Economic inequality

For the economic inequality among countries, see international inequality.

See also: Social inequality and Social apartheid

File:Gini Coefficient World CIA Report.svg

Differences in national income equality around the world as measured by the national Gini coefficient. The Gini coefficient is a number between 0 and 1, where 0 corresponds with perfect equality (where everyone has the same income) and 1 corresponds with absolute inequality (where one person has all the income, and everyone else has zero income).

Economic inequality is the difference found in various measures of economic well-being among individuals in a group, among groups in a population, or among countries. Economic inequality is sometimes called income inequality, wealth inequality, or the wealth gap. Economists generally focus on economic disparity in three metrics: wealth, income, and consumption. The issue of economic inequality is relevant to notions of equity, equality of outcome, and equality of opportunity.

Economic inequality varies between societies, historical periods, economic structures and systems. The term can refer to cross-sectional distribution of income or wealth at any particular period, or to changes of income and wealth over longer periods of time. There are various numerical indices for measuring economic inequality. A widely used index is the Gini coefficient, but there are also many other methods.

Some studies say economic inequality is a social problem. E.g., too much inequality can be destructive, because it might hinder long term growth. Too much income equality is also destructive since it decreases the incentive for productivity and the desire to take-on risks and create wealth.

Empirical measurement of inequality

Economists generally consider three metrics of economic dispersion: wealth, income, and consumption. A skilled professional may have low wealth and low income as student, low wealth and high earnings in the beginning of the career, and high wealth and low earnings after the career. People's preferences determine whether they consume earnings immediately or defer consumption to the future. The distinction is also important at the level of economy:

• There are economies with high income inequality and relatively low wealth inequality (such as Japan and Italy).
• There are economies with relatively low income inequality and high wealth inequality (such as Switzerland and Denmark).

There are many different ways to measure income inequality and wealth inequality. Different choices lead to different results. The Organisation for Economic Co-operation and Development (OECD) provides data on the following eight types of income inequality:

• Dispersion of hourly wages among full-time (or full-time equivalent) workers
• Wage dispersion among workers – E.g. annual wages, including wages from part-time work or work during only part of the year.
• Individual earnings inequality among all workers – Includes the self-employed.
• Individual earnings inequality among the entire working-age population – Includes those who are inactive, e.g. students, unemployed, early pensioners, etc.
• Household earnings inequality – Includes the earnings of all household members.
• Household market income inequality – Includes incomes from capital, savings and private transfers.
• Household disposable income inequality – Includes public cash transfers received and direct taxes paid.
• Household adjusted disposable income inequality – Includes publicly provided services.

There are many challenges in comparing data between economies, or in a single economy in different years. Examples of challenges include:

• Data can be based on joint taxation of couples (e.g. France, Germany, Ireland, Netherlands, Portugal and Switzerland) or individual taxation (e.g. Australia, Canada, Italy, Japan, New Zealand, Spain, the UK).
• The tax authorities generally only collect information on income that is potentially taxable.
• The precise definition of gross income varies from country to country. There are differences when it comes to inclusion of pension entitlements and other savings, and benefits such as employer provided health insurance.
• Differences when it comes under-declaration of income and/or wealth in tax filings.
• A special event like an exit from business may lead to a very high income in one year, but much lower income in other years of the person's lifetime.
• Much income and wealth in non-western countries is obtained or held extra-legally through black market and underground activities such as unregistered businesses, informal property ownership arrangements, etc.

Measurements

A 2011 study "Divided we Stand: Why Inequality Keeps Rising” by the Organisation for Economic Co-operation and Development (OECD) investigated economic inequality in OECD countries, including the following factors:

• Changes in the structure of households can play an important role. Single-headed households in OECD countries have risen from an average of 15% in the late 1980s to 20% in the mid-2000s, resulting in higher inequality.
• Assortative mating refers to the phenomenon of people marrying people with similar background, for example doctors marrying doctors rather than nurses. OECD found out that 40% of couples where both partners work belonged to the same or neighbouring earnings deciles compared with 33% some 20 years before.
• In the bottom percentiles number of hours worked has decreased.
• The main reason for increasing inequality seems to be the difference between the demand for and supply of skills.
• Income inequality in OECD countries is at its highest level for the past half century. The ratio between the bottom 10% and the top 10% has increased from 1:7, to 1:9 in 25 years.
• There are tentative signs of a possible convergence of inequality levels towards a common and higher average level across OECD countries.
• With very few exceptions (France, Japan, and Spain), the wages of the 10% best-paid workers have risen relative to those of the 10% lowest paid.

A 2011 OECD study investigated economic inequality in Argentina, Brazil, China, India, Indonesia, Russia and South Africa. It concluded that key sources of inequality in these countries include "a large, persistent informal sector, widespread regional divides (e.g. urban-rural), gaps in access to education, and barriers to employment and career progression for women."

A study by the World Institute for Development Economics Research at United Nations University reports that the richest 1% of adults alone owned 40% of global assets in the year 2000. The three richest people in the world possess more financial assets than the lowest 48 nations combined. The combined wealth of the "10 million dollar millionaires" grew to nearly $41 trillion in 2008. A January 2014 report by Oxfam claims that the 85 wealthiest individuals in the world have a combined wealth equal to that of the bottom 50% of the world's population, or about 3.5 billion people. According to a Los Angeles Times analysis of the report, the wealthiest 1% owns 46% of the world's wealth; the 85 richest people, a small part of the wealthiest 1%, own about 0.7% of the human population's wealth, which is the same as the bottom half of the population. More recently, in January 2015, Oxfam reported that the wealthiest 1 percent will own more than half of the global wealth by 2016. An October 2014 study by Credit Suisse also claims that the top 1% now own nearly half of the world's wealth and that the accelerating disparity could trigger a recession. In October 2015, Credit Suisse published a study which shows global inequality continues to increase, and that half of the world's wealth is now in the hands of those in the top percentile, whose assets each exceed $759,900. A 2016 report by Oxfam claims that the 62 wealthiest individuals own as much wealth as the poorer half of the global population combined. Oxfam's claims have however been questioned on the basis of the methodology used: by using net wealth (adding up assets and subtracting debts), the Oxfam report, for instance, finds that there are more poor people in the United States and Western Europe than in China (due to a greater tendency to take on debts). Anthony Shorrocks, the lead author of the Credit Suisse report which is one of the sources of Oxfam's data, considers the criticism about debt to be a "silly argument" and "a non-issue . . . a diversion."

According to PolitiFact the top 400 richest Americans "have more wealth than half of all Americans combined." According to the New York Times on July 22, 2014, the "richest 1 percent in the United States now own more wealth than the bottom 90 percent". Inherited wealth may help explain why many Americans who have become rich may have had a "substantial head start". In September 2012, according to the Institute for Policy Studies, "over 60 percent" of the Forbes richest 400 Americans "grew up in substantial privilege".

The existing data and estimates suggest a large increase in international (and more generally inter-macroregional) component between 1820 and 1960. It might have slightly decreased since that time at the expense of increasing inequality within countries.

The United Nations Development Programme in 2014 asserted that greater investments in social security, jobs and laws that protect vulnerable populations are necessary to prevent widening income inequality....

