By: Bikal Dhungel
There are already
few articles about inequality in this blog. In one I dealt about the
educational causes of inequality and in others the status of inequality around
the world, historical causes and so on. This article will focus on why
inequality matters for us and what are some of the drawbacks of inequality
measurement tool called Gini-coefficient. Why I combine these two issues is
because Gini-coefficient can be misleading, it might not represent the real
world issues of inequality and biased data might arise which is likely to
induce wrong policy.
To answer the
question of why inequality matters, it is worth rewinding the origin of
inequality quickly. There are basically five reasons of inequality.
1) Luck and the
starting point – Luck is one of the most important determining factors of our
success in life. If we are lucky and were born to rich parents, our likelihood
of having a better life is higher. In the contrary, being born to poor parents
or in a poor country, we are less likely to succeed or face difficulties in
various aspects of life. For example, studies on inequality have shown that
being a woman means earning 21% less in average. Being a Bangladeshi or black African
in the US would mean that you will earn 20% less in average. Being a white and
male would mean that you will earn more. You don’t determine yourself either
you will born to whites or blacks or Asians or South Americans. You luck, which
means, you didn’t choose to belong to a particular group will have a huge
impact in your life. Hence, it is one of the most important factors that will
determine inequality.
2) Childhood and
early life opportunities – It is little bit related to the first point but not
fully. It is not necessary to belong to a rich family. Also when we are in a
country that at least guarantees us education, health and equality of
opportunities, this will predict our better future. A child born in a family
that is not really rich but can afford these things, children will earn more in
the future than those who did not enjoy such privileges. Hence, the inequality
between them will rise. This is why, in countries that guarantees all its
citizens with free education health and opportunities are more equal than those
that could not guarantee.
3) Global Factors –
We live in a globalised world. We are more globalised than any time in history.
But globalization is not without faults. A detailed account of this has been
written on Joseph Stiglitz's book 'Globalisation and its discontents', but also
in many others. One major criticism of globalization is, it has accelerated the
increase of inequality. Firms internationalize and though it might have
increased the total employment rate, inequality has increased. Moreover, the
rise of so called 'Emerging Economics' like China, Brazil and South Africa has
increased inequality. Here exactly I would like to mention why I incorporated
the issue of Gini-coefficient. Though the rise of emerging economies has
increased inequality, this might not be necessarily bad for us. But we will
discuss this later. Then there is the issue of trade liberalisation and
economic liberalization of national economies. This include deregulation, free
trade etc which will help some industries to grow but there are also losers of
free trade and globalization in practice. Once there are additional firms
operating within a country, there will be a shift of labours from agriculture
to manufacturing. This will contribute to growing inequality as well because
the productivity of manufacturing is higher than in agriculture. Hence, those
working in agriculture will be more unequal in comparison to industrial
labourers.
4) National Economic
Form – The form of an economy determines the degree of inequality. For example,
if 20% of the economy consist of financial sector and the remaining
agriculture, the income of this 20% will be very unequal than those working on
fields. In an agricultural economy where largest portion of the population is
subsistence farmers, there will be high equality. Accordingly, we can differentiate
how many percentage of the labour force are engaged in manufacturing or
agriculture of service sector to predict inequality. Levels of unionization
also play a role in it. Trade Unions bargain wages for the workers and avoid
their misuse and ensure that the workers get decent wages for living. This will
reduce inequality. Countries with strong trade unions are typically more equal
than those without.
5) Tax Policy –
Though there are capitalist class, labour class, rich and poor and high
inequality, an appropriate tax policy can reduce inequality. A more progressive
tax policy will reduce inequality because in this system, the more you earn,
the more you pay as tax whereas in the regressive system, the richest get tax
breaks or pay less. When the richer class is also the lawmaker, they would
bring policies that are better for them. One can look at the US. President Bush
for example is a business man. There are many senators who are business
tycoons. Hence they fight for less government, more tax reliefs for big
corporations etc. Consequently, inequality will remain higher. In Western
Europe where there is predominantly progressive tax system, the rich subsidises
the poor and inequality is lower. So, the form of tax policy in a given country
will contribute to the level of inequality.
Having a close look
at the origin of inequality, it will now be easier to analyse why inequality
matters. First is the economy itself. Imagine a country with a regressive tax
system that grants tax reliefs for the ultra-rich and pressures the poor. In
such system, tax collection will be lower. With lower tax collection, they can
invest less in education, infra-structure, health and other sectors that are
fundamental to raise the living standard of the poor. By failing to grant this,
the poor will remain poor and the rich will get richer and richer. This will
affect the economy in long term as most talents go wasted, a phenomenon we see
in a typical developing country. The cause of financial crisis lies in such
culture. The ever widening divide between the rich and poor can fuel societal
violence which we see in the form of street protests all over the world.
