and podcasts
Income inequality is ‘brake on growth’, Oxfam chief warns Davos France 24, Winnie Byanyima (22/1/15)
Davos dilemma: Can the 1% cure income inequality? Yahoo Finance, Lizzie O’Leary and Shawna Ohm (21/1/15)
Richest 1% ‘Will Own Half The World’s Wealth By 2016′ ITN on YouTube, Sarah Kerr (19/1/15)
The Price of Inequality BBC Radio 4, Robert Peston (3/2/15 and 10/2/15)

Articles
Richest 1% will own more than all the rest by 2016 Oxfam blogs, Jon Slater (19/1/15)
Global tax system can cut inequality The Scotsman, Jamie Livingstone (23/1/15)
A new framework for a new age Financial Times, Tony Elumelu (23/1/15)
The global elite in Davos must give the world a pay rise New Statesman, Frances O’Grady (22/1/15)
New Oxfam report says half of global wealth held by the 1% The Guardian, Larry Elliott and Ed Pilkington (19/1/15)
Davos is starting to get it – inequality is the root cause of stagnation The Guardian, Larry Elliott (25/1/15)
Inequality isn’t inevitable, it’s engineered. That’s how the 1% have taken over The Guardian, Suzanne Moore (19/1/15)
Why extreme inequality hurts the rich BBC News, Robert Peston (19/1/15)
Eurozone stimulus ‘reinforces inequality’, warns Soros BBC News, Joe Miller (22/1/15)
Hot topic for the 1 percent at Davos: Inequality CNBC, Lawrence Delevingne (21/1/15)
Global inequality: The wrong yardstick The Economist (24/1/15)
A Richer World (a compendium of articles) BBC News (27/1/15)

Data
OECD Income Distribution Database: Gini, poverty, income, Methods and Concepts OECD
The effects of taxes and benefits on household income ONS

Questions

  1. Why has inequality increased in most countries in recent years?
  2. For what reasons might it be difficult to measure the distribution of wealth?
  3. Which gives a better indication of differences in living standards: the distribution of wealth or the distribution of income?
  4. Discuss the benefits and costs of using the tax system to redistribute (a) income and (b) wealth from rich to poor
  5. Go through each of the seven policies advocated by Oxfam and consider how practical they are and what possible objections to them might be raised by political leaders.
  6. Why is tax avoidance/tax evasion by multinational companies difficult to tackle?
  7. Does universal access to education provide the key to reducing income inequality within and between countries?
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Inequality and economic growth

What is the relationship between the degree of inequality in a country and the rate of economic growth? The traditional answer is that there is a trade off between the two. Increasing the rewards to those who are more productive or who invest encourages a growth in productivity and capital investment, which, in turn, leads to faster economic growth. Redistribution from the rich to the poor, by contrast, is argued to reduce incentives by reducing the rewards from harder work, education, training and investment. Risk taking, it is claimed, is discouraged.

Recent evidence from the OECD and the IMF, however, suggests that when income inequality rises, economic growth falls. Inequality has grown massively in many countries, with average incomes at the top of the distribution seeing particular gains, while many at the bottom have experienced actual declines in real incomes or, at best, little or no growth. This growth in inequality can be seen in a rise in countries’ Gini coefficients. The OECD average Gini coefficient rose from 0.29 in the mid-1980s to 0.32 in 2011/12. This, claims the OECD, has led to a loss in economic growth of around 0.35 percentage points per year.

But why should a rise in inequality lead to lower economic growth? According to the OECD, the main reason is that inequality reduces the development of skills of the lower income groups and reduces social mobility.

By hindering human capital accumulation, income inequality undermines education opportunities for disadvantaged individuals, lowering social mobility and hampering skills development.

The lower educational attainment applies both to the length and quality of education: people from poorer backgrounds on average leave school or college earlier and with lower qualifications.