There is a significant difference in the measured wealth distribution and the public’s understanding of wealth distribution. Michael Norton of the Harvard Business School and Dan Ariely of the Departement of Psychology at Duke University found this to be true in their research, done in 2011. The actual wealth going to the top quintile in 2011 was around 84% where as the average amount of wealth that the general public estimated to go to the top quintile was around 58%.

Global income inequality is decreasing, due to strong economic growth in developing countries. Income inequality is higher than it has ever been within OECD member nations and is at increased levels in many emerging economies. According to a June 2015 report by the International Monetary Fund:

Widening income inequality is the defining challenge of our time. In advanced economies, the gap between the rich and poor is at its highest level in decades. Inequality trends have been more mixed in emerging markets and developing countries (EMDCs), with some countries experiencing declining inequality, but pervasive inequities in access to education, health care, and finance remain.

Global wealth distribution estimates

Main article: List of countries by distribution of wealth

The following table displays the wealth patterns within countries. The table was created from information provided by the Credit Suisse, Research Institute's "Global Wealth Databook", published 2013.
Country	Adults Thousands	Mean wealth per adult USD	Median wealth per adult USD	Distribution of adults (%) by wealth range (USD)					Gini  %
				under 10K	10K – 100K	100K – 1M	> 1M	Total
Denmark	4,190	255,066	57,675	39.5	17	37.8	5.7	100	107.7
Russian Federation	110,365	10,976	871	93.7	5.6	0.6	0.1	100	93.1
Ukraine	35,912	3,413	419	97.4	2.3	0.2	0	100	90
Kazakhstan	10,958	7,161	1,176	93.1	6.3	0.6	0.1	100	86.7
Lebanon	2,953	30,868	6,076	66.8	29.8	3.2	0.3	100	86.3
United States of America	239,279	301,140	44,911	30.7	33	30.7	5.5	100	85.1
Zimbabwe	6,690	2,913	479	93.9	5.8	0.3	0	100	83.8
Turkey	51,687	25,909	5,326	67	30.3	2.5	0.2	100	83.7
South Africa	31,034	19,613	3,051	72.3	24.9	2.6	0.1	100	83.6
Hong Kong, China	6,052	153,312	32,384	30.3	49.7	18.3	1.7	100	83.1
Philippines	56,730	8,799	1,849	88.1	11.1	0.8	0.1	100	82.9
Indonesia	157,869	11,839	2,393	81.1	17.6	1.3	0.1	100	82.8
Thailand	49,642	7,772	1,855	90.5	8.8	0.6	0	100	82.6
Venezuela	18,991	6,900	1,505	90.9	8.5	0.6	0	100	82.5
Brazil	135,385	23,278	5,117	66.6	30.5	2.7	0.2	100	82.1
Malaysia	18,382	27,007	5,831	61.4	35.3	3.1	0.2	100	81.5
Chile	12,461	49,032	11,742	45	48	6.6	0.4	100	81.4
India	767,612	4,706	1,040	94.4	5.2	0.3	0	100	81.3
Switzerland	6,101	512,562	95,916	5.2	46	38.8	10	100	80.6
Sweden	7,299	299,441	52,677	15.6	48.3	29.2	6.9	100	80.3
Egypt	52,710	7,285	1,852	90.4	9	0.6	0	100	80.3
Nigeria	80,462	3,620	894	94.9	4.9	0.3	0	100	80
Colombia	30,464	26,222	6,228	60.2	35.8	3.9	0.2	100	79.7
Seychelles	54	60,003	14,617	40	50	9.2	0.8	100	79.6
Argentina	28,265	15,638	4,032	72.1	26.1	1.7	0.1	100	79.6
Saudi Arabia	16,694	37,346	9,772	53.3	41.1	5.3	0.3	100	79.3
Namibia	1,256	19,899	4,531	67.5	28.3	4.2	0.1	100	78.7
Israel	4,947	137,351	38,164	30	44.8	23.7	1.5	100	78.7
Comoros	388	2,872	670	93.8	6.1	0.2	0	100	78.7
Cyprus	694	119,568	34,874	23.8	56.3	18.6	1.4	100	78.3
Mexico	73,380	35,872	9,718	53.5	40.6	5.7	0.3	100	78
Norway	3,733	380,473	92,859	19.4	32.5	40.6	7.5	100	77.8
Austria	6,761	203,931	57,450	28.2	31.8	37	3	100	77.8
Libya	4,291	28,397	6,563	58.1	35.7	6	0.1	100	77.7
Botswana	1,181	10,348	2,649	81	17.6	1.4	0	100	77.2
Germany	67,068	192,232	49,370	29	33.3	35.1	2.6	100	77.1
Haiti	5,813	3,532	960	92.3	7.5	0.2	0	100	76.1
Angola	9,273	14,708	3,934	69.1	28.8	2.1	0	100	75.6
Central African Republic	2,370	800	241	99.1	0.9	0	0	100	74.8
Bolivia	5,800	4,604	1,368	89.3	10.4	0.3	0	100	74.4
Zambia	6,151	1,817	548	96.8	3.2	0	0	100	74.1
Czech Republic	8,437	44,975	15,541	40	53.2	6.4	0.3	100	74
Singapore	3,955	281,764	90,466	20	34.2	41.4	4.4	100	73.9
Kuwait	2,291	119,101	42,897	21.8	55.5	21.5	1.2	100	73.8
Poland	30,255	26,056	9,109	55	41.5	3.3	0.1	100	73.7
Taiwan	18,359	151,752	53,336	22.5	45.1	30.8	1.7	100	73.6
Netherlands	12,914	185,588	83,631	23.3	30.9	43.6	2.2	100	73.2
Belize	188	9,998	3,130	76.3	22.6	1.1	0	100	73.1
Suriname	344	14,250	4,544	68.8	29.6	1.6	0	100	73
Nicaragua	3,424	3,432	1,147	92.5	7.3	0.1	0	100	73
Romania	16,692	14,044	5,137	69.3	29.2	1.4	0.1	100	73
Lesotho	1,079	3,457	1,105	92.4	7.5	0.1	0	100	72.9
Paraguay	3,910	10,934	3,726	73.2	25.6	1.3	0	100	72.8
Swaziland	628	4,360	1,393	90	9.8	0.2	0	100	72.7
Panama	2,322	22,292	7,509	57.3	38.5	4.2	0	100	72.7
Rwanda	5,306	723	245	99.3	0.7	0	0	100	72.7
Sao Tome and Principe	86	2,721	959	94.3	5.7	0.1	0	100	72.7
Canada	27,173	251,034	90,252	30	21.5	44.9	3.7	100	72.7
Korea	38,350	79,475	30,938	25.3	59.5	14.5	0.7	100	72.6
Papua New Guinea	3,752	8,470	2,821	81.1	18	0.8	0	100	72.4
Cape Verde	295	16,313	5,478	65	32.5	2.5	0	100	72.3
Antigua and Barbuda	63	19,011	6,281	58.8	38.3	3	0	100	72.2
Costa Rica	3,246	28,124	9,532	54.1	40.2	5.7	0.1	100	72.2
Dominica	50	24,086	8,349	55	40.3	4.7	0.1	100	72
St. Kitts and Nevis	34	23,613	8,185	56.3	39.1	4.6	0.1	100	71.9
St. Vincent and the Grenadines	71	10,196	3,492	73.8	25.1	1.1	0	100	71.9
Grenada	67	14,473	5,017	67.5	30.7	1.7	0	100	71.9
New Zealand	3,234	182,548	76,607	25.6	34.1	38.1	2.3	100	71.8
