Income Inequality

Causes of Income Inequality

There are typically a few things most often accepted as being causes of income inequality:

• Labor outsourcing - Companies in India and China pay their workers a lot less money than American companies pay theirs. Since American companies are typically wanting to make as much of a profit as possible, a lot of them outsource jobs overseas so that they can get production done for a far cheaper price. Whereas factory jobs may have paid well before, now that these jobs can be outsourced for cheaper, they either will be outsourced or the workers who are working in the factories will not be well-paid.

• Technological advances - While technological advances seem like a positive addition to the workplace, they can actually be detrimental to the workers. For example, self-checkout lanes are replacing actual cashiers. These cashiers now either have to get a different position within the company or they're let go because their services are no longer needed.

• Education - Americans with college educations make 84 percent more than people with just a high school diploma during their lifetime.¹

• Inflation - If wages remain the same or don't go up as much as inflation does, then people are having to spend more with less money.

Measuring Income Inequality

Measuring income inequality is extremely important to economists. The Gini coefficient, which is closely related to the Lorenz curve, is the most often used measurement to determine the level of economic inequality. While both are used to compare and illustrate distributions across nations, policies, and historical periods, the Gini coefficient is the one that's focused on most.

Figure 1. Gini coefficient, StudySmarter Originals

Figure 1 above shows the Lorenz curve and the Gini coefficient. The Gini coefficient is determined by taking the area between the Lorenz curve and the 45-degree line of equality (area A) and dividing it by everything beneath the 45-degree line (area A+B). Written out in formula form, this would be:

$Ginicoefficient=\frac{A}{(A+B)}$

This will result in an answer between 0 and 1, with 0 meaning no inequality (such as where everyone makes the same amount of money) and 1 meaning full inequality. Basically, the closer to 0 a society is, the closer it is to being fully equal income-wise. If a society were to have completely equal incomes, then the line would follow the equality line on the diagram. But since that's not the case, inequality is creating the curve underneath the equality line which we recognize as the Lorenz curve.

Problem of Income Inequality

Whenever there is income inequality, there are bound to be problems associated with it. Higher inequality reduces growth by limiting lower-income families' capabilities to stay healthy and acquire wealth. For example, inequality can lead to under-funding of education for kids since disadvantaged students end up in lower-quality institutions and are less likely to go on to college. Consequently, future labor productivity might be lower due to this.

Along with that, it's been noticed that nations with greater rates of income inequality have lower levels of inter-generational mobility, and the income of the parents actually becomes a more important indicator of children's future earnings. Also, due to the fact that the wealthiest spend a smaller proportion of their incomes than middle- and lower-income groups, increasing income concentration might weaken demand and hinder growth.

There also tends to be a spike in crime when the income inequality is high. Property crime particularly increases in richer locations when the economic difference with the poorest nearby block becomes greater. When poorer households look for nearby crime chances, they are more likely to pick places with higher incomes than locations with lower incomes.

Income inequality directly influences the rate at which growth allows poverty to be reduced. Growth is less effective in reducing poverty in nations with high rates of inequality right from the beginning, or when the growth distribution benefits the people who aren't poor. Furthermore, because economies are regularly prone to various types of shocks that impair growth, increased inequality causes a larger portion of the population to be prone to poverty.

Income inequality is an issue because it gives the rich almost all of the power, leaving many people with very little economic or social mobility. It can lead to decreased living costs for many, more hardship, and spikes in crime, mental issues, and social instability.

The Problem of Inequality, StudySmarter Originals

Examples of Income Inequality

Let's talk about some of the examples of income inequality issues that have been taking place in the United States.

Between 2016 and 2019, groups of people with low income historically (like Black and Hispanic families) saw improvement in their median wealth. These improvements ranged from 25%-60% for Black and Hispanic families, and families with a high school diploma.¹

Groups with traditionally larger incomes, such as white families as well as families with a minimum of a bachelor's degree, obtained 4% to 5% more money throughout the same period of time.¹ However, because these families were already wealthy, these tiny increases translated into enormous cash benefits. As a result, large wealth inequalities persisted, and wealth levels among Black, Hispanic, and other households with only high school diplomas remained low, making it harder for them to maintain financial stability.

In 2019, 39% of households had at least one person that had a four-year college degree, which is an increase from the 36% it was in 2016. Highly educated households continue to have far more money than families with less education. Families with bachelor's degrees (minimum) controlled 77 percent of wealth in 2019 and had a median worth of $310,000. This is an increase from 2016 when they had 75% of the wealth and $293,000 in median wealth.²

Yet, the average household without a bachelor's degree was earning only $66,000 in 2019 in comparison, slightly higher compared to the $54,000 it was earning in 2016.² The inequality between these categories widened by roughly $5,000, despite a percentage-wise decrease.² Essentially, while less educated families' wealth expanded faster in percentage terms, more educated families had more wealth to begin with, therefore their actual gain in terms of dollars was bigger.

Also, it's important to note that employers seldom provide medical coverage, sick leave, or pension plans to low-wage workers. These workers typically can't take time off if they become sick, and they can't even fathom retiring. These inequalities contribute to inequalities within the health-care field which raises the overall cost of medical treatment for everyone, not just the low-wage workers.