But if greater inequality generally results in lower economic growth, will a redistribution from rich to poor necessarily result in faster economic growth? According to the OECD:

Anti-poverty programmes will not be enough. Not only cash transfers but also increasing access to public services, such as high-quality education, training and healthcare, constitute long-term social investment to create greater equality of opportunities in the long run.

Thus redistribution policies need to be well designed and implemented and focus on raising incomes of the poor through increased opportunities to increase their productivity. Simple transfers from rich to poor via the tax and benefits system may, in fact, undermine economic growth. According to the IMF:

That equality seems to drive higher and more sustainable growth does not in itself support efforts to redistribute. In particular, inequality may impede growth at least in part because it calls forth efforts to redistribute that themselves undercut growth. In such a situation, even if inequality is bad for growth, taxes and transfers may be precisely the wrong remedy.

Articles
Inequality ‘significantly’ curbs economic growth – OECD BBC News (9/12/14)
Is inequality the enemy of growth? BBC News, Robert Peston (6/10/14)
Income inequality damages growth, OECD warns Financial Times, Chris Giles (8/10/14)
OECD finds increasing inequality lowers growth Deutsche Welle, Jasper Sky (10/12/14)
Revealed: how the wealth gap holds back economic growth The Guardian, Larry Elliott (9/12/14)
Inequality Seriously Damages Growth, IMF Seminar Hears IMF Survey Magazine (12/4/14)
Warning! Inequality May Be Hazardous to Your Growth iMFdirect, Andrew G. Berg and Jonathan D. Ostry (8/4/11)

Videos
Record inequality between rich and poor OECD on YouTube (5/12/11)
The Price of Inequality The News School on YouTube, Joseph Stiglitz (5/10/12)

Reports and papers
FOCUS on Inequality and Growth OECD, Directorate for Employment, Labour and Social Affairs (December 2014)
Trends in Income Inequality and its Impact on Economic Growth OECD Social, Employment and Migration Working Papers, Federico Cingano (9/12/14)
An Overview of Growing Income Inequalities in OECD Countries: Main Findings OCED (2011)
Redistribution, Inequality, and Growth IMF Staff Discussion Note, Jonathan D. Ostry, Andrew Berg, and Charalambos G. Tsangarides (February 2014)
Measure to Measure Finance and Development, IMF, Jonathan D. Ostry and Andrew G. Berg (Vol. 51, No. 3, September 2014)

Data
OECD Income Distribution Database: Gini, poverty, income, Methods and Concepts OECD
The effects of taxes and benefits on household income ONS

Questions

  1. Explain what are meant by a Lorenz curve and a Gini coefficient? What is the relationship between the two?
  2. The Gini coefficient is one way of measuring inequality. What other methods are there? How suitable are they?
  3. Assume that the government raises taxes to finance higher benefits to the poor. Identify the income and substitution effects of the tax increases and whether the effects are to encourage or discourage work (or investment).
  4. Distinguish between (a) progressive, (b) regressive and (c) proportional taxes?
  5. How will the balance of income and substitution effects vary in each of the following cases: (a) a cut in the tax-free allowance; (b) a rise in the basic rate of income tax; (c) a rise in the top rate of income tax? How does the relative size of the two effects depend, in each case, on a person’s current income?
  6. Identify policy measures that would increase both equality and economic growth.
  7. Would a shift from direct to indirect taxes tend to increase or decrease inequality? Explain.
  8. By examining Tables 3, 26 and 27 in The Effects of Taxes and Benefits on Household Income, 2012/13, (a) explain the difference between original income, gross income, disposable income and post-tax income; (b) explain the differences between the Gini coefficients for each of these four categories of income in the UK.
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UK spending on welfare: definitions, myths and facts

How much does the UK spend on welfare? This is a highly charged political question, with some arguing that benefit claimants are putting great demands on ‘hard-working tax payers’. According to information being sent by the government to all 24 million income tax payers in the UK, the figure of £168bn being spent on welfare is around 24.5% of public spending. But what is included in the total? Before you read on, try writing down the categories of government expenditure included under the heading ‘welfare’.

