2 Global Income Inequality

Bryan Collado, Maria Aldrich, Diogenes Rosario

Introduction

In this chapter, a general assessment of the current global economy will be made which will allow for an extrapolation of future trends. More specifically, this chapter will analyze the global economy through topics such as, global income inequality trends, income polarization, investment in developing countries, availability of resources across countries, social mobility, etc…

In the next section, we will review the current state of income inequality from a global perspective. More specifically, trends across advanced economies, in addition to developing and emerging economies, will be examined. Then, key drivers of income inequality will be examined to explain some of the differences between developed and developing nations with respect to income disparities.

Income Inequality

In order to understand income inequality, a breakdown is intrinsic. Income is the flow of cash or cash-equivalents received from work, capital, or land. It can refer to one’s earnings or remaining revenues after expenses and taxes have been deducted. Income consists of wages or salaries, interest or profits, and rent. Income inequality refers to the concentration of income that is unevenly distributed amongst a population. It’s often described as the gap between the richest and the poorest individuals.

Income inequality, measured by the portion of the richest 1 percent and poorest 10 percent of the adult population, has steadily risen since the 1980s (Dervis & Qureshi 1). Income inequality, within nations, has reached levels that have not been seen since the pre-war period. As a result, the topic of income inequality has become one of great debates of current times due to its gained attention and above all, significance. According to a 2016 Global Wealth Report, income inequality is projected to continue rising across the world as a whole. While thevbottom half of the world adult population owns less than 1 percent of all global assets, the richest top 10 percent of adults accounted for about 90% of all global assets (Dervis & Qureshi 1 ). In essence, the world’s richest individuals account for the majority of the world’s wealth. On the other side of the spectrum, the world’s poorest individuals account for a relatively small portion of all global wealth.

Income Inequality Across Developing Countries

In most major developing economies, income inequality has risen over the last 30 years (Dervis & Qureshi 1). Between 1990 and 2010, there was an average of an 11% increase in all developing countries, according to a report released by the UN Development Programme. The largest increases have taken place in the economies of China, India, and South Africa. On the contrary, the region of Latin America has experienced some decline with respect to income inequality, specifically in the economy of Brazil, the largest economy in the Latin American region. Nonetheless, income inequality in Brazil remains the highest in relation to all other emerging nations. With respect to Africa, ten of the 19 most unequal countries in the world are situated in Africa (Gandhi, 1). There is an immense presence of income inequality in the region, particularly in the sub-Saharan region; thus, it’s deserving of its’ own section.

In sub-Saharan Africa, average and median income inequality are higher in the region relative to other developing regions (Gandhi 1). This is be mainly driven by the presence of 7 countries with extreme levels of income inequality: South Africa, Namibia, Botswana, Central African Republic, Comoros, Zambia, and Lesotho. According to a report by the World Bank Group, there was an increase of 135 million people living in poverty in the region from 1990 to 2015 (Nikal 1). As of 2015, most of the global poor live in sub-Saharan Africa. Though being poor constitutes a variety of other things aside from income: education, access to basic utilities, health care, security, etc.., income is a substantial piece of the pie. It’s important to note that in Eastern and Western economies in Africa, with a predominantly strong emphasis on agriculture, experienced declines in income inequality. Southern and Central African regions, on the other hand, with oil and resource rich economies, saw a rise in income inequality (Gandhi 1).

However, not all news is bad. The rising trend of income inequality is not one that is globally uniform. Otherwise stated, despite the strong concentration of rising income inequality in Africa, the rising trend does not hold across all countries. In fact, while some regions in the developing world, such as Asia, Africa, and Europe, experienced an increase in income inequality, the opposite was true for Latin America and the Caribbean as they experienced a fall in income inequality throughout the 2000s (Messina et. al 317). Latin America and the

Caribbean experienced some of the largest average declines in inequality, with a significant 5% decrease.  This mainly stemming from the large reductions in inequality during the 2000s in the large countries of the region namely, Argentina, Brazil, and Mexico. The only break held in Costa Rica were income inequality actually rose 1.7 GINI points, according to Messina et. al (317).

