Tag: income distribution

The Economist is probably not the kind of newspaper that you will read more than once per issue – certainly not two years after its publication date. That is because, by definition, financial news articles are ephemeral: they have greater value, the more recent they are – especially in the modern financial world, where change can be strikingly fast. To my surprise, however, I found myself reading again an article on inequality that I had first read two years ago – and it is (of course) still relevant today.

The title of the article was ‘You may be higher in the global wealth pyramid than you think’ and it discusses exactly that: how much wealth does it take for someone to be considered ‘rich’? The answer to this question is of course, ‘it depends’. And it does depend on which group you compare yourself against. Although this may feel obvious, some of the statistics that are presented in this article may surprise you.

According to the article

If you had $2200 to your name (adding together your bank deposits, financial investments and property holdings, and subtracting your debts) you might not think yourself terribly fortunate. But you would be wealthier than half the world’s population, according to this year’s Global Wealth Report by the Crédit Suisse Research Institute. If you had $71 560 or more, you would be in the top tenth. If you were lucky enough to own over $744 400 you could count yourself a member of the global 1% that voters everywhere are rebelling against.

For many (including yours truly) these numbers may come as a surprise when you first see them. $2200 in today’s exchange rate is about £1640. And this is wealth, not income – including all earthly possessions (net of debt). £1640 of wealth is enough to put you ahead of half of the planet’s population. Have a $774 400 (£556 174 – about the average price of a two-bedroom flat in London) and – congratulations! You are part of the global richest 1% everyone is complaining about…

Such comparisons are certainly thought provoking. They show how unevenly wealth is distributed across countries. They also show that countries which are more open to trade are more likely to have benefited the most from it. Take a closer look at the statistics and you will realise that you are more likely to be rich (compared to the global average) if you live in one of these countries.

Of course, wealth inequality does not happen only across countries – it happens also within countries. You can own a two-bedroom flat in London (and be, therefore, part of the 1% global elite), but having to live on a very modest budget because your income (which is a flow variable, as opposed to wealth, which is a stock variable) has not grown fast enough in relation to other parts of the national population.

Would you be better off if there were less trade? Certainly not – you would probably be even poorer, as trade theories (and most of the empirical evidence I am aware of) assert. Why do we then talk so much about trade wars and trade restrictions recently? Why do we elect politicians who advocate such restrictions? It is probably easier to answer these questions using political than economic theory (although game theory may have some interesting insights to offer – have you heard of the ‘Chicken game‘?). But as I am neither political scientists nor a game theorist, I will just continue to wonder about it.

Articles and information

Questions

  1. Were you surprised by the statistics mentioned in this report? Explain why.
  2. Do you think that income inequality is a natural consequence of economic growth? Are there pro-growth policies that can be used to tackle it?
  3. Identify three ways in which widening income inequality can hurt economies (and societies).

In the last blog post, As UK inflation rises, so real wages begin to fall, we showed how the rise in inflation following the Brexit vote is causing real wages in the UK to fall once more, after a few months of modest rises, which were largely due to very low price inflation. But how does this compare with other OECD countries?

In an article by Rui Costa and Stephen Machin from the LSE, the authors show how, from the start of the financial crisis in 2007 to 2015 (the latest year for which figures are available), real hourly wages fell further in the UK than in all the other 27 OECD countries, except Greece (see the chart below, which is Figure 5 from their article). Indeed, only in Greece, the UK and Portugal were real wages lower in 2015 than in 2007.

The authors examine a number of aspects of real wages in the UK, including the rise in self employment, differences by age and sex, and for different percentiles in the income distribution. They also look at how family incomes have suffered less than real wages, thanks to the tax and benefit system.

The authors also look at what the different political parties have been saying about the issues during their election campaigns and what they plan to do to address the problem of falling, or only slowly rising, real wages.

Articles

Real Wages and Living Standards in the UK LSE – Centre for Economic Performance, Rui Costa and Stephen Machin (May 2017)
The Return of Falling Real Wages LSE – Centre for Economic Performance, David Blanchflower, Rui Costa and Stephen Machin (May 2017)
The chart that shows UK workers have had the worst wage performance in the OECD except Greece Independent, Ben Chu (5/6/17)

Data

Earnings and working hours ONS
OECD.Stat OECD
International comparisons of productivity ONS

Questions

  1. Why have real wages fallen more in the UK than in all OECD countries except Greece?
  2. Which groups have seen the biggest fall in real wages? Explain why.
  3. What policies are proposed by the different parties for raising real wages (a) generally; (b) for the poorest workers?
  4. How has UK productivity growth compared with that in other developed countries? What explanations can you offer?
  5. What is the relationship between productivity growth and the growth in real wages?

GDP is often used as a measure of wellbeing, even though it is really only a measure of the market value of a nation’s output or an indicator of economic activity. But although higher consumption can improve living standards, it is only one contributor to wellbeing, whether at individual or social level.

There are essentially four types of problems from using GDP as a measure of how society is doing.

The first is that it does not include (as negative figures) many external costs, such as pollution, stress and family breakdown related to work.