The heading does not include spending on certain parts of the ‘welfare state’, such as health and education. These are services, the production of which contributes to GDP. The category ‘welfare’ does not include expenditure on produced services, but rather transfer payments. The way the government is using the term, it does not include state pensions either, which account for 11.6% of public expenditure. So does the 24.5% largely consist of payments to the unemployed? The answer is no.

The category ‘welfare’ as used by the government includes the following elements. The percentages are of total managed expenditure (i.e. government spending).

Public service pensions, paid to retired public-sector employees, such as teachers, police officers, doctors and nurses (2.6%)
Other support for the elderly, including pension credit, winter fuel allowance, bus passes, etc. (1.5%)
Sickness and disability benefits, including long-term care for the elderly, sick and disabled (6.6%)
Support for families and children, such as child benefit and child tax credits (3.4%)
Social exclusion, including income support and housing benefit (7.8%)
Unemployment benefits, including Job Seekers Allowance (0.7%)
Other (1.9%)

Lumping all these together under a single heading ‘welfare’ can be highly misleading, as many people have strongly held preconceptions about who gets welfare. In fact the term is used pejoratively by many who resent their taxes being given to those who do not work.

But, as you can see from the figures, only a small proportion goes to the unemployed, the majority of whom (around 65%) are unemployed for less than a year as they move between jobs (see). The bulk of benefits goes to children, the retired and the working poor.

Another preconception is that much of welfare spending goes to fraudulent claimants. But, as the article by Professor Hills states:

Just 0.7% of all benefits was over-paid as the result of fraud, less than the amount underpaid as a result of official error. For the main benefit for unemployed people, Jobseeker’s Allowance, estimated fraud was 2.9%, or an annual total of £150million.

It is also important to consider people’s life cycle. The same people receive benefits (via their parents or guardians) as children, pay taxes when they work and receive benefits when they retire or fall sick. Thus you might be a net contributor to public finances at one time and a net beneficiary at another. For example, the majority of pensioners were net contributors when they were younger and are now mainly net beneficiaries. Many unemployed people who rely on benefits now were net contributors when they had a job.

The message is that you should be careful when interpreting statistics, even if these statistics are factually accurate. How figures are grouped together and the labels put on them can give a totally misleading impression. And politicians are always keen to ‘spin’ statistics to their advantage – whether in government or opposition.

Webcast
Annual Tax Summary: TUC and MPs on spending information BBC Daily Politics, Jo Coburn (3/11/14)

Articles
Osborne’s tax summary dismissed as propaganda by the TU BBC News (3/11/14)
The truth about welfare spending: Facts or propaganda? BBC News, Brian Milligan (4/11/14)
Its Cost Is Just One of the Myths Around ‘Welfare’ Huffington Post, John Hills (12/11/14)
Welfare spending summary criticised Express & Star (4/11/14)

Data and Reports
Public Expenditure: Statistical Analyses (PESA) 2014 HM Treasury (see Table 5.2)
DWP annual report and accounts 2013 to 2014 Department of Work and Pensions (see Table 2)
Welfare trends report – October 2014 Office for Budget Responsibility
What is welfare spending? Institute for Fiscal Studies (4/11/14)

Questions

  1. What benefits do you receive? How would you expect this to change over your lifetime?
  2. What are the arguments for (a) reducing and (b) increasing welfare payments. In each case, under which categories of welfare would you decrease or increase the level of benefits?
  3. Referring to Table 5.2 in the PESA data below (the table used for the government’s calculations), which of the categories would be classified as expenditure on goods and services and which as transfer payments?
  4. Assess the arguments of the IFS for the reclassification of the categories of ‘welfare’ payments.
  5. Referring to the pie chart above, also in the BBC video and articles and Table 5.2 in the PESA data, assess the arguments about the size of the UK’s contributions to the EU budget.
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Even more dwarfs and fewer but larger giants

In his 1971 book, Income Distribution, Jan Pen, a Dutch economist, gave a graphic illustration of inequality in the UK. He described a parade of people marching by. They represent the whole population and the parade takes exactly one hour to pass by. The height of each person represents his or her income. People of average height are the people with average incomes – the observer is of average height. The parade starts with the people on the lowest incomes (the dwarfs), and finishes with those on the highest incomes (the giants).