Income Inequality Across Developed Countries

When compared to the world’s emerging nations, the developed regions of the world tend to have lower income inequality. When analyzed separately, however, there are exceptions; the U.S. being one of those exceptions.The United States has one of the highest levels of income per capita, or average income per person, but remains a country with significantly high income inequality (Santacreu 1). In fact, since the 1970s, income inequality has been steadily rising in the U.S. According to Census Bureau estimates, the Gini coefficient, which is considered to be the most common measure of income inequality, rose 21% from 1975 to 2015 (Hertz & Silva 2).

In the mid-to-early 90s, the average CEO of a company in the United States would earn 20 times more than a regular employee. In today’s day and age, an employee is able to make substantially more than his or her counterpart. Though the top 1% of earners in the United States contribute substantially, the top 10% of earners also bring about the large differences in income inequality.

The richest 1% of Americans captured ⅕ of the country’s income in 2017, while the richest 10% of Americans captured about half of all the country’s income (Reed 1). Interestingly enough, the advanced economies of Finland and Sweden have substantially lower income inequality than the United States despite having similar income per capita as that of the U.S (Santacreau 1). The drivers of income inequality in these countries is explained in the following section.

 

Drivers of income inequality

The first and arguably the most important driver of inequality is geography. The country to which one is born in has much more of an influence on income than the amount of hard work and innate abilities and skills one possesses. Country regions may vary in terms of productivity levels, allocation of government resources, and distances to and from markets. Furthermore, governmental favoritism including unequal access to education, social services, and government revenues massively contribute and deepen inequalities within regions. Geography’s impact on within-country income inequality is most evident when comparing urban and rural regions. “Urban-rural inequality accounts for 40% of mean country inequality, and much of the variation in inequality across countries” (Galasso 29). This suggests that developing countries with significantly high levels of income inequality contain large urban-rural disparities.

Technological change is also another major driver of income inequality. As technological advancements and improvements set in, skilled workers become more favored over unskilled workers. Thus, creating wage and income inequalities between the two groups of workers. The Kuznets curve, brought about by famous Economist, Simon Kuznets, argued that technological change caused wage inequality to increase (Galasso 31). More specifically, Kuznets argued that the creation of the computer increased the productivity and demand for skilled workers relative to unskilled workers, As a result, wages for skilled workers increased relative to unskilled workers. Furthermore, there was an increase on the Gini coefficient of .42 percent between 1981 and 2003 for 51 countries (Galasso 31). Of this amount, technology contributed  a whopping .74 annually, signaling how significant technological change is as a driver of income inequality.

The combination of technology and geography may very well be intercorrelated, further enlarging income inequalities. For example, industries requiring higher skills tend to emerge in urban areas as opposed to rural. Similarly, there is a tension that forms between manufacturing jobs and agricultural jobs as waging gaps rise. This tends to follow the geographical divide. Additionally, becoming a high-skilled worker comes with the responsibility of having access to skills training and education, which is something that geography pre determines access or restriction to. It’s quite evident how significant technology and geography are in driving income inequality. In the following section, there will be discussion that further explores inequality, but from a different perspective.

 

Government Involvement in the Economy

Social Mobility: Differences in Economic Systems

Differences in political systems across countries can have impact on social mobility and income inequality. Alexi Gugushvili discusses the intergenerational social mobility in various post-communist societies (Gugushvili 62). He theorizes that social mobility is higher in societies with democratic politics and less liberalized economies. Gugushvili focuses on the 21 post-communist societies that were formerly part of the Soviet Union(65). There are many factors that can have an impact social mobility such as the varying social origins of individuals and even their age. For many countries, societies that transitioned from communist systems to capitalist systems suffered a decrease in economic output. Gugushvili also states that many of the post-communist countries had high levels of immigration, and migration can be positively correlated to social mobility because migrants may disrupt the system of social mobility in a country.

Gugushvili hypothesizes that democracy would positively affect social mobility because of equality of opportunities, civil law, fair elections, higher tolerance and gender equality (72). Less democratic states may have less occupational attainment because of corruption and nepotism which limits intergenerational mobility. Corruption makes for inefficient economies which can increase economic inequality. Corruption is an abuse of power for the purpose of private gain. This leads to unproductive and inefficient economies. When corruption occurs, the group who holds the most power will gain the benefits. In the same sense, nepotism keeps the power in the in the group that already has power, assuming that the nepotism is happening to a group with power. For example, if an employer only hires in a family, then that keeps the income and wealth in their own family.