The second is that it includes things that are produced to counteract the adverse effects of increased production, such as security, antidepressants, therapy and clean-up activities.

The third is that it ignores things that are produced and do contribute to wellbeing and yet are not traded in the market. Examples include volunteer work, the ‘output’ of clubs and societies, work within the home, production from allotments and various activities taking place in the ‘underground economy’ to avoid taxation.

The fourth is the sustainability of economic growth. If we deplete natural resources, the growth of today may be at the cost of the wellbeing of future generations.

Then there is the question of the distribution of the benefits of production. Although GDP figures can be adjusted for distribution, crude GDP growth figures are not. If a few wealthy get a lot richer and the majority do not, or even get poorer, a growth in GDP will not signify a growth in wellbeing of the majority.

Then there is the question of the diminishing marginal utility of income. If an extra pound to a rich person gives less additional wellbeing than an extra pound to a poor person, then any given growth rate accompanied by an increase in inequality will contribute less to wellbeing than the same growth rate accompanied by a decrease in inequality.

The first article below criticises the use of crude indicators, such as the growth in GDP or stock market prices to signify wellbeing. It also looks at some alternative indicators that can capture some of the contributions to wellbeing missed by GDP figures.

Articles

Want to know how society’s doing? Forget GDP – try these alternatives The Guardian, Mark Rice-Oxley (27/1/17)
The Increasingly Inadequate Measurement Of Productivity The Market Mogul, Chris Woods (20/1/17)
Why GDP fails as a measure of well-being CBS News, Mark Thoma (27/1/16)
Limitations of GDP as Welfare Indicator The Sceptical Economist, zielonygrzyb (31/7/12)

Questions

  1. Should GDP be abandoned as an indicator?
  2. How could GDP be refined to capture more of the factors affecting wellbeing?
  3. Go through each of the indicators discussed in the first article above and consider their suitability as an indicator of wellbeing.
  4. “Everywhere you look, there are better benchmarks than these tired old financial yardsticks.” Identify three such indicators not considered in the first article and discuss their suitability as measures of economic performance.
  5. How might the benefit you gain from free apps be captured?
  6. Consider the suitability of these alternatives to GDP.

Some commentators have seen the victory of Donald Trump and, prior to that, the Brexit vote as symptoms of a crisis in capitalism. Much of the campaigning in the US election, both by Donald Trump on the right and Bernie Sanders on the left focused on the plight of the poor. Whether the blame was put on immigration, big government, international organisations, the banks, cheap imports undercutting jobs or a lack of social protection, the message was clear: capitalism is failing to improve the lot of the majority. A small elite is getting significantly richer while the majority sees little or no gain in their living standards and a rise in uncertainty.

The articles below look at this crisis. They examine the causes, which they agree go back many years as capitalism has evolved. The financial crash of 2008 and the slow recovery since are symptomatic of the underlying changes in capitalism.

The Friedman article focuses on the slowing growth in technological advance and the problem of aging populations. What technological progress there is is not raising incomes generally, but is benefiting a few entrepreneurs and financiers. General rises in income may eventually come, but it may take decades before robotics, biotechnological advances, e-commerce and other breakthrough technologies filter through to higher incomes for everyone. In the meantime, increased competition through globalisation is depressing the incomes of the poor and economically immobile.

All the articles look at the rise of the rich. The difference with the past is that the people who are gaining the most are not doing so from production but from financial dealing or rental income; they have gained while the real economy has stagnated.

The gains to the rich have come from the rise in the value of assets, such as equities (shares) and property, and from the growth in rental incomes. Only a small fraction of finance is used to fund business investment; the majority is used for lending against existing assets, which then inflates their prices and makes their owners richer. In other words, the capitalist system is moving from driving growth in production to driving the inflation of asset prices and rental incomes.

The process whereby financial markets grow and in turn drive up asset prices is known as ‘financialisation’. Not only is the process moving away from funding productive investment and towards speculative activity, it is leading to a growth in ‘short-termism’. The rewards of senior managers often depend on the price of their companies’ shares. This leads to a focus on short-term profit and a neglect of long-term growth and profitability – to a neglect of investment in R&D and physical capital.

The process of financialisation has been driven by deregulation, financial innovation, the growth in international financial flows and, more recently, by quantitative easing and low interest rates. It has led to a growth in private debt which, in turn, creates more financial instability. The finance industry has become so profitable that even manufacturing companies are moving into the business of finance themselves – often finding it more profitable than their core business. As the Foroohar article states, “the biggest unexplored reason for long-term slower growth is that the financial system has stopped serving the real economy and now serves mainly itself.”

So will the election of Donald Trump, and pressure from populism in other countries too, mean that governments will focus more on production, job creation and poverty reduction? Will there be a movement towards fiscal policy to drive infrastructure spending? Will there be a reining in of loose monetary policy and easy credit?