Because income distribution is unequal, there are many tiny people. Indeed, for the first few minutes of the parade, the marchers are so small they can barely be seen. Even after half an hour, when people on median income pass by, they are barely waist high to the observer.

The height is growing with tantalising slowness, and forty-five minutes have gone by before we see people of our own size arriving. To be somewhat more exact: about twelve minutes before the end the average income recipients pass by.

In the final minutes, giants march past and then in the final seconds:

the scene is dominated by colossal figures: people like tower flats. Most of them prove to be businessmen, managers of large firms and holders of many directorships and also film stars and a few members of the Royal Family.

The rear of the parade is brought up by a few participants who are measured in miles. Indeed they are figures whose height we cannot even estimate: their heads disappear into the clouds and probably they themselves do not even know how tall they are.

Pen’s description could be applied to most countries – some with even more dwarfs and even fewer but taller giants. Generally, over the 43 years since the book was published, countries have become less equal: the giants have become taller and the dwarfs have become smaller.

The 2011 Economist article, linked below, uses changes in Gini coefficients to illustrate the rise in income inequality. A Gini coefficient shows the area between the Lorenz curve and the 45° line. The figure will be between 0 and 1 (or 0% and 100%). a figure of 0 shows total equality; a figure of 1 shows a situation of total inequality, where one person earns all the nation’s income. The higher the figure, the greater the inequality.

The chart opposite shows changes in the Gini coefficient in the UK (see Table 27 in the ONS link below for an Excel file of the chart). As this chart and the blog post Rich and poor in the UK show, inequality rose rapidly during the years of the 1979–91 Thatcher government, and especially in the years 1982–90. This was associated with cuts in the top rate of income tax and business deregulation. It fell in the recession of the early 1990s as the rich were affected more than the poor, but rose with the recovery of the mid- to late 1990s. It fell again in the early 2000s as tax credits helped the poor. It fell again following the financial crisis as, once more, the rich were affected proportionately more than the poor.

The most up-to-date international data for OECD countries can be found on the OECD’s StatExtracts site (see chart opposite: click here for a PowerPoint). The most unequal developed county is the USA, with a Gini coefficient of 0.389 in 2012 (see The end of the American dream?), and US inequality is rising. Today, the top 1% of the US population earns some 24% of national income. This compares with just 9% of national income in 1976.

Many developing countries are even less equal. Turkey has a Gini coefficient of 0.412 and Mexico of 0.482. The figure for South Africa is over 0.6.

When it comes to wealth, distribution is even less equal. The infographic, linked below, illustrates the position today in the USA. It divides the country into 100 equal-sized groups and shows that the top 1% of the population has over 40% of the nation’s wealth, whereas the bottom 80% has only 7%.

So is this inequality of income and wealth desirable? Differences in wages and salaries provide an incentive for people to work harder or more effectively and to gain better qualifications. The possibility of increased wealth provides an incentive for people to invest.

But are the extreme differences in wealth and income found in many countries today necessary to incentivise people to work, train and invest? Could sufficient incentives exist in more equal societies? Are inequalities in part, or even largely, the result of market imperfections and especially of economic power, where those with power and influence are able to use it to increase their own incomes and wealth?

Could it even be the case that excessive inequality actually reduces growth? Are the huge giants that exist today accumulating too much financial wealth and creating too little productive potential? Are they spending too little and thus dampening aggregate demand? These arguments are considered in some of the articles below. Perhaps, by paying a living wage to the ‘tiny’ people on low incomes, productivity could be improved and demand could be stimulated.