Asongu and Batuo studies the liberalization policies that have been affecting Africa for about 30 years (Asongu et al 10). They have found that the income inequality has stayed persistently high despite these policies that focus on financial, trade, political and economic liberalizations on economic inequality. The authors find that economic freedom has a negative income redistribution effect (22). They also find that that institutional quality fuels inequality which may be because of the transaction costs on the poor. The poor have to learn the ways of these new institutions which can be costly for lower educated groups.

With new institutions comes new rules and techniques that one will need to learn. For example, new technology requires training and individuals with low levels of education may need to attend a higher education facility in order to adapt to the new institutions. This may increase the effects of economic inequality because the group with higher education will gain exceedingly more benefits because they are more equipped for the introduction of more advanced facilities. However, there is a positive impact of political liberalization on inequality in Africa. The authors do note that democracy will not necessarily bring about good politicians that will want the best for the economy. This goes back to the idea of corruption which, in essence, brings about higher levels of economic inequality.

Income Polarization & Globalization in the World Economy

The world economy has become more unequal, yet wealthier, during the previous few years. A look at the global economy revealed that there are polarized groups in both industrialized countries and throughout the developing world (Seshanna & Decornez 336). More specifically, it was previously found that the wealthy had become more wealthy while the lower income classes have become comparatively poorer. One trend in the growing world economy is the increase in globalization. Both Seshanna and Decornez has deemed that, “Globalization refers to the increasing economic integration of the world economy, encompassing declining barriers to trade, migration, capital flows, foreign direct investment (FDI) and technology transfer” (337). However, there has since been some debate surrounding the use of globalization as a solution for income inequality amongst low, middle, and high-income countries. Some have even suggested that the use of globalization has widened the polarization of income amongst countries because high-income countries have taken advantage of open economies while developing countries have been gradually experiencing an increase in wealth.

Although studies have found that income inequality had previously increased, a study done by B. Milanovic in 2005 has shown that the overall inequality has decreased (Koc et. al 6). A fall from 70.5 in 2008 to 67 in 2011 is the first time since the Industrial Revolution that global inequality has failed to increase (Koc et. al 2). One potential reason for this change in status is both China and India. “Well-born” countries, or countries born into a high-income group, such as England has remained prosperous while China and India has seen a “catch-up” effect (Koc et. al 13). Income inequality in a global manner has contributed positively to the world economy and has grown relationships among these countries. China and India has been able to build strong relationships with developed countries, such as the United States, and has experienced an increase in trade. China, specifically, has increased their exports to the United States by offering inexpensive products and has then been able to improve their economy. This has a crowding out effect on the other developing Asian countries and has impacted other relationships built for international trading.

Hakura et. al has focused on the impact of income inequality on the economic growth of Sub-Saharan Africa and has found that high levels of income inequality could be influenced by structural features (19). One example of these features would include demographics. A fast demographic transition can help to reduce inequality by decreasing the amount of dependent children, especially for low-income households, and investing in human capital as well as the female labor force (Hakura et. al 23). Another potential cause for this large trend in inequality is the association of lower poverty and inequality in the larger share of the agricultural sector (Hakura et al. 23). One reason for a large trend of inequality in this sector is because the agricultural sector “mainly reflects the generally low female labor force participation gaps in low-income and fragile economies where women have to work for subsistence” (Hakura et al. 7). The agricultural sector is a low-productivity industry throughout sub-Saharan Africa which consists of low-skilled workers, who would otherwise remain working in the household (Hakura et. al 7). This leads us back to the issue that each sector is impacted by income inequality, and that developing countries may struggle with lowering income inequalities due to the demographic income inequality dilemma.

In addition, Hakura et. al has found that economic policies such as fiscal redistribution can impact income inequality in different ways (20). For example, financial development can worsen inequality for financial frictions and can make further financial services more available to the rich (Hakura et. al 19). The transfer of low-skilled positions from developed countries to low-income countries, otherwise known as outsourcing, allows for additional opportunities throughout the manufacturing and services sector while there is an overall impact on wage disparities and inequality (Hakura et. al 19). The availability of basic resources, such as water and electricity, allow women to spend time outside of the house and participate in advanced markets through service positions (Hakura et. al 19). One well-known example is call centers or other support centers. This improves wages for women while creating a larger wage disparity when in comparison to skilled labor wages which requires more education or experience.