Ecuador	8,723	12,350	4,403	69.8	28.8	1.4	0	100	71.4
El Salvador	3,738	12,039	4,483	70	28.7	1.3	0	100	71
Ireland	3,488	183,804	75,573	20.9	36.5	40.4	2.2	100	70.9
Kenya	20,757	2,843	1,049	94.2	5.7	0.1	0	100	70.9
Oman	1,872	48,415	18,152	40	47.8	12	0.2	100	70.8
Peru	18,865	18,227	6,705	58.5	38.9	2.6	0	100	70.8
Gambia	908	864	324	99.2	0.8	0	0	100	70.8
Congo-Brazzaville	2,024	3,892	1,420	91.2	8.6	0.1	0	100	70.8
United Arab Emirates	3,777	126,791	51,882	20	50.6	28.2	1.3	100	70.5
Qatar	1,278	153,294	58,237	25	38.3	35	1.7	100	70.5
Portugal	8,614	89,074	38,846	25.8	54.8	18.7	0.8	100	70.1
Mozambique	11,441	811	313	99.3	0.7	0	0	100	70
Jamaica	1,719	11,401	4,393	70	28.8	1.2	0	100	69.9
Uruguay	2,400	47,002	17,998	39.6	48.3	11.9	0.2	100	69.8
Uganda	15,107	750	294	99.4	0.6	0	0	100	69.6
DR Congo	31,854	321	124	99.9	0.1	0	0	100	69.6
China	998,254	22,230	8,023	58.4	39.1	2.4	0.1	100	69.5
Madagascar	10,359	448	177	99.8	0.2	0	0	100	69.4
Guyana	474	3,801	1,506	91.6	8.3	0.1	0	100	69.2
Fiji	523	6,473	2,630	85	14.6	0.4	0	100	69
France	48,124	295,933	141,850	21.7	22.9	50.8	4.6	100	69
Barbados	200	22,289	8,108	55	41.5	3.5	0	100	69
Eritrea	2,781	2,125	875	96.3	3.7	0	0	100	68.9
Macedonia	1,561	11,543	4,743	69.3	29.6	1.1	0	100	68.8
Sierra Leone	2,897	681	273	99.6	0.4	0	0	100	68.8
Ghana	13,501	1,811	743	97.7	2.3	0	0	100	68.6
St. Lucia	119	13,087	5,296	66.3	32.5	1.2	0	100	68.5
Tunisia	7,452	21,084	8,823	55	41.5	3.5	0	100	68.2
Gabon	869	21,860	9,240	55	41.3	3.7	0	100	68.2
Solomon Islands	298	9,868	4,261	73.8	25.3	1	0	100	68.1
Morocco	21,355	11,398	4,750	70	28.9	1.1	0	100	68.1
Côte d'Ivoire	11,501	2,640	1,104	95	4.9	0.1	0	100	68.1
Sri Lanka	14,326	5,033	2,101	87.9	11.9	0.2	0	100	68
Turkmenistan	3,352	36,570	15,305	40	52.1	7.8	0.1	100	68
Georgia	3,172	21,640	9,178	54.7	41.8	3.5	0	100	68
Togo	3,693	2,450	1,049	95.6	4.3	0	0	100	67.9
United Kingdom	48,220	243,570	111,524	18	28.8	50	3.2	100	67.7
Mauritania	1,832	1,967	865	97	3	0	0	100	67.7
Burkina Faso	7,721	1,273	543	98.7	1.3	0	0	100	67.7
Djibouti	508	3,465	1,488	92.8	7.2	0.1	0	100	67.5
Chad	5,485	1,131	483	99	1	0	0	100	67.5
Trinidad and Tobago	987	15,088	6,459	60	38.5	1.5	0	100	67.4
Malawi	7,417	207	89	100	0	0	0	100	67.3
Guinea	5,301	882	380	99.4	0.6	0	0	100	67.3
Iceland	253	211,592	104,733	20	30	47.3	2.7	100	67.3
Tonga	54	15,905	7,217	58.8	39.8	1.5	0	100	67.2
Senegal	6,423	2,597	1,125	95.3	4.7	0	0	100	67.2
Cameroon	10,459	2,603	1,115	95.2	4.8	0	0	100	67.2
Vanuatu	138	6,068	2,753	85	14.7	0.3	0	100	67.1
Benin	4,733	3,187	1,398	93.6	6.3	0.1	0	100	67.1
Samoa	92	34,537	15,132	40	53	6.9	0.1	100	67
Cambodia	9,151	2,644	1,155	95	4.9	0	0	100	67
Yemen	12,192	4,951	2,193	88.3	11.6	0.2	0	100	66.8
Iran	53,270	8,727	3,846	75	24.4	0.6	0	100	66.8
Liberia	2,118	2,173	987	96.5	3.5	0	0	100	66.7
Tanzania	22,038	951	423	99.3	0.7	0	0	100	66.6
Laos	3,618	5,393	2,411	86.7	13.1	0.2	0	100	66.5
Lithuania	2,537	23,411	10,635	47.5	48.5	3.9	0	100	66.5
Myanmar	34,180	2,214	941	97	3	0	0	100	66.4
Finland	4,195	171,821	95,095	29	22.3	47.2	1.6	100	66.4
Maldives	210	5,556	2,480	85	14.8	0.2	0	100	66.3
Bahamas	242	41,106	17,842	35	55.9	9	0.1	100	66.2
Spain	37,206	123,997	63,306	17.4	52.4	29	1.1	100	66.1
Mongolia	1,855	14,214	6,433	61.1	37.6	1.3	0	100	66.1
Syrian Arab Republic	13,352	7,073	3,198	82.7	16.9	0.4	0	100	66
Latvia	1,787	24,285	11,338	45	50.9	4	0	100	66
Greece	9,105	102,971	53,937	20.4	53.7	25.1	0.8	100	65.9
Jordan	3,858	14,364	6,589	60.3	38.3	1.4	0	100	65.9
Kyrgyz Republic	3,568	5,385	2,432	85.9	13.9	0.2	0	100	65.9
Viet Nam	61,765	4,857	2,215	87.8	12	0.2	0	100	65.8
West Bank and Gaza	1,739	8,979	4,200	73.1	26.3	0.6	0	100	65.8
Equatorial Guinea	365	19,525	9,130	55	42.6	2.4	0	100	65.8
Bosnia and Herzegovina	2,985	11,173	5,139	68.2	30.9	0.9	0	100	65.8
Luxembourg	390	315,240	182,768	15	22.5	57	5.5	100	65.7
Estonia	1,055	33,701	15,724	40	53.3	6.6	0.1	100	65.7
Guinea-Bissau	836	424	199	99.9	0.1	0	0	100	65.7
Albania	2,237	9,450	4,451	72.7	26.6	0.7	0	100	65.6
Niger	7,014	937	434	99.3	0.7	0	0	100	65.5
Algeria	23,982	10,100	4,673	70	29.2	0.7	0	100	65.5
Sudan	23,811	1,291	595	98.9	1.1	0	0	100	65.4
Burundi	4,729	293	137	99.9	0.1	0	0	100	65.2
Azerbaijan	6,276	16,344	7,721	57.1	41.4	1.5	0	100	65.1
Croatia	3,498	26,551	12,639	41.2	54.1	4.7	0	100	65.1
Italy	49,117	241,383	138,653	20	20.5	56.5	3	100	65
Mali	6,464	955	455	99.4	0.6	0	0	100	64.7
Moldova	2,692	3,854	1,874	91.8	8.1	0.1	0	100	64.7
Nepal	17,273	1,998	951	97.7	2.3	0	0	100	64.7
Bangladesh	104,135	1,894	908	97.9	2.1	0	0	100	64.6
Mauritius	935	37,308	19,247	40	52.5	7.4	0.1	100	64.5
Hungary	7,915	28,379	14,068	40	55	4.9	0	100	64
Armenia	2,263	5,613	2,793	85.5	14.3	0.2	0	100	63.9
Tajikistan	4,022	3,168	1,581	94.3	5.7	0.1	0	100	63.8
Pakistan	106,365	4,248	2,106	90.8	9	0.1	0	100	63.8
Ethiopia	42,750	411	207	99.9	0.1	0	0	100	63.6
Australia	16,617	402,578	219,505	6.9	23.7	62.6	6.8	100	63.6
Japan	104,315	216,694	110,294	9.2	37.7	50.6	2.5	100	63.5
Montenegro	467	21,340	10,929	45	52.6	2.4	0	100	63.4
Belgium	8,387	255,573	148,141	17.4	22.1	57.3	3.2	100	62.6
Serbia	7,527	15,175	7,978	56.8	42	1.3	0	100	62.5
Bulgaria	5,991	16,818	8,825	55.2	43.4	1.4	0	100	62.5
Belarus	7,543	2,407	1,271	96.8	3.1	0	0	100	62.2
Malta	330	71,448	42,898	18.8	65	15.9	0.3	100	59.5
Bahrain	571	44,822	26,675	28.7	60	11.2	0	100	58.5
Brunei Darussalam	286	51,373	31,527	26.2	58.7	15	0	100	58.5
Slovenia	1,655	64,067	44,932	19.4	60.6	19.9	0.1	100	53.5
Slovakia	4,303	27,224	20,740	19.8	77.8	2.4	0	100	44.7