Infographic
Wealth Inequality in America YouTube, Politizane (20/11/12)

Articles
The rise and rise of the cognitive elite The Economist (20/1/11)
Inequality in America: Gini in the bottle The Economist (26/11/13)
Pen’s Parade: do you realize we’re mostly dwarves? LVTFan’s Blog (21/2/11)
Here Are The Most Unequal Countries In The World Business Insider, Andy Kiersz (8/11/14)
Inequality in the World Dollars & Sense, Arthur MacEwan (Nov/Dec 14)
Britain is scared to face the real issue – it’s all about inequality The Observer, Will Hutton (19/1/14)
The tame inequality debate FundWeb, Daniel Ben-Ami (Nov 14)
Is inequality the enemy of growth? BBC News, Robert Peston (6/10/14)

Data
GINI index World Bank data
List of countries by income equality Wikipedia
The Effects of Taxes and Benefits on Household Income, 2012/13 ONS (see table 27)
Income Distribution and Poverty: Gini (disposale income) OECD StatExtract

Questions

  1. Distinguish between income and wealth. Is each one a stock or a flow?
  2. Explain how (a) a Lorenz curve and (b) a Gini coefficient are derived.
  3. What other means are there of measuring inequality of income and wealth other than using Gini coefficients (and giants and dwarfs!)?
  4. Why has inequality been rising in many countries over the years?
  5. How do (a) periods of rapid economic growth and (b) recessions affect income distribution?
  6. Define ‘efficiency wages’. How might an increase in wages to people on low incomes result in increased productivity?
  7. What is the relationship between the degree of inequality and household debt? What implications might this have for long-term economic growth and future financial crises? Is inequality the ‘enemy of growth’?
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The UK’s Mansion Tax under Labour

The housing market and what to do about bubbles, second homes and first time buyers is likely to be one of many battle grounds at the next election. For many years, the idea of a mansion tax has been debated and the Shadow Chancellor, Ed Balls, has outlined plans for a mansion tax under a Labour government.

The policy would see houses valued at between £2 and £3 million pay £250 a month as a mansion tax. Those owning a home worth tens of millions and those with second homes would pay more under the mansion tax, which would be based on a progressive system. Concerns have been raised about the impact of this tax on home-owners in areas like London, where average house prices are considerably higher than the UK average. Ed Balls has sought to reassure homeowners that payment of the mansion tax could be deferred if earnings do not reach the £42,000 threshold. However, critics have suggested that this policy will only make things worse for middle income households who will not be able to defer such a payment if their income is £43,000. Labour’s MP for Greenwich, Nick Raynsford said, ‘What it does is create a cliff edge. It will still hit people who are asset rich but cash poor.” Writing in the Evening Standard, Ed Balls said:

“Long-standing residents who now find themselves living in high-value homes but do not have an income high enough to pay the higher or top rate of income tax — in other words earn less than £42,000 a year — will be guaranteed the right to defer the charge until the property changes hands.

So a tax on the highest value properties will be done fairly and carefully to help fund our NHS for the future.

Ordinary Londoners should be protected and wealthy foreign investors must finally make a proper tax contribution in this country.”

Although similar in its objective to the Liberal Democrat’s mansion tax, the amount of the tax as a percentage of the value of the home under Labour is significantly lower. It is likely to be between 0.1% and 0.15% of the home’s valued, compared to the 1% levy proposed by the Liberal Democrats.

One debate now surrounds the amount that this tax is expected to raise, especially given the revenue has been ear-marked to finance the NHS. The number of homes whose value is estimated to fall between £2m and £3m varies considerably and hence so would the revenues raised from such a tax. However, the income generated by even the most generous estimates will not come close to raising the ear-marked figure of £1.2bn. As such, there are suggestions that the tax levied on houses worth more than £3m; on foreign owners of residences in the UK and second homes will need to be significant to make up the short fall. A spokesperson for the Conservatives said:

“Serious questions have now been raised about how much revenue Labour would be able to raise from the tax …This is a further unravelling of the policy, which faced fierce criticism after it was revealed that no money would be raised until halfway through the next parliament, and the proposals for mass valuations of family homes was widely slammed as unworkable.”