Overall, sub-Saharan Africa has seen growth in per capita income during recent years yet this has not reduced poverty nor income inequality (Hakura et. al 23). The region, unlike elsewhere, has seen a higher amount of inequality as a result of a larger GDP per capita growth (Hakura et. al 23). This can be traced back to the mentioned structural features as well as a significant skills premium due to the improvement in education and financial services. Hakura et. al have determined that both these structural problems and fiscal policies have been relevant factors to the difference in income inequality by regions and the lack of development in driving down the gap in inequality (23). It is clear that there is a need to aim policies on reducing income inequality without adversely impacting economic growth including: an increased access to education and healthcare as well as the removal of legal restrictions. This will offer women with the opportunity to learn new skill sets and to contribute to the economy, thus reducing the issue of gender inequality in the area as well.

Comparisons of countries’ economic growth, more specifically their PPP adjusted real GDP per capita growth, indicates a large income inequality across different countries. In other words, the polarization of income across groups from various countries has widened throughout recent years. Research has shown that a group with higher per capita income will experience a faster increase in their average income than a group with a below world average income per capita. They have also found that poorer countries do, in fact, become more wealthy from the given changes in the economy but that rich countries also become more wealthy, only at a faster rate than the poorer countries (Seshanna & Decornez 339). Industrialized countries are able to take advantage of the open economy and trading policies while developing countries progressively make use of open trade policies. For example, developed countries are able to profit from open trade policies due to a stable economic structure and a strong government while developing countries are unable to benefit from these policies perhaps as a result of corrupt governments or poor economic regulations.

Various studies[1] have examined globalization as the solution for income polarization amongst countries but have come to different conclusions regarding the widening of the income gap (Seshanna & Decornez 338). For example, people who fall in the anti-globalization group have argued that the widening in the inequality gap as a result of globalization is a large drawback in the search for a better global economy.  However, people who support globalization in the past have seen relatively stable polarization and inequality while non-globalizers continued to face increasing polarization and levels of inequality (Seshanna & Decornez 338). Although, globalizers have also endured an increasing gap in real GDP per capita than non-globalizers in the past (Seshanna & Decornez 338). Nevertheless, it is agreed by researchers and economists that there is a need for action to keep a stable economy throughout the world as they search for potential recommendations.

Investment in Developing Countries

Bogliaccini et. al have found that emerging economies rich in resources experience increased inequality when using liberal economic reforms (209). One suggestion of researchers is that trade helps to reduce inequality in developing countries while others have found a link between increasing trade and growth in inequality (Bogliaccini et. al 215). However, the focus of Bogliaccini et. al is on the impact of direct foreign investment on income inequality to determine whether there is a causal relationship (209). One argument is that recent trends in FDI contribute to the redistribution of employment with less polarized income structures, like manufacturing, into areas with greater wage differentials, but both Bogliaccini and Egan argue that employment and wage changes, as a result of FDI, have distributional consequences which vary by sector (227).

More specifically, Feenstra and Hanson found that increases in foreign investment are associated with increases in demand for skilled labor, with unskilled labor remaining unchanged, and increases in their wages (211). In other words, the increased use of FDI has been proven to cause further polarization as skilled labor wages increase and unskilled wages remain the same.  Investment in developing countries can also bring about substitutes for unskilled labor. Skill-based technological change, or SBTC, serves as a substitute for unskilled labor and lead to skill bias (Bogliaccini and Egan 211). Pressure can then be added to the country’s government to take precautionary actions for the economy as skilled workers wages have decreased while unskilled workers must either learn new skills or compete for unskilled labor positions.

Developing countries with an abundance of natural resources offer a valuable source for public investment. However, most developing countries face limited tax revenues as well as borrowing constraints (Berg & et. al 30). These factors are essential to the development a country’s economy. Policymakers are faced with the challenge of investing in their country’s poor living conditions in addition to their capital-scarce economies when managing revenue from non-renewable resources (Berg & et. al 3). Other problems also arise when a developing country invests in their non-renewable resources such as capital scarcity and credit constraints on the financing of public investments.