Causes

There are many reasons for economic inequality within societies. Recent growth in overall income inequality, at least within the OECD countries, has been driven mostly by increasing inequality in wages and salaries.

Economist Thomas Piketty, who specializes in the study of economic inequality, argues that widening economic disparity is an inevitable phenomenon of free market capitalism when the rate of return of capital (r) is greater than the rate of growth of the economy (g).

Common factors thought to impact economic inequality include:

• labor market outcomes
• globalization, by:
  • suppressing wages in low-skill jobs due to a surplus of low-skill labor in developing countries
  • increasing the market size and the rewards for people and firms succeeding in a particular niche
  • providing more investment opportunities for already-wealthy people
  • increasing international influence [3]
  • decreasing domestic influence [4]
• policy reforms
• extra-legal ownership of property (real estate and business)
• more regressive taxation
• plutocracy
• computerization, automation and increased technology, which means more skills are required to obtain a moderate or high wage
• ethnic discrimination
• gender discrimination
• nepotism
• variation in natural ability
• neoliberalism
• Growing acceptance of very high CEO salaries, e.g. in the United States since the 1960s
• Land speculation- Followers of Henry george believe that landlords and land speculators derive excess wealth and income from the tendency of land to increase exponentially with development and at a much higher rate than population growth. Their solution is to tax land value, though not necessarily structures or other improvements. This concept is known as Georgism.

Theoretical frameworks

Neoclassical economics

Neoclassical economics views inequalities in the distribution of income as arising from differences in value added by labor, capital and land. Within labor income distribution is due to differences in value added by different classifications of workers. In this perspective, wages and profits are determined by the marginal value added of each economic actor (worker, capitalist/business owner, landlord). Thus, in a market economy, inequality is a reflection of the productivity gap between highly-paid professions and lower-paid professions.

Marxian economics

Marxian economics attributes rising inequality to job automation and capital deepening within capitalism. The process of job automation conflicts with the capitalist property form and its attendant system of wage labor.

In Marxian analysis, capitalist firms increasingly substitute capital equipment for labor inputs (workers) under competitive pressure to reduce costs and maximize profits. Over the long-term, this trend increases the organic composition of capital, meaning that less workers are required in proportion to capital inputs, increasing unemployment (the "reserve army of labour"). This process exerts a downward pressure on wages. The substitution of capital equipment for labor (mechanization and automation) raises the productivity of each worker, resulting in a situation of relatively stagnant wages for the working class amidst rising levels of property income for the capitalist class.

Labour market

A major cause of economic inequality within modern market economies is the determination of wages by the market. Where competition is imperfect; information unevenly distributed; opportunities to acquire education and skills unequal market failure results.Since many such imperfect conditions exist in virtually every market, there is in fact little presumption that markets are in general efficient. This means that there is an enormous potential role for government to correct such market failures.

In a purely capitalist mode of production (i.e. where professional and labor organizations cannot limit the number of workers) the workers wages will not be controlled by these organizations, or by the employer, but rather by the market. Wages work in the same way as prices for any other good. Thus, wages can be considered as a function of market price of skill. And therefore, inequality is driven by this price. Under the law of supply and demand, the price of skill is determined by a race between the demand for the skilled worker and the supply of the skilled worker. "On the other hand, markets can also concentrate wealth, pass environmental costs on to society, and abuse workers and consumers." "Markets, by themselves, even when they are stable, often lead to high levels of inequality, outcomes that are widely viewed as unfair." Employers who offer a below market wage will find that their business is chronically understaffed. Their competitors will take advantage of the situation by offering a higher wage the best of their labor. For a businessman who has the profit motive as the prime interest, it is a losing proposition to offer below or above market wages to workers.

A job where there are many workers willing to work a large amount of time (high supply) competing for a job that few require (low demand) will result in a low wage for that job. This is because competition between workers drives down the wage. An example of this would be jobs such as dish-washing or customer service. Competition amongst workers tends to drive down wages due to the expendable nature of the worker in relation to his or her particular job. A job where there are few able or willing workers (low supply), but a large need for the positions (high demand), will result in high wages for that job. This is because competition between employers for employees will drive up the wage. Examples of this would include jobs that require highly developed skills, rare abilities, or a high level of risk. Competition amongst employers tends to drive up wages due to the nature of the job, since there is a relative shortage of workers for the particular position. Professional and labor organizations may limit the supply of workers which results in higher demand and greater incomes for members. Members may also receive higher wages through collective bargaining, political influence, or corruption.

These supply and demand interactions result in a gradation of wage levels within society that significantly influence economic inequality. Polarization of wages does not explain the accumulation of wealth and very high incomes among the 1%. Joseph Stiglitz believes that "It is plain that markets must be tamed and tempered to make sure they work to the benefit of most citizens."

On the other hand, higher economic inequality tends to increase entrepreneurship rates at the individual level (self-employment). However, most of it is often based on necessity rather than opportunity. Necessity-based entrepreneurship is motivated by survival needs such as income for food and shelter ("push" motivations), whereas opportunity-based entrepreneurship is driven by achievement-oriented motivations ("pull") such as vocation and more likely to involve the pursue of new products, services, or underserved market needs. The economic impact of the former type of entrepreneurialism tends to be redistributive while the latter is expected to foster technological progress and thus have a more positive impact on economic growth.