Or will addressing the problem of financialisation and the crisis of capitalism result in the rich continuing to get richer at the expense of the poor, but this time through more conventional channels, such as increased production and monopoly profits and tax cuts for the rich? Trump supporters from among the poor hope the answer is no. Those who supported Bernie Sanders in the Democratic primaries think the answer will be yes and that the solution to over financialisation requires more, not less, regulation, a rise in minimum wages and fiscal policies aimed specifically at the poor.

Articles

Can Global Capitalism Be Saved? Project Syndicate, Alexander Friedman (11/11/16)
American Capitalism’s Great Crisis Time, Rana Foroohar (12/5/16)
The Corruption of Capitalism by Guy Standing review – work matters less than what you own The Guardian, Katrina Forrester (26/10/16)

Questions

  1. Do you agree that capitalism is in crisis? Explain.
  2. What is meant by financialisation? Why has it grown?
  3. Will the policies espoused by Donald Trump help to address the problems caused by financialisation?
  4. What alternative policies are there to those of Trump for addressing the crisis of capitalism?
  5. Explain Schumpeter’s analysis of creative destruction.
  6. What technological innovations that are currently taking place could eventually benefit the poor as well as the rich?
  7. What disincentives are there for companies investing in R&D and new equipment?
  8. What are the arguments for and against a substantial rise in the minimum wage?

Research published by the Institute for Fiscal Studies shows that graduates from wealthier family backgrounds earn significantly more than those from poorer backgrounds. If you compare the 20% of graduates from the richest backgrounds with the remaining 80%, the average earnings gap in 2012/13, 10 years after graduation, was £8000 per year for men and £5300 for women. Even when you take graduates in similar degrees from similar universities, there is still a gap of around 10% between those from richer and those from poorer backgrounds.

The research also shows that in 2012/13, 10 years after graduation, the median earnings for economics graduates was the second highest of any subject (just behind graduates in medicine) and that at the 90th percentile economics graduates had the highest earnings (£93 900 for women and £121 400 for men) of any subject. In fact, graduates in economics were the only males at this percentile earning over £100 000. (Click here for a PowerPoint of the chart.) As the Press Release to the IFS working paper states:

For males, it is estimated that approximately 12% of economics graduates earned above £100 000 some ten years after graduation; by contrast, 6% of those studying medicine or law earned more than £100 000.

For females, it is estimated that approximately 9% of economics graduates earned above £100 000 some ten years after graduation; by contrast, just 1% of those studying medicine and 3% of those studying law did so.

For some subjects, graduates earned little more than non-graduates.

Those studying the creative arts had the lowest earnings, and indeed earned no more on average than non-graduates.

The research also shows that earnings vary substantially by gender and university. For those earning £8000 or more, the median earnings for male graduates 10 years after graduation was £30 000 (compared with £21 000 for non-graduates), whereas for women it was £27 000 (compared with £18 000 for non-graduates).

Earnings are substantially higher for graduates from some universities, such as Oxford, Cambridge and the LSE. “At the other end of the spectrum, there were some institutions (23 for men and 9 for women) where the median graduate earnings were less than those of the median non-graduate ten years on.” Differences in graduate earnings by university tend to compound the difference by students’ family background as those from poorer backgrounds disproportionately attend universities with lower average graduate earnings by discipline.

The following articles consider the findings and their implications for higher education policy

Articles

Graduates from wealthy backgrounds reap earnings benefits Times Higher Education, John Morgan (13/4/16)
Graduate Earnings Guided By Parents’ Wealth, Institute For Fiscal Studies Report Finds Huffington Post, George Bowden (13/4/16)
Graduates from poorer backgrounds earn less than richer peers on same course, major international study finds Independent. Oliver Wright (13/4/16)
Richer students have higher graduate income, study finds The Guardian (13/4/16)
Want a Higher Salary? It Helps If You’re a Man With Rich Parents Bloomberg, Robert Hutton (13/4/16)
Economics graduates are in the money Why Study Economics? Economics in Action blog (15/4/16)

IFS paper
What and where you study matter for graduate earnings – but so does parents’ income IFS Press Release (13/4/16)
How English domiciled graduate earnings vary with gender, institution attended, subject and socio-economic background IFS Working Paper W16/06, Jack Britton, Lorraine Dearden, Neil Shephard and Anna Vignoles (13/4/16)

Data

Free Online Statistics – Students & qualifiers Higher Education Statistics Agency (HESA)
Applications and acceptances for types of higher education course – 2015 UCAS
What do graduates do? Higher Education Careers Services Unit

Questions

  1. For what reasons are graduates from rich backgrounds likely to earn substantially more than graduates from poor backgrounds?
  2. Why are graduates in economics likely to earn more than graduates in other subjects, especially those in the top percentile of earners from any given subject?
  3. How might marginal productivity help to explain the differences in earnings of different graduates?
  4. What are meant by ‘soft skills’. Why may students from richer backgrounds have better soft skills in the context of (a) university admission and (b) getting a job on graduation?
  5. Why are female graduates likely to earn less than male graduates with the same class of degree in the same subject?
  6. What could be done by (a) universities and (b) the government to increase social mobility?
  7. Do you think that the findings of the research have implications for the way students’ study is funded? Explain.