One study has developed a model to better public investment in developing countries to address these problems as well as other potential issues. This model suggests increasing public investment while also saving some of the country’s natural resources (Berg et. al 3). An increase in public investment will help to preserve resource wealth while upholding the economic stability and still meeting a country’s development needs (Berg & et. al 4). It also counteracts any effects from a common issue throughout resource rich developing countries, the Dutch disease, through an increase in productivity in non-resource trade sectors. The Dutch disease is the term given to a country who bases their market on the exploitation of a valuable resource. A country suffering from Dutch disease will experience a rise in currency value, an increase in unemployment, and generally a worsened economy. This model further encourages the use of public investment in the economy and prevents the overuse of natural resources.

Berg et. al have also suggested that a government in a developing country may still make public investments by utilizing their own revenue towards the economic market even if foreign capital is scarce (29). Domestic investment into the market promotes economic growth and allows the developing country to become more sustainable. It also encourages the availability of jobs and may decrease the unemployment rate while the standard of living begins to rise from domestic market improvements. The economy becomes more stable through this sustainable investing approach as the government is able to build up public capital from the use of good projects and the preservation of public capital (Berg & et. al 4). In other words, domestic investment encourages the availability of jobs as a potential solution for income inequality within a country. The buildup of public capital helps the government to reinvest into the market and increase fiscal spending towards welfare programs to drive down income inequality.

As mentioned, the developing country experiences a multitude of benefits from the use of a sustainable investing approach. A more specific benefit which the country may experience is the improvement in health and education for a worker. This increases human capital as well as productivity in the country. The use of natural resources may also relax borrowing constraints and in turn, better stabilize accumulated commercial debt, thus improving the economy as a whole. Overall, the use of FDI can impact income inequality to move in either of two directions. An increase in wage premiums has the potential to the provide opportunity to earn higher wages yet negatively impact unskilled workers in the short term throughout certain sectors. This could deepen inequalities in certain industries throughout developing countries or, it could potentially offer a liberalizing effect for others (Berg & et. al 4). In either case, more information and research should be done to see the overall impact of FDI on various economies.

It is clear that there is some debate surrounding investment in foreign countries and whether globalization is beneficial for the global world. Economists must first consider the availability of resources throughout countries prior to making decisions regarding developing countries, such as contributing foreign aid or making trade policies more open. Access to resources has a large impact on these economic policies and are significant to the accumulation of wealth throughout developing countries which can determine equal or unequal income distribution.

Availability of Resources Across Countries

Unequal Access to Resources

Social and economic inequality differs between developed and developing countries but there are many similar trends that we can analyze. One trend that we see is social exclusions and discrimination between different groups in society. Naureen Karachiwalla examines how social exclusion can result in underinvestment in human capital which can lead to poverty for the individuals and overall negative effects for a country. The author specifically looks at the interaction between children and teacher in rural Pakistan, where they have the caste system, to study the learning outcomes of these individuals (Karachiwalla 6). The author observes that there is a positive effect when high caste teachers interact with low-caste students. The low-caste students learn significantly more when taught by a high-caste teacher. The low-caste students do not have equal access to high caste teachers as the high-caste students do (30). This creates problems in inequality in education which is one of the most important resources to an economy.

Human capital, which is enhanced by education, is one of the most significant resources in economic development. Neglecting the importance of education may decrease the progress of a country and can most likely lead to higher levels of economic inequality. A government that neglects the impact of education will be less likely to implement subsidies and financial assistance to the less educated which will decrease intergenerational mobility. Karachiwalla continues to find that these high-caste provide significantly more help with homework and that the low-caste students have higher career aspirations when taught by high-caste teachers.

Education as a resource is very significant in developed and developing countries. Emma Garcia and Elaine Weiss study how a child’s social class is one of the most significant predictors of their educational success (Garcia et al. 3). They suggest that children who start behind stay behind which increases the level of economic inequality. This supports the idea that education is an extremely important resource that has a great impact on economic inequality. The increasing skill gap in developed and developing countries will continue to decrease intergenerational mobility and increase the  levels of economic inequality, especially if the importance of education us neglected by the countries.