Taxes

Another cause is the rate at which income is taxed coupled with the progressivity of the tax system. A progressive tax is a tax by which the tax rate increases as the taxable base amount increases. In a progressive tax system, the level of the top tax rate will often have a direct impact on the level of inequality within a society, either increasing it or decreasing it, provided that income does not change as a result of the change in tax regime. Additionally, steeper tax progressivity applied to social spending can result in a more equal distribution of income across the board. The difference between the Gini index for an income distribution before taxation and the Gini index after taxation is an indicator for the effects of such taxation.

There is debate between politicians and economists over the role of tax policy in mitigating or exacerbating wealth inequality. Economists such as Paul Krugman, Peter Orszag, and Emmanuel Saez have argued that tax policy in the post World War II era has indeed increased income inequality by enabling the wealthiest Americans far greater access to capital than lower-income ones.

Education

Illustration from a 1916 advertisement for a vocational school in the back of a US magazine. Education has been seen as a key to higher income, and this advertisement appealed to Americans' belief in the possibility of self-betterment, as well as threatening the consequences of downward mobility in the great income inequality existing during the Industrial Revolution.

An important factor in the creation of inequality is variation in individuals' access to education. Education, especially in an area where there is a high demand for workers, creates high wages for those with this education, however, increases in education first increase and then decrease growth as well as income inequality. As a result, those who are unable to afford an education, or choose not to pursue optional education, generally receive much lower wages. The justification for this is that a lack of education leads directly to lower incomes, and thus lower aggregate savings and investment. Conversely, education raises incomes and promotes growth because it helps to unleash the productive potential of the poor.

In 2014, economists with the Standard & Poor's rating agency concluded that the widening disparity between the U.S.'s wealthiest citizens and the rest of the nation had slowed its recovery from the 2008-2009 recession and made it more prone to boom-and-bust cycles. To partially remedy the wealth gap and the resulting slow growth, S&P recommended increasing access to education. It estimated that if the average United States worker had completed just one more year of school, it would add an additional $105 billion in growth to the country's economy over five years.

During the mass high school education movement from 1910–1940, there was an increase in skilled workers, which led to a decrease in the price of skilled labor. High school education during the period was designed to equip students with necessary skill sets to be able to perform at work. In fact, it differs from the present high school education, which is regarded as a stepping-stone to acquire college and advanced degrees. This decrease in wages caused a period of compression and decreased inequality between skilled and unskilled workers. Education is very important for the growth of the economy, however educational inequality in gender also influence towards the economy. Lagerlof and Galor stated that gender inequality in education can result to low economic growth, and continued gender inequality in education, thus creating a poverty trap. It is suggested that a large gap in male and female education may indicate backwardness and so may be associated with lower economic growth, which can explain why there is economic inequality between countries.

More of Barro studies also find that female secondary education is positively associated with growth. His findings show that countries with low female education; increasing it has little effect on economic growth, however in countries with high female education, increasing it significantly boosts economic growth. More and better education is a prerequisite for rapid economic development around the world. Education stimulates economic growth and improves people's lives through many channels.

By increasing the efficiency of the labour force it create better conditions for good governance, improving health and enhancing equality. Labor market success is linked to schooling achievement, the consequences of widening disparities in schooling is likely to be further increases in earnings inequality

The United States funds education through property taxes, which can lead to large discrepancies in the amount of funding a public school may receive. Often, but not always, this results in more funding for schools attended by children from wealthier parents. As of 2015 the United States, Israel, and Turkey are the only three OECD countries where the government spends more on schools in rich neighborhoods than in poor neighborhoods.

Economic liberalism, deregulation and decline of unions

John Schmitt and Ben Zipperer (2006) of the CEPR point to economic liberalism and the reduction of business regulation along with the decline of union membership as one of the causes of economic inequality. In an analysis of the effects of intensive Anglo-American liberal policies in comparison to continental European liberalism, where unions have remained strong, they concluded "The U.S. economic and social model is associated with substantial levels of social exclusion, including high levels of income inequality, high relative and absolute poverty rates, poor and unequal educational outcomes, poor health outcomes, and high rates of crime and incarceration. At the same time, the available evidence provides little support for the view that U.S.-style labor-market flexibility dramatically improves labor-market outcomes. Despite popular prejudices to the contrary, the U.S. economy consistently affords a lower level of economic mobility than all the continental European countries for which data is available."

Sociologist Jake Rosenfield of the University of Washington asserts that the decline of organized labor in the United States has played a more significant role in expanding the income gap than technological changes and globalization, which were also experienced by other industrialized nations that didn't experience steep surges in inequality. He points out that nations with high rates of unionization, particularly in Scandinavia, have very low levels of inequality, and concludes "the historical pattern is clear; the cross-national pattern is clear: high inequality goes hand-in-hand with weak labor movements and vice-versa."

A 2015 study by the International Monetary Fund found that the decline of unionization in many advanced economies starting in the 1980s has fueled rising income inequality.

Globalization

Trade liberalization may shift economic inequality from a global to a domestic scale. When rich countries trade with poor countries, the low-skilled workers in the rich countries may see reduced wages as a result of the competition, while low-skilled workers in the poor countries may see increased wages. Trade economist Paul Krugman estimates that trade liberalisation has had a measurable effect on the rising inequality in the United States. He attributes this trend to increased trade with poor countries and the fragmentation of the means of production, resulting in low skilled jobs becoming more tradeable. However, he concedes that the effect of trade on inequality in America is minor when compared to other causes, such as technological innovation, a view shared by other experts. Empirical economists Max Roser and Jesus Crespo-Cuaresma find support in the data that international trade is increasing income inequality. They empirically confirm the predictions of the Stolper–Samuelson theorem regarding the effects of international trade on the distribution of incomes. Lawrence Katz estimates that trade has only accounted for 5-15% of rising income inequality. Robert Lawrence argues that technological innovation and automation has meant that low-skilled jobs have been replaced by machine labor in wealthier nations, and that wealthier countries no longer have significant numbers of low-skilled manufacturing workers that could be affected by competition from poor countries.

Gender

File:OECD Gender Pay Gap.001.png

The gender gap in median earnings of full-time employees according to the OECD 2008

In many countries, there is a Gender pay gap in favor of males in the labor market. Several factors other than discrimination may contribute to this gap. On average, women are more likely than men to consider factors other than pay when looking for work, and may be less willing to travel or relocate. Thomas Sowell, in his book Knowledge and Decisions, claims that this difference is due to women not taking jobs due to marriage or pregnancy, but income studies show that that does not explain the entire difference. A U.S. Census's report stated that in US once other factors are accounted for there is still a difference in earnings between women and men. The income gap in other countries ranges from 53% in Botswana to -40% in Bahrain.

Gender inequality and discrimination is argued to cause and perpetuate poverty and vulnerability in society as a whole. Gender Equity Indices seek to provide the tools to demonstrate this feature of equity.

19th century socialists like Robert Owen, William Thompson, Anna Wheeler and August Bebel argued that the economic inequality between genders was the leading cause of economic inequality; however Karl Marx and Fredrick Engels believed that the inequality between social classes was the larger cause of inequality.