The UK residential research director of Savills estate agency, Lucian Cook, added:

“Given Labour’s stated ambition to raise £1.2bn, that would leave at least £1.08bn to be raised from the remaining 57,000 properties, possibly more to account for tax leakage elsewhere in the system.”

The impact of the mansion tax will depend on exactly how it is imposed and the thresholds, together with how the threshold changes with the housing market. In the UK, we have seen some houses increase in value by huge amounts in just a few months and with a mansion tax, any such increase in price could move more home-owners into the new progressive tax system. Some argue that it is a tax on Londoners. The following articles consider the proposed policy by Labour.

Ed Balls seeks to reassure London home owners over mansion tax plans The Guardian, Patrick Wintour (20/10/14)
Ed Balls: Mansion tax would start at £250 a month BBC News (20/10/14)
‘Mansion tax’ will mean bill of £250 a month, says Ed Balls Financial Times, Emily Cadman, Kate Allen, Vanessa Houlder and George Parker (20/10/14)
Mansion tax can be deferred in you earn less than £42,000, Ed Balls insists as he reveals details of levy on £2million homes Mail Online, Matt Chorley (20/10/14)
Ed Balls: Mansion tax will cost homeowners £250 a month London Evening Standard (20/10/14)
Middle-class families hit by Labour’s mansion tax The Telegraph, Steven Swinford (20/10/14)
Balls says mansion-tax threshold to rise with home values Bloomberg, Svenja O’Donnell (20/10/14)

Questions

  1. How does a progressive tax system work?/li>
  2. Why are some critics arguing that this mansion tax would just be a tax on Londoners?
  3. What objective is the £42,000 income threshold trying to achieve? Do you think that critics are correct in their assertion that it penalises middle income households?
  4. Fiscal drag is mentioned in the BBC News article as a potential problem with the mansion tax proposed by Labour and that houses may move into the taxable threshold. What is fiscal drag and why is it a potential concern?
  5. How might such a policy affect the incentives of foreigners to invest in the UK housing market? Would this be a good or a bad thing and for who?
  6. The revenues generated from houses between £2 and £3m will not be sufficient to generate £1.2bn. What are the implications for how progressive the mansion tax would need to be and how this might affect homeowners?
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Big Mac wages

At least once a year The Economist publishes its ‘hamburger standard’ exchange rates for currencies. It is a light-hearted attempt to see if currencies are exchanging at their purchasing-power parity rates. The test is the price at which a ‘Big Mac’ McDonald’s hamburger sells in different countries!

According to this simplified version of the purchasing-power parity theory, exchange rates should adjust so that a Big Mac costs the same in dollars everywhere (see Economics 8th edition Box 25.4).

These Big Mac exchange rates can be used to compare various prices and incomes between countries. The article linked below from The Guardian compares minimum wages between European countries in Big Mac terms.

There are 25 countries across Europe which have minimum wages. A clear pattern of minimum wage rates can be seen: although actual exchange rates understate the purchasing power of incomes in poorer European countries compared to richer ones, minimum wages, even in purchasing-power standard terms, are still higher in the richer countries.

Luxembourg’s minimum wage buys you just about three Big Macs in an hour, while most of northern Europe (and France) between 2–2.5 Big Macs. Moving south, the minimum wage nets about one Big Mac an hour. As we progress east, it begins to cost more than an hour of work on the minimum wage in order to afford a Big Mac.

Of course, there are other factors determining the dollar price of a Big Mac other than the failure of exchange rates to reflect purchasing-power parities. Nevertheless, using the Big Mac index in this way does give a useful preliminary snap shot of differences in what minimum wages can buy in different countries.

