Topic 2:Inequality. -relative vs absolute; four principles; Lorenz curves,gini coefficient, etc

Transcription

1 Topic 2:Inequality -relative vs absolute; four principles; Lorenz curves,gini coefficient, etc

2 Inequality Definitions and measurements Theoretical & empirical debate: inequality & growth Jenkins & Micklewright (2007) New Directions in the Analysis of Inequality and Poverty, ISER working paper

3 2.1. Definition Who has benefited from economic growth? By how much? Who has been made worse off? Inequality also affects other economic goals

4 Cont d Economic inequality is the fundamental disparity that permits one individual certain material choices while denying another individual those very same choices RAY, p. 170

5 2.1. cont d Ethically why should some be treated differently? (gender/race discrimination) Hard to resolve the ethical dilemma on philosophical grounds. Some are simply born to poverty or prosperity and some had it coming to them via preferences/decisions (child born in Congo vs a lazy student with 2.2 instead a first-exogenous/endogenous )

6 Cont d A practical goal is tolerable levels of inequality Tolerance is determined by social values/attitudes and by expectations of economic policy s results Changes in relative inequality are more acceptable if there are absolute gains for all

7 2.1. cont d Sen (1992) Equality of what? (Y, health?) heterogeneity of human beings The multiplicity of variables in terms of which inequality can be judged The first consideration implies preferences for different measures amongst different people

8 Cont d Distinguish between achievement and freedom to achieve the latter is largely ignored X is richer than y but lives under a dictator (so inequality is a slippery concept and is linked with broader issues such as freedom and security)

9 2.1. cont d Equality should be measured in terms of functionings and capabilities, not income Often => wealth/income/economic inequality The distribution of income -source of many of problems and is related to the process of growth/development

10 WHICH CONCEPT IS APPROPRIATE? Inequality in current income flows? Inequality in the distribution of wealth (e.g. land and other assets)? The distribution of lifetime income?

11 2.2. Measurement The size distribution of income shows the frequency with which the various amounts are distributed in the sample But ignores the source of the income [RAY, ch. 6, fig. 6.2, p. 176 & fig. 6.3, p. 177-Historgram example]

12 Cont d We can measure the location (mean, median etc.) and dispersion (range, standard deviation) of the distribution Quintiles(y) by % of income earned(x). E.g. the poorest quintile earns 9% of the total income.

13 2.2. cont d But what is of interest, changes in A.The distribution of absolute income (the whole range of actual values)? OR B. Relative income inequality in the distribution of income (the dispersion of income in the distribution)?

14 2.2. cont d Measures of income inequality are not objective due to normative assumptions about who matters It is typically assumed in these analyses that Social welfare = f (income, inequality) +ve -ve But increases in inequality do not necessarily mean that overall welfare has declined(china)

15 Data and empirical issues Reliability of income and consumption data for inequality measurement Source: household surveys There are errors in income (reporting & measurement error)

16 Cont d Some products/services are not recorded Consumption data are often used, but they understate inequality/income differentials Many transactions are not undertaken in cash

17 2.2. cont d Common ownership rights - not captured Estimation of income and consumption has a high variance (why? Covariate/idiosyncratic shocks- former understates and latter overstates inequality)

18 Cont d Sample survey limitations - recall error, short period of reference (e.g. last week), remote villagers and other marginal groups not captured Price indices are unavailable e.g. for rural-urban price differentials

19 INEQUALITY MEASUREMENT CRITERIA (RAY, ch. 6) 1. Anonymity principle - who has what/how much is irrelevant for measurement - meaning we can always arrange our income distribution as y1, y2 yn

20 2. Population principle - population size is irrelevant. Only population shares matters. - cloning the entire population should not alter inequality

21 2.2. cont d 3. Relative income principle Absolute values irrelevant. - Like principle 2 above, the income shares not the absolute levels of income should matter (i.e. what % of the total income earned went to the poorest/richest quintile?).

22 Cont d 4. The Dalton principle (the Pigou-Dalton Principle) If we can move from one distribution to another by transferring resources from the relatively poor to the relatively rich (i.e. regressive transfer) we will end up with a more unequal distribution than before

23 FORMAL APPROACH For all i = 1, 2,, n with incomes yi the income distribution is (y1, y2,, yn) An inequality index I = I (y1, y2,, yn) can be defined over all (y1, y2,, yn).

24 The value of I (e.g. a Gini coefficient) represents the inequality of the distribution. Lorenz curve is its graphical counterpart. The larger the value of I the greater the inequality of the distribution of income

25 Anonymity principle I is completely insensitive to the ordering of y1 y2 yn Knowing who gets how much does not affect I.

26 Population principle For every identical income distribution I(y1, y2,, yn) = I(y1, y2,, yn; y1, y2,, yn) Cloning the population has no effect on I.