Economic development

File:Kuznets curve.png

A Kuznets curve

Main article: Kuznets curve

Economist Simon Kuznets argued that levels of economic inequality are in large part the result of stages of development. According to Kuznets, countries with low levels of development have relatively equal distributions of wealth. As a country develops, it acquires more capital, which leads to the owners of this capital having more wealth and income and introducing inequality. Eventually, through various possible redistribution mechanisms such as social welfare programs, more developed countries move back to lower levels of inequality.

Plotting the relationship between level of income and inequality, Kuznets saw middle-income developing economies level of inequality bulging out to form what is now known as the Kuznets curve. Kuznets demonstrated this relationship using cross-sectional data. However, more recent testing of this theory with superior panel data has shown it to be very weak. Kuznets' curve predicts that income inequality will eventually decrease given time. As an example, income inequality did fall in the United States during its High school movement from 1910 to 1940 and thereafter. However, recent data shows that the level of income inequality began to rise after the 1970s. This does not necessarily disprove Kuznets' theory. It may be possible that another Kuznets' cycle is occurring, specifically the move from the manufacturing sector to the service sector. This implies that it may be possible for multiple Kuznets' cycles to be in effect at any given time.

Individual preferences

Related to cultural issues, diversity of preferences within a society may contribute to economic inequality. When faced with the choice between working harder to earn more money or enjoying more leisure time, equally capable individuals with identical earning potential may choose different strategies. The trade-off between work and leisure is particularly important in the supply side of the labor market in labor economics.

Likewise, individuals in a society often have different levels of risk aversion. When equally-able individuals undertake risky activities with the potential of large payoffs, such as starting new businesses, some ventures succeed and some fail. The presence of both successful and unsuccessful ventures in a society results in economic inequality even when all individuals are identical.

Wealth concentration

Main article: Wealth concentration

Wealth concentration is a theoretical process by which, under certain conditions, newly created wealth concentrates in the possession of already-wealthy individuals or entities. According to this theory, those who already hold wealth have the means to invest in new sources of creating wealth or to otherwise leverage the accumulation of wealth, thus are the beneficiaries of the new wealth. Over time, wealth condensation can significantly contribute to the persistence of inequality within society. Thomas Piketty in his book Capital in the Twenty-First Century argues that the fundamental force for divergence is the usually greater return of capital (r) than economic growth (g), and that larger fortunes generate higher returns [pp. 384 Table 12.2, U.S. university endowment size vs. real annual rate of return]

Rent seeking

Economist Joseph Stiglitz argues that rather than explaining concentrations of wealth and income, market forces should serve as a brake on such concentration, which may better be explained by the non-market force known as "rent-seeking". While the market will bid up compensation for rare and desired skills to reward wealth creation, greater productivity, etc., it will also prevent successful entrepreneurs from earning excess profits by fostering competition to cut prices, profits and large compensation. A better explainer of growing inequality, according to Stiglitz, is the use of political power generated by wealth by certain groups to shape government policies financially beneficial to them. This process, known to economists as rent-seeking, brings income not from creation of wealth but from "grabbing a larger share of the wealth that would otherwise have been produced without their effort"

Rent seeking is often thought to be the province of societies with weak institutions and weak rule of law, but Stiglitz believes there is no shortage of it in developed societies such as the United States. Examples of rent seeking leading to inequality include

• the obtaining of public resources by "rent-collectors" at below market prices (such as granting public land to railroads, or selling mineral resources for a nominal price in the US),
• selling services and products to the public at above market prices (medicare drug benefit in the US that prohibits government from negotiating prices of drugs with the drug companies, costing the US government an estimated $50 billion or more per year),
• securing government tolerance of monopoly power (The richest person in the world in 2011, Carlos Slim, controlled Mexico's newly privatized telecommunication industry).

Since rent seeking aims to "pluck the goose to obtain the largest amount of feathers with the least possible amount of hissing" – it is by nature obscure, avoiding public spotlight in legal fine print, or camouflaged its extraction with widely accepted rationalizations (markets are naturally competitive and so need no government regulation against monopolies).

Finance industry

Jamie Galbraith argues that countries with larger financial sectors have greater inequality, and the link is not an accident.

Effects

File:Contraste (5401613082) (2).jpg

Buildings in Rio de Janeiro, demonstrating economic inequality

Effects of inequality researchers have found include higher rates of health and social problems, and lower rates of social goods, a lower level of economic utility in society from resources devoted on high-end consumption, and even a lower level of economic growth when human capital is neglected for high-end consumption. For the top 21 industrialised countries, counting each person equally, life expectancy is lower in more unequal countries (r = -.907). A similar relationship exists among US states (r = -.620).

2013 Economics Nobel prize winner Robert J. Shiller said that rising inequality in the United States and elsewhere is the most important problem. Increasing inequality harms economic growth. High and persistent unemployment, in which inequality increases, has a negative effect on subsequent long-run economic growth. Unemployment can harm growth not only because it is a waste of resources, but also because it generates redistributive pressures and subsequent distortions, drives people to poverty, constrains liquidity limiting labor mobility, and erodes self-esteem promoting social dislocation, unrest and conflict. Policies aiming at controlling unemployment and in particular at reducing its inequality-associated effects support economic growth.

The economic stratification of society into "elites" and "masses" played a central role in the collapse of other advanced civilizations such as the Roman, Han and Gupta empires.

Health

British researchers Richard G. Wilkinson and Kate Pickett have found higher rates of health and social problems (obesity, mental illness, homicides, teenage births, incarceration, child conflict, drug use), and lower rates of social goods (life expectancy by country, educational performance, trust among strangers, women's status, social mobility, even numbers of patents issued) in countries and states with higher inequality. Using statistics from 23 developed countries and the 50 states of the US, they found social/health problems lower in countries like Japan and Finland and states like Utah and New Hampshire with high levels of equality, than in countries (US and UK) and states (Mississippi and New York) with large differences in household income.

Income inequality and mortality in 282 metropolitan areas of the United States. Mortality is strongly associated with higher income inequality, but, within levels of income inequality, not with per capita income.

For most of human history higher material living standards – full stomachs, access to clean water and warmth from fuel – led to better health and longer lives. This pattern of higher incomes-longer lives still holds among poorer countries, where life expectancy increases rapidly as per capita income increases, but in recent decades it has slowed down among middle income countries and plateaued among the richest thirty or so countries in the world. Americans live no longer on average (about 77 years in 2004) than Greeks (78 years) or New Zealanders (78), though the USA has a higher GDP per capita. Life expectancy in Sweden (80 years) and Japan (82) – where income was more equally distributed – was longer.

In recent years the characteristic that has strongly correlated with health in developed countries is income inequality. Creating an index of "Health and Social Problems" from nine factors, authors Richard Wilkinson and Kate Pickett found health and social problems "more common in countries with bigger income inequalities", and more common among states in the US with larger income inequalities. Other studies have confirmed this relationship. The UNICEF index of "child well-being in rich countries", studying 40 indicators in 22 countries, correlates with greater equality but not per capita income.

Pickett and Wilkinson argue that inequality and social stratification lead to higher levels of psychosocial stress and status anxiety which can lead to depression, chemical dependency, less community life, parenting problems and stress-related diseases.