The rich reside in a
wealthy neighbourhood whereas the poor will move to the ghettos and go to
school there. This causes a social divide and their chances of rising up
remains low. The distance between the people will be larger and at last result
in even more inequality. From the argument, we can say that inequality impede
equity and social mobility in the long run.
Bad health is
another consequence of inequality. The book called 'Price of inequality' by
Joseph Stiglitz gives a detailed account of the impact on health. Status
anxiety has become a normal problem recently which contributed to ill health of
people. The famous 'Glasgow Effect' shows this in a creative way. Two parts of
the city of Glasgow, one rich and another poor have different health
indicators. In rich part, normal citizens live and in poor part, most drug
addicts and people on benefits. The rich live 77 years on average whereas the
poor less than 65. And then border of these two areas, it can be observed, if
you live 10 meters away to another street, you will live 77 years on average
and if you live in the poor side, your life expectancy will be well below 70. Inequality
will have negative effects on health.
I gave the example
of regressive tax form where the rich pay lower taxes. Another consequence of
having rich individuals is they can have tremendous influence on policy making.
The rich sponsor the political campaign for a certain politician and once he is
elected, he will give his best to bring laws that favours the rich. The rich
then give their best to avoid redistribution of their wealth. Hence, a just
policy is endangered. There will be a democratic deficit when the laws are made
by the rich to fulfil their own interests which are against the will of the
poor. The matter of justice is itself a problem. When a government is not
spending on our children, inequality will be transferred to their generation and
further and further. This is simply not right. Inequality is morally wrong.
Evidences from
developing countries show some psychological effects of inequality. We live in
a society. We compare ourselves with people around us. How much we have
achieved, how much money do we have, how many houses we have etc. It is a
natural phenomenon to compare ourselves with people. But sometimes we cross the
limit to show up. Even we cannot afford a motorcycle, we buy it just to show
our neighbours or friends. Having done that, we are ignoring our other needs.
When a person is
struggling to fulfill the basic needs of his family but buys a motor cycle will
have to abandon things that are necessary. People even fall into debt to
finance this. Hence, the presence of inequality will cause negative societal
effects.
We live in a world
of over 7 billion people with three billion extreme rich , 1 billion extreme
poor and the remaining marching towards the rich. The rich and those marching
towards them are consuming goods at a rate that earth alone cannot sustain.
Researchers say that 4 other Earth is required to keep up with the pace. In
addition to this, food waste is a serious problem in richer world, and of
course obesity. This caused an immense burden on the planet. Inequality
resulted in overconsumption in one part and mal nutrition in the other. Again,
ths means a waste of talents of those who are not being able to bring it out.
Looking at some real
world example, places where there is very high inequality, namely South Africa,
India, few countries of South America, there is high political and economic
instability. In order to avoid any violence, they invest heavy amount in
security, in police and army. The crime rate ig higher and for the rich, it is
difficult to secure their property. As a result, many rich have brought their
wealth to safer countries impacting the economy of places where they are from.
In such a scenario, both rich and poor are affected. That is why, inequality is
bad for everybody.
Now let us move to
the measurement of inequality, the Gini-coefficient. Before we start, let us
underline again that inequality per se is not bad itself rather the particular
kind of inequality that is bad. The Gini-coefficient measures the inequality
among and between nations that gives us a framework for analyzing. But our
analysis based on Gini should be carefully dealt as there are many issues that
Gini doesn’t and cannot answer. So, let us begin with a short introduction of
what is Gini co-efficient.
Gini Co-efficient
and the limits of it
Gini-coefficient
is the measure of income dispersion. It shows the difference between the rich
and poor which we call inequality. When you read that a Gini of a country is 0,
it means there is perfect equality and a Gini of 1 means highest inequality
which implies that one person has all the wealth and another has nothing at
all. In some cases, Gini can even go higher than 1, when the income is negative
for example. Many organisations use in the form of 0 to 100 as well but it is
the same thing when we convert. A Gini index between 0.24 and 0.5 can be
regarded as normal and above that, one can say that the society is unequal. The
statistical data shows that in fact, African countries are most unequal since
most of them have Gini above 0.6. However, it is also important to see before
tax and after tax Gini index. A country can have a Gini index of 0.7 before tax
(highly unequal) but due to better taxation, the income will be redistributed
which will lower the inequality hence moving the Gini index downwards.
Statistics shows that Latin America has the highest Gini after tax. It shows
that inequality and tax systems are not pro poor there. The graphical
representation of Gini could be done with the help of Lorenz Curve which shows
how much wealth does the bottom 10% of the population possess, how much the
next 20% or 10% or so do. When the curve is 45 degree, it means that bottom 10%
possess exactly 10% of wealth, top 20% will possess exactly 20%, meaning everything
is equal. Lower the curve goes in the middle, higher the inequality.