27 Relative income principle For every positive number > 0, I(y1, y2,, yn) = I( y1, y2,, yn) Example: Doubling the income of everyone is irrelevant to the magnitude of I.

28 Pigou- Dalton principle For every income distribution and every transfer > 0, I(y1,,yi,,yj,,yn) < I(y1,,yi-,,yj+,..,yn) ; whenever yi yj Regressive transfers increase I (e.g. IFS s criticism of UK gov ts plans ).

29 LORENZ CURVES A Lorenz curve plots the cumulative percentage of total income(y) received against the cumulative percentage of the population(x) who receive it, in ascending order of income [RAY, ch. 6, figure 6.4, p. 179]

30 2.2. cont d A 45-degree line represents the line of absolute equality (y=x) Increasing inequality is indicated when the Lorenz curve falls further below this line

31 THE LORENZ CRITERION: A. If one Lorenz curve lies wholly above another, the first represents a more equal income distribution than the second [RAY, ch. 6, figure 6.5, p. 180]

32 2.2. Cont d B. If two Lorenz curves coincide, the two distributions are equally unequal C. If two Lorenz curves intersect we cannot make any clear judgement about relative inequality [RAY, ch. 6, figure 6.7, p. 183]

33 Lorenz-consistency An inequality measure is Lorenzconsistent iff it is simultaneously consistent with the anonymity, population, relative income and Dalton principles.

34 2.2. Cont d Formally an inequality measure is Lorenz-consistent if, for every pair of income distributions, (y1, y2,, yn) and (z1, z2,, zn): I(y1, y2,, yn) I(z1, z2,, zn) whenever the Lorenz curve of (y1, y2,, yn) lies everywhere to the right of (z1, z2,, zn) [RAY, ch. 6, figure 6.6, p. 182]

35 2.2. Cont d Lorenz curves and measures based on them are mean independent Thus, they are relative inequality and not absolute inequality measures

36 Formula MEASURES [RAY, ch. 6, pp ; Sen (1997)] Notation: m - distinct incomes j - classes of income n - number of people y - income

37 2.2. cont d Range R 1 ( y max y min ) Mean 1 m j 1 n n j y j n m j 1 n j

38 1. Range It is A. A crude measure B. Useful when complete data is not available on income distribution. C. Ignores everyone in between D. Does not satisfy the Dalton principle.

39 2. The Kuznets ratio (KR) The share of income of the richest x% divided by the share of income of the poorest y%. The ratios are basically components of the Lorenz curve. Good when data is missing. KR = share of income of richest x% share of income of poorest y% Not the whole distribution used

40 3. The mean absolute deviation uses the idea that inequality is proportional to the distance from mean income (first measure to take the whole distribution; insensitive to Dalton principle-why?) M 1 n i m j n j y j

41 4.The coefficient of variation gives more weight to larger deviations from the mean and is less sensitive than M. So insensitivity to Dalton addressed C 1 j m 1 n j n ( y j 2 )

42 5. The Gini coefficient is the sum of differences between all possible pairs of incomes divided by population squared and mean income (why multiplying by 2? Since yi-yk =d= yk-yi i.e. deviations counted and summed twice) G 1 2 2n j m 1 k m 1 n j n k y j y k

43 Measures summary Most measures are additively decomposable Contribution to overall inequality! Therefore, we can calculate betweengroups or within-groups Gini coefficients.

44 Example We sub-divide the population of UK into groups of Whites, Blacks and Asians and computer the respective between-group G s. In some instances it is interesting to look the within-group inequalities (e.g. among whites).

45 Gini coefficient G measures the area between the Lorenz curve and the line of absolute equality as a percentage of the total area under this line (0 = perfect equality, 100 = perfect inequality) [TOD, ch. 5, figure 5.3, p. 214] The Gini coefficient is Lorenz-consistent and is widely used in empirical work

46 Other measures Decile or fractile comparisons are frequently cited, they are just parts of the Lorenz curve Both the coefficient of variation and the Gini coefficient are useful, but give conflicting indications when Lorenz curves cross - incomplete measures of true inequality Sen s, Enthropy and Atkinson s indices

47 2.3. Income inequality: causes (policy level) The functional distribution of income divides income according to its source (e.g. land, labour, capital, transfers) [RAY, ch. 6, figure 6.1, p. 172] An extended functional distribution approach captures conflicts between industrial sectors, modes of production and geographical location This understanding of the sources of income inequality may influence how we judge the outcome

48 2.3. cont d Bigsten s (1987) categorization of causes: Institutional Determinants type of economic system Determinants of the Functional Distribution - factor proportions - technology (both affect returns to labour)

49 2.3. cont d Determinants of Both Function & Size - sectoral structure (labour-intensive or not) - regional structure (rural-urban) - factor markets (market imperfections) - commodity markets (relative price changes)