Social cohesion

Further information: Social cohesion

Research has shown an inverse link between income inequality and social cohesion. In more equal societies, people are much more likely to trust each other, measures of social capital (the benefits of goodwill, fellowship, mutual sympathy and social connectedness among groups who make up a social units) suggest greater community involvement, and homicide rates are consistently lower.

Comparing results from the question "would others take advantage of you if they got the chance?" in U.S General Social Survey and statistics on income inequality, Eric Uslaner and Mitchell Brown found there is a high correlation between the amount of trust in society and the amount of income equality. A 2008 article by Andersen and Fetner also found a strong relationship between economic inequality within and across countries and tolerance for 35 democracies.

In two studies Robert Putnam established links between social capital and economic inequality. His most important studies established these links in both the United States and in Italy. His explanation for this relationship is that

Community and equality are mutually reinforcing... Social capital and economic inequality moved in tandem through most of the twentieth century. In terms of the distribution of wealth and income, America in the 1950s and 1960s was more egalitarian than it had been in more than a century... [T]hose same decades were also the high point of social connectedness and civic engagement. Record highs in equality and social capital coincided. Conversely, the last third of the twentieth century was a time of growing inequality and eroding social capital... The timing of the two trends is striking: somewhere around 1965–70 America reversed course and started becoming both less just economically and less well connected socially and politically.

Albrekt Larsen has advanced this explanation by a comparative study of how trust increased in Denmark and Sweden in the latter part of the 20th century while it decreased in the US and UK. It is argued that inequality levels influence how citizens imagine the trustworthiness of fellow citizens. In this model social trust is not about relations to people you meet (as in Putnam's model) but about people you imagine.

The economist Joseph Stiglitz has argued that economic inequality has led to distrust of business and government.

Crime

Crime rate has also been shown to be correlated with inequality in society. Most studies looking into the relationship have concentrated on homicides – since homicides are almost identically defined across all nations and jurisdictions. There have been over fifty studies showing tendencies for violence to be more common in societies where income differences are larger. Research has been conducted comparing developed countries with undeveloped countries, as well as studying areas within countries. Daly et al. 2001 found that among U.S States and Canadian Provinces there is a tenfold difference in homicide rates related to inequality. They estimated that about half of all variation in homicide rates can be accounted for by differences in the amount of inequality in each province or state. Fajnzylber et al. (2002) found a similar relationship worldwide. Among comments in academic literature on the relationship between homicides and inequality are:

• The most consistent finding in cross-national research on homicides has been that of a positive association between income inequality and homicides.
• Economic inequality is positively and significantly related to rates of homicide despite an extensive list of conceptually relevant controls. The fact that this relationship is found with the most recent data and using a different measure of economic inequality from previous research, suggests that the finding is very robust.

A 2016 study, controlling for different factors than previous studies, challenges the aforementioned findings. The study finds "little evidence of a significant empirical link between overall inequality and crime", and that "the previously reported positive correlation between violent crime and economic inequality is largely driven by economic segregation across neighborhoods instead of within-neighborhood inequality".

Social, cultural, and civic participation

Higher income inequality led to less of all forms of social, cultural, and civic participation among the less wealthy. When inequality is higher the poor do not shift to less expensive forms of participation.

Utility, economic welfare, and distributive efficiency

Following the utilitarian principle of seeking the greatest good for the greatest number – economic inequality is problematic. A house that provides less utility to a millionaire as a summer home than it would to a homeless family of five, is an example of reduced "distributive efficiency" within society, that decreases marginal utility of wealth and thus the sum total of personal utility. An additional dollar spent by a poor person will go to things providing a great deal of utility to that person, such as basic necessities like food, water, and healthcare; while, an additional dollar spent by a much richer person will very likely go to luxury items providing relatively less utility to that person. Thus, the marginal utility of wealth per person ("the additional dollar") decreases as a person becomes richer. From this standpoint, for any given amount of wealth in society, a society with more equality will have higher aggregate utility. Some studies have found evidence for this theory, noting that in societies where inequality is lower, population-wide satisfaction and happiness tend to be higher.

Economist Arthur Cecil Pigou argues that

... it is evident that any transference of income from a relatively rich man to a relatively poor man of similar temperament, since it enables more intense wants, to be satisfied at the expense of less intense wants, must increase the aggregate sum of satisfaction. The old "law of diminishing utility" thus leads securely to the proposition: Any cause which increases the absolute share of real income in the hands of the poor, provided that it does not lead to a contraction in the size of the national dividend from any point of view, will, in general, increase economic welfare.

Philosopher David Schmidtz argues that maximizing the sum of individual utilities will harm incentives to produce.

A society that takes Joe Rich’s second unit [of corn] is taking that unit away from someone who . . . has nothing better to do than plant it and giving it to someone who . . . does have something better to do with it. That sounds good, but in the process, the society takes seed corn out of production and diverts it to food, thereby cannibalizing itself.

However, in addition to the diminishing marginal utility of unequal distribution, Pigou and others point out that a "keeping up with the Joneses" effect among the well off may lead to greater inequality and use of resources for no greater return in utility.

a larger proportion of the satisfaction yielded by the incomes of rich people comes from their relative, rather than from their absolute, amount. This part of it will not be destroyed if the incomes of all rich people are diminished together. The loss of economic welfare suffered by the rich when command over resources is transferred from them to the poor will, therefore, be substantially smaller relatively to the gain of economic welfare to the poor than a consideration of the law of diminishing utility taken by itself suggests.

When the goal is to own the biggest yacht – rather than a boat with certain features – there is no greater benefit from owning 100 metre long boat than a 20 m one as long as it is bigger than your rival. Economist Robert H. Frank compare the situation to that of male elks who use their antlers to spar with other males for mating rights.

The pressure to have bigger ones than your rivals leads to an arms race that consumes resources that could have been used more efficiently for other things, such as fighting off disease. As a result, every male ends up with a cumbersome and expensive pair of antlers, ... and "life is more miserable for bull elk as a group."

Aggregate demand, consumption and debt

Some economists, such as Alfred Pigou, have argued that income inequality lowers aggregate demand, leading to increasingly large segments of formerly middle class consumers unable to afford as many luxury and essential goods and services. This pushes production and overall employment down.

Conservative researchers have argued that income inequality is not significant because consumption, rather than income should be the measure of inequality, and inequality of consumption is less extreme than inequality of income in the US. Will Wilkinson of the libertarian Cato Institute states that "the weight of the evidence shows that the run-up in consumption inequality has been considerably less dramatic than the rise in income inequality," and consumption is more important than income. According to Johnson, Smeeding, and Tory, consumption inequality was actually lower in 2001 than it was in 1986. The debate is summarized in "The Hidden Prosperity of the Poor" by journalist Thomas B. Edsall. Other studies have not found consumption inequality less dramatic than household income inequality, and the CBO's study found consumption data not "adequately" capturing "consumption by high-income households" as it does their income, though it did agree that household consumption numbers show more equal distribution than household income.

Others dispute the importance of consumption over income, pointing out that if middle and lower income are consuming more than they earn it is because they are saving less or going deeper into debt. Income inequality has been the driving factor in the growing household debt, as high earners bid up the price of real estate and middle income earners go deeper into debt trying to maintain what once was a middle class lifestyle.