Articles
Comparing the minimum wage across Europe using the price of a Big Mac The Guardian datablog, Alberto Nardelli (25/9/14)
Minimum wage statistics Eurostat (Sept/14)

Data
Earnings Database Eurostat

Questions

  1. What is meant by ‘purchasing-power parity exchange rates’?
  2. Why may actual exchange rates not accurately reflect the purchasing power of currencies within countries?
  3. Using the link to Eurostat article above, compare Big Mac minimum wages with (a) actual minimum wages and (b) minimum wages expressed in purchasing-power standard terms.
  4. Using the links to the Eurostat article and Eurostat data, describe how the proportion of employees earning minimum wages varies across European countries. What factors determine this proportion?
  5. Using the same links, describe how the monthly minimum wage as a proportion of average monthly earnings varies across European countries. Explain these differences.
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A growing debt burden

The linked article below from The Guardian paints a disturbing picture of the long-term problem of servicing both private-sector and public-sector debts.

With interest rates at historical lows, the problem has been masked for the time being. But with interest rates set to rise within a few months, and significantly over the coming years, the burden of debt servicing is likely to become severe. This could have profound effects both on long-term economic growth and on the distribution of income.

As the author, Phillip Inman states:

The funding gap is growing and with deficits on so many fronts, it is hard to see how promises to pensioners and health service users can be met without a dash for growth that is unsustainable, a switch to dramatic cost-cutting in other areas or higher taxes on those who came through the recession relatively unscathed.

You are probably facing the problem of growing debt yourself. How long, if ever, will it take you to repay your student loans? What impact will this have on your ability to spend and to have a ‘decent’ standard of living? Will you be able to afford a mortgage large enough to buy a reasonable house or flat? Will you be able to afford to do a masters degree or PhD without support from your parents or relatives or without a scholarship? And even if you manage to secure a well-paid job, will you be able to afford a reasonable pension for when you eventually retire?

The article looks at the nature of the problem and its causes. It concludes by saying:

Britain has become expert at putting off decisions and hoping for something to turn up. Without a return to ultra-cheap commodities, another technological/productivity revolution, or a return to more modest living and delayed gratification, it’s a plan that is running out of time.

Article
Trouble in store: the grave future of British public and private debt The Guardian, Phillip Inman (20/7/14)

Report
Fiscal sustainability report Office for Budget Responsibility (10/7/14)
Fiscal sustainability report – Executive summary Office for Budget Responsibility (10/7/14)
Fiscal sustainability report – Supplementary data series Office for Budget Responsibility (10/7/14)

Questions

  1. Why is public-sector debt likely to continue rising significantly over the coming years unless there is a concerted policy to make cuts in public expenditure?
  2. What factors are likely to lead to a rise in private-sector debt over the coming years?
  3. What factors have caused a redistribution from the younger to the older generation?
  4. How have ultra low interest rates affected the distribution of income?
  5. What is likely to happen to the gap in wages between ‘graduate’ jobs and ‘non-graduate’ jobs? Identify the factors likely to influence this gap?
  6. What is meant by ‘hire purchase’? Are leasing schemes for car purchase a form of ‘hire purchase? Are there similar schemes in the housing market?
  7. Does it matter if a country’s debts rise (either public or private) if the creditors are in the same country? Explain.
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Rich and poor in the UK

The ONS has just released its annual publication, The Effects of Taxes and Benefits on Household Income. The report gives data for the financial year 2012/13 and historical data from 1977 to 2012/13.

The publication looks at the distribution of income both before and after taxes and benefits. It divides the population into five and ten equal-sized groups by household income (quintiles and deciles) and shows the distribution of income between these groups. It also looks at distribution within specific categories of the population, such as non-retired and retired households and different types of household composition.

The data show that the richest fifth of households had an average pre-tax-and-benefit income of £81,284 in 2012/13, 14.7 times greater than average of £5536 for the poorest fifth. The richest tenth had an average pre-tax-and-benefit income of £104,940, 27.1 times greater than the average of £3875 for the poorest tenth.

After the receipt of cash benefits, these gaps narrow to 6.6 and 11.0 times respectively. When the effect of direct taxes are included (giving ‘disposable income’), the gaps narrow further to 5.6 and 9.3 times respectively. However, when indirect taxes are also included, the gaps widen again to 6.9 and 13.6 times.