In a different sense with the availability of natural resources, Gylfason and Zoega take a broader approach at determining the effects of increased dependency of these natural resources on the inequality of income across countries (Gylfason and Zoega 4). These authors also look at the policies that were made to support education in order to increase economic equality. A worker can earn a living by working in a sector of extracting natural resources or they can work in the manufacturing sector. However, the earnings will always be unequal because of the competition for the rent created by the natural resource(6). Assuming that the manufacturing sector provides greater opportunities for learning, there will be a lower rate of growth for the workers in the primary sector. Natural resource extraction is the primary sector for these countries and this sector yields a lower rate of growth than with manufacturing sectors (9). If a country has an abundance of natural resources, then their primary work sector will be the extraction of these natural resources meaning that most of their labor force will consist of this sector.

Similarly, the middle east is struggling with the inequality brought about by natural resources. Alvaredo, Assouad and Piketty study the inequality in the Middle East and state that the the inequality in the Middle East is largely due to the geography of oil ownership and the oil revenues( Alvaredo et al. 21). Oil ownership increases inequality because the country who owns the oil will profit from exporting it which means there will be abundant employment for the extraction of oil and this sector of work leads to unequal earning than a manufacturing sector job. The earnings in the resource extraction sectors are unequal because of the competition of rent generated by the natural resources. Having natural resource extraction as a primary sector will draw workers away from the manufacturing sector, where earnings are equal and, it is assumed, there is more capacity of innovation and growth. Therefore, abundant natural resources can cause inequality and slow growth by drawing people toward the primary sector and away from manufacturing where earnings are more equal.

Distribution of Wealth

The difference in wealth distribution across countries is what causes social and economic inequality between these countries. Horacio Levy studies the tradeoff between inequality and growth but also the impact on the distribution of wealth. The Organization for Economic Co-operation and Development (OECD) has 36 member countries and was created to attempt to stimulate economic progress in the world. Levy observes that GDP does not capture the actual economic well-being of households or income inequality as a whole (Levy 7). The author additionally addresses that household income may be a better indicator, but it also does not fully help us understand the view of economic resources available for the individual’s consumption and the household’s wealth. Income and wealth are two separate things, just because a household has a low level of wealth, does not mean that they are poor in income. The household’s with wealth can afford to consume more and have a higher standard of living. Also lower income households tend to spend more of their wealth than high income households. By observing the different demographic groups, we can understand how wealth may be distributed between these different groups and better formulate policies to improve the economic inequalities.

Policy-makers have been more concerned with the importance of the distribution of wealth for the increasing economic inequality between households. Levy finds that, on average, wealth inequality is twice the level of income inequality (Levy 21). The author also finds that, out of the OECD countries, wealth inequality has increased in both the United Kingdom and the United States since the Great Recession which may have to do with fall in house prices and the higher prices of financial assets. Although it is true that income and wealth are not the same, higher income households are more likely to receive a higher inheritance which, in turn, increases their wealth.The higher income households will most likely remain with higher and the lower income households will be unable to accumulate as much wealth, thereby, decreasing the possibility of intergenerational mobility. In essence, the income inequality gap is increasing because the rich are getting richer.

Household wealth is important because it raises long-term consumption and provides financing for entrepreneurial activities. Davies, Sandstrom, Shorrocks and Wolff researched the effects the distribution of wealth throughout countries and how it affects the economic inequality across countries. The authors state that roughly thirty percent of world wealth is found in each of North America, Europe, and the rich Asian-Pacific countries (Davies et al. 5). They are also concerned that wealth may be lowest in the areas that need it the most. Household wealth has more significance in countries without social safety nets and state pension agreements, but the wealth tends to be lower because, without these facilities, household wealth is less compelling and more difficult to obtain (22). Individuals are less inclined to increase their household wealth if there is a possibility that they may lose it, that is why it is essential to have these facilities that act as a safety net.   Therefore, countries that lack these facilities, usually developing countries, lack private wealth when they are the ones who need it the most.

 

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  1. Including the study done by Lindert & Williamson in 2001, a study done in 2000 by Mazur, and the study completed by Dollar & Kraay in 2001 on the debate of globalization and its impact on income polarization and inequality across developing countries.

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