50 2.3. cont d Determinants of Size Distribution - asset ownership (e.g. land, capital) - possession of human capital - social stratification (e.g. discrimination)

51 2.3. What can be done? HISTORY s/1960s growth will eliminate inequality s/1980s redistribution with growth - Chenery (1974) advocated targeting certain groups e.g. landless, unemployed, working poor - basic needs strategy

52 2.3. cont d International Labour Office (1976) argued for direct effort at alleviating basic wants (food, shelter, clothing; healthcare, education, water) More recently debate focuses on links between inequality and economic growth (Jenkins & Micklewright, 2007)

53 Any lesson from FIFA rules Milanovic, Globalization and Goals: Does Soccer Show the Way? Soccer is the most globalized sport with an almost fully free circulation of labor (players). This has led to a concentration of quality among the top, that is the richest, clubs.

54 .But on the other hand, the existence of the FIFA requirement that players cannot change national teams has produced the opposite effects: greater equality in the quality of national teams.

55 If soccer is a paradigm for world economy, it shows that certain inequality features that are fostered by globalization need to be moderated through the existence of some overarching (global) rules whose objective is to redistribute the gains from globalization. FIFA's rules do precisely that.

56 Regulation of prices [Sundrum(1990),chs.15-16; TOD,ch.5] - promoting competitive market conditions - removing factor price distortions (e.g. reducing subsidies to capital) - price ceilings for essential commodities - minimum wages (government determined) - controlling inflation

57 2.3. cont d Regulation of production - improve the relative position of agriculture - encouraging labour-intensive techniques Re-distributive policies - promoting equality of opportunity (e.g. in education and health care)

58 2.3. cont d - redistribution of assets (e.g. land reform; Not like Mugabe) - redistribution of incomes (through progressive taxation and transfer payments) - subsidising public consumption goods available to the poor (e.g. health care)

59 2.4 Inequality & growth: Empirical level Growth will usually only result in redistribution to the poor as a result of government social expenditure policies (e.g. via pro-poor interventions) Redistributive policies may also promote economic growth e.g. reducing crime and political instability, increasing nutrition and labour productivity levels

60 2.4. cont d Also they may reduce market failures in land, labour and, especially, credit markets Developing countries could grow faster, and more equitably, by shifting investment towards rural, labourintensive activities especially farming

61 2.4 cont d Does growth increase or decrease income inequality? - Inequality is not well correlated with income ( e.g. Bolivia & Cameroon: GNP per capita, 1,010 for both but gini 0.60 & 0.45 respectively) [TOD, ch. 5, table 5.3, p. 229]

62 2.4. cont d KUZNETS INVERTED U- HYPOTHESIS Kuznets (1955, 1963) found a statistical association between income levels and inequality across countries - an inverted U-shaped pattern[tod, ch. 5, figure 5.10, p. 227] He concluded that growth would lead to rising inequality in the early stages of development.

63 2.4. cont d Why? - structural change (agriculture industry) - little scope for redistribution of benefits However, further growth would reduce inequality if there is an/a; - increase in agricultural productivity / wages - transfer payments from rich to poor

64 2.4. cont d EVIDENCE ON THE KUZNETS CURVE/HYPOTHESIS Cross-sectional analysis provides some support [RAY, ch. 7, figure 7.1, p. 203] However the evidence is not convincing [TOD, ch. 5, figure 5.11, p. 230] Time-series studies indicate that inequality falls over the course of development (e.g. Deininger & Squire, 1996)

65 2.4. cont d Causality could run in both directions; growth or inequality inequality growth. Simultaneous equations set up.

66 2.4. cont d Does initial inequality affect subsequent growth? Greater initial inequality hinders growth if: a. poor lack access to credit for investment b. low incomes low demand for local products

67 c. the rich don t save to finance investment d. the poor are socially and politically excluded

68 2.4. cont d Lower initial inequality hinders growth if: - the incentives to save are reduced by redistributive policies (if capital flight is encouraged ) - re-distributive policies require higher levels of taxation which are bad for promoting economic growth

69 2.4. cont d Inequality and Growth: evidence Traditionally negative relationship between initial inequality and subsequent growth (e.g. Deininger & Squire 1996; for an opposing view see Forbes 2000) However, the evidence is mixed [TOD, ch. 5, figure 5.14, p. 233]

70 However, the evidence is mixed [TOD, ch. 5, figure 5.14, p. 233] -ve growth and higher G: 20 countries -ve growth and lower G: 3 countries +ve growth and lower G: 10 countries +ve grwoth and higher G: 26 countries (WDI, 2007)

71 2.4. cont d Initial inequality in land-crucial Do inequalities perpetuate themselves through consumption patterns, lack of access to capital markets or human capital investments? If yes, then there is a rationale for government intervention and policy formation in these markets