Until now, we
talked about the Gini-coefficient in general. However, it is necessary to be
focused and apply Gini-coefficient in wider area. For example, the
Gini-coefficient of education, Gini of Opportunity, Gini of social mobility etc
will give us a better picture about where the problem lies. If we only focus on
income inequality and try to fight for the cause, we might end up worsening the
situation of a country because income inequality can also rise when one person
works really hard and the other doesn’t work at all. Bill Gates and Steve Jobs didn’t
inherit their wealth, they worked hard for it, they spent lifetime learning and
at last made so much money. Though they possess lots of wealth and drove the
inequality index higher, this is not necessary a bad thing. We all profit from
their idea and innovation. That is why
we should see the Gini of education and opportunity here, either everybody else
had the same education levels or opportunity as Gates and Jobs.
Many newspaper
articles and some academic journals have based their research on the data
represented by Gini-coefficient to explain the issue of inequality. However,
careful examination is required. Let us start from developing countries for
example South Africa which has among the highest Gini index. While Gini index
has risen, the number of poor people has in fact decreased. This is because the
rich are getting richer in a higher pace than the poor. Growth of income of
rich is growing at the rate of 10% annually whereas the income of poor is
growing at the rate of 5%. In this case inequality increased but poverty has
decreased. From this fact, we can conclude that Gini is just a relative and not
an absolute measure. Moreover, socio economic factors like the population
growth, immigration or emigration affects the index as well. Coming back to the
relative and absolute numbers, suppose a country has 10 trillion $ wealth and top
10% have 50% of this amount or 5 trillion. Suppose another country which has 10
million $ as total wealth and also the top 10% have 50% of wealth or 5 million.
The Gini index of both of them will be same. However, we can easily notice that
their wealth is not the same. The Gini index of Afghanistan and Denmark is same
but this doesn’t mean that both of them are equal. Denmark is much richer than
Afghanistan and when we focus on Gini index of Opportunity or Education, people
in Denmark enjoy free education in all levels while people in Afghanistan do
not. Similar examples could be seen in countries like Norway where the Gini
index is low but wealth is very high.
Mathematically,
taking the example of Afghanistan and Denmark, Afghanistan has an unemployment
rate of about 50% and the 50% wealth belongs to the remaining 50% of the
population. In this case, the calculation of Gini would exactly give a
coefficient of 0.5. In Denmark on the other hand top 25% possess 75% of wealth
and lowest 75% people possess only 25% of the wealth. Using the formula to
calculate Gini index, in this case, Denmark will also have the Gini index of
0.5. So, is it the same? Absolutely not. I mentioned the effect of population
growth above. Population growth either by birth or by immigration will affect
inequality. Immigrants either come with lots of wealth or very little wealth to
work, both will affect Gini index. For example the international students come
to Germany, bring their own money to pay for living cost or live in a
subsistence level and the inequality within Germany will rise. However, once
they finish their studies and enter the job market with above average salary,
the Gini will approach to the level it was before their arrival. Calculating
the Gini across ages gives us a picture about the inequality of a country but
it is normal that people are relatively poor in their twenties when they are still
studying or participating in vocational trainings but get slowly richer once
they enter the job market. A country with lots of young people, like the
developing countries these days will show a high Gini index than a country that
has an ageing society like Japan and Western Europe. Which one is good, depends
on your analysis. In the same case, when these young people find no job and
still get poorer in the long term, Gini falls further. Finally, more than half
of developing countries economy is regarded as
informal. There is no monetary value of goods produced, the jobs done in
agriculture are not really regarded as jobs which makes difficult to calculate
their income and hence the inequality level. A household where the husband goes
to work, wife works in the household will have a Gini index of 0.5 but that
they share the income equally cannot be taken into consideration and will bias
our analysis of inequality measure. Informal economy is hard to measure even in
developed countries because there is no data. So, the inequality measures
cannot be fully accurate.
Considering all
the above mentioned facts, it becomes clear that Gini-coefficient cannot and
should not be used as a measure to analyse the inequality within a country. It
can be used to gain a quick overlook but the uses of this should be carefully
examined before making any assumptions. However, the issue of inequality is a
major concern of today that will engage us intensively in the coming decades.
The article started with the origin of inequality, explained why inequality
matters or why it is an important topic and why it is better to have a just
society with fair opportunity for everybody and finally mentioned the limits of
the most important inequality measurement tool. I would like to repeat that
inequality matters but we should be careful with studying it. The wrong use of
instrument will cause fraudulent policy and we all are worse off by this.
Hence, to avoid this catastrophe, we need intelligent tools.