This shows that although direct taxes are progressive between bottom and top quintiles and deciles, indirect taxes are so regressive that the overall effect of taxes is regressive. In fact, the richest fifth paid 35.1% of their income in tax, whereas the poorest fifth paid 37.4%.

Taking the period from 1977 to 2012/13, inequality of disposable income (i.e. income after direct taxes and cash benefits) increased from 1977 to 1988, especially during the second two Thatcher governments (1983 to 1990) (see chart opposite). But then in the first part of the 1990s inequality fell, only to rise again in the late 1990s and early 2000s. However, with the Labour government giving greater cash benefits for the poor, inequality reduced once more, only to widen again in the boom running up to the banking crisis of 2007/8. But then, with recession taking hold, the incomes of many top earners fell and automatic stabilisers helped protect the incomes of the poor. Inequality consequently fell. But with the capping of benefit increases and a rise in incomes of many top earners as the economy recovers, so inequality is beginning to rise once more – in 2012/13, the Gini coefficient rose to 0.332 from 0.323 the previous year.

As far as income after cash benefits and both direct and indirect taxes is concerned, the average income of the richest quintile relative to that of the poorest quintile rose from 7.2 in 2002/3 to 7.6 in 2007/8 and then fell to 6.9 in 2012/13.

Other headlines in the report include:

Since the start of the economic downturn in 2007/08, the average disposable income has decreased for the richest fifth of households but increased for the poorest fifth.

Cash benefits made up over half (56.4%) of the gross income of the poorest fifth of households, compared with 3.2% of the richest fifth, in 2012/13.

The average disposable income in 2012/13 was unchanged from 2011/12, but it remains lower than at the start of the economic downturn, with equivalised disposable income falling by £1200 since 2007/08 in real terms. The fall in income has been largest for the richest fifth of households (5.2%). In contrast, after accounting for inflation and household composition, the average income for the poorest fifth has grown over this period (3.5%).

This is clearly a mixed picture in terms of whether the UK is becoming more or less equal. Politicians will, no doubt, ‘cherry pick’ the data that suit their political position. In general, the government will present a good news story and the opposition a bad news one. As economists, it is hoped that you can take a dispassionate look at the data and attempt to relate the figures to policies and events.

Report
The Effects of Taxes and Benefits on Household Income, 2012/13 ONS (26/6/14)

Data
Reference tables in The Effects of Taxes and Benefits on Household Income, 2012/13 ONS (26/6/14)
The Effects of Taxes and Benefits on Household Income, Historical Data, 1977-2012/13 ONS (26/6/14)
Rates of Income Tax: 1990-91 to 2014-15 HMRC

Articles
Inequality is on the up again – Osborne’s boast is over New Statesman, George Eaton (26/6/14)
Disposable incomes rise for richest fifth households only Money.com, Lucinda Beeman (26/6/14)
Half of families receive more from the state than they pay in taxes but income equality widens as rich get richer Mail Online, Matt Chorley (26/6/14)
Rich getting richer as everyone else is getting poorer, Government’s own figures reveal Mirror, Mark Ellis (26/6/14)
The Richest Households Got Richer Last Year, While Everyone Else Got Poorer The Economic Voice (27/6/14)

Questions

  1. Define the following terms: original income, gross income, disposable income, post-tax income, final income.
  2. How does the receipt of benefits in kind vary across the quintile groups? Explain.
  3. What are meant by the Lorenz curve and the Gini coefficient and how is the Gini coefficient measured? Is it a good way of measuring inequality?
  4. Paint a picture of how income distribution has changed over the past 35 years.
  5. Can changes in tax be a means of helping the poorest in society?
  6. What types of income tax cuts are progressive and what are regressive?
  7. Why are taxes in the UK regressive?
  8. Why has the fall in income been largest for the richest fifth of households since 2007/8? Does this mean that, as the economy recovers, the richest fifth of households are likely to experience the fastest increase in disposable incomes?
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