Central Banking economist Raghuram Rajan argues that "systematic economic inequalities, within the United States and around the world, have created deep financial 'fault lines' that have made [financial] crises more likely to happen than in the past" – the Financial crisis of 2007–08 being the most recent example. To compensate for stagnating and declining purchasing power, political pressure has developed to extend easier credit to the lower and middle income earners – particularly to buy homes – and easier credit in general to keep unemployment rates low. This has given the American economy a tendency to go "from bubble to bubble" fueled by unsustainable monetary stimulation.

Monopolization of labor, consolidation, and competition

Greater income inequality can lead to monopolization of the labor force, resulting in fewer employers requiring fewer workers. Remaining employers can consolidate and take advantage of the relative lack of competition, leading to less consumer choice, market abuses, and relatively higher real prices.

Economic incentives

Some economists believe that one of the main reasons that inequality might induce economic incentive is because material well-being and conspicuous consumption relate to status. In this view, high stratification of income (high inequality) creates high amounts of social stratification, leading to greater competition for status.

One of the first writers to note this relationship, Adam Smith, recognized "regard" as one of the major driving forces behind economic activity. From The Theory of Moral Sentiments in 1759:

[W]hat is the end of avarice and ambition, of the pursuit of wealth, of power, and pre-eminence? Is it to supply the necessities of nature? The wages of the meanest labourer can supply them... [W]hy should those who have been educated in the higher ranks of life, regard it as worse than death, to be reduced to live, even without labour, upon the same simple fare with him, to dwell under the same lowly roof, and to be clothed in the same humble attire? From whence, then, arises that emulation which runs through all the different ranks of men, and what are the advantages which we propose by that great purpose of human life which we call bettering our condition? To be observed, to be attended to, to be taken notice of with sympathy, complacency, and approbation, are all the advantages which we can propose to derive from it. It is the vanity, not the ease, or the pleasure, which interests us.

Modern sociologists and economists such as Juliet Schor and Robert H. Frank have studied the extent to which economic activity is fueled by the ability of consumption to represent social status. Schor, in The Overspent American, argues that the increasing inequality during the 1980s and 1990s strongly accounts for increasing aspirations of income, increased consumption, decreased savings, and increased debt.

In the book Luxury Fever, Robert H. Frank argues that satisfaction with levels of income is much more strongly affected by how someone's income compares with others than its absolute level. Frank gives the example of instructions to a yacht architect by a customer – shipping magnate Stavros Niarchos – to make Niarchos' new yacht 50 feet longer than that of rival magnate Aristotle Onassis. Niarchos did not specify or reportedly even know the exact length of Onassis's yacht.

Economic growth

Main article: Economic growth

A 1999 review in the Journal of Economic Literature states high inequality lowers growth, perhaps because it increases social and political instability. The article also says:

Somewhat unusually for the growth literature, studies have tended to concur in finding a negative effect of high inequality on subsequent growth. The evidence has not been accepted by all: some writers point out the concentration of richer countries at the lower end of the inequality spectrum, the poor quality of the distribution data, and the lack of robustness to fixed effects specifications. At least, though, it has become extremely difficult to build a case that inequality is good for growth. This in itself represents a considerable advance. Given the indications that inequality is harmful for growth, attention has moved on to the likely mechanisms.... the literature seems to be moving ... towards an examination of the effects of inequality on fertility rates, investment in education, and political stability.

A 1992 World Bank report published in the Journal of Development Economics said that inequality:

is negatively, and robustly, correlated with growth. This result is not highly dependent upon assumptions about either the form of the growth regression or the measure of inequality...Although statistically significant, the magnitude of the relationship between inequality and growth is relatively small.

NYU economist William Baumol found that substantial inequality does not stimulate growth because poverty reduces labor force productivity. Economists Dierk Herzer and Sebastian Vollmer found that increased income inequality reduces economic growth, but growth itself increases income inequality.

Berg and Ostry of the International Monetary Fund found that of the factors affecting the duration of growth spells (not the rate of growth) in developed and developing countries, income equality is more beneficial than trade openness, sound political institutions, or foreign investment.

According to International Monetary Fund economists, inequality in wealth and income is negatively correlated with the duration of economic growth spells (not the rate of growth). High levels of inequality prevent not just economic prosperity, but also the quality of a country's institutions and high levels of education. According to IMF staff economists, "if the income share of the top 20 percent (the rich) increases, then GDP growth actually declines over the medium term, suggesting that the benefits do not trickle down. In contrast, an increase in the income share of the bottom 20 percent (the poor) is associated with higher GDP growth. The poor and the middle class matter the most for growth via a number of interrelated economic, social, and political channels."

According to economists David Castells-Quintana and Vicente Royuela, increasing inequality harms economic growth. High and persistent unemployment, in which inequality increases, has a negative effect on subsequent long-run economic growth. Unemployment can harm growth not only because it is a waste of resources, but also because it generates redistributive pressures and subsequent distortions, drives people to poverty, constrains liquidity limiting labor mobility, and erodes self-esteem promoting social dislocation, unrest and conflict. Policies aiming at controlling unemployment and in particular at reducing its inequality-associated effects support economic growth.

Economist Joseph Stiglitz presented evidence in 2009 that both global inequality and inequality within countries prevent growth by limiting aggregate demand. Economist Branko Milanovic, wrote in 2001 that, "The view that income inequality harms growth – or that improved equality can help sustain growth – has become more widely held in recent years. ... The main reason for this shift is the increasing importance of human capital in development. When physical capital mattered most, savings and investments were key. Then it was important to have a large contingent of rich people who could save a greater proportion of their income than the poor and invest it in physical capital. But now that human capital is scarcer than machines, widespread education has become the secret to growth."

In 1993, Galor and Zeira showed that inequality in the presence of credit market imperfections has a long lasting detrimental effect on human capital formation and economic development. A 1996 study by Perotti examined the channels through which inequality may affect economic growth. He showed that, in accordance with the credit market imperfection approach, inequality is associated with lower level of human capital formation (education, experience, and apprenticeship) and higher level of fertility, and thereby lower levels of growth. He found that inequality is associated with higher levels of redistributive taxation, which is associated with lower levels of growth from reductions in private savings and investment. Perotti concluded that, "more equal societies have lower fertility rates and higher rates of investment in education. Both are reflected in higher rates of growth. Also, very unequal societies tend to be politically and socially unstable, which is reflected in lower rates of investment and therefore growth."

Research by Harvard economist Robert Barro, found that there is "little overall relation between income inequality and rates of growth and investment". According to work by Barro in 1999 and 2000, high levels of inequality reduce growth in relatively poor countries but encourage growth in richer countries. A study of Swedish counties between 1960 and 2000 found a positive impact of inequality on growth with lead times of five years or less, but no correlation after ten years. Studies of larger data sets have found no correlations for any fixed lead time, and a negative impact on the duration of growth.

Studies on income inequality and growth have sometimes found evidence confirming the Kuznets curve hypothesis, which states that with economic development, inequality first increases, then decreases. Economist Thomas Piketty challenges this notion, claiming that from 1914 to 1945 wars and "violent economic and political shocks" reduced inequality. Moreover, Piketty argues that the "magical" Kuznets curve hypothesis, with its emphasis on the balancing of economic growth in the long run, cannot account for the significant increase in economic inequality throughout the developed world since the 1970s.

Some theories developed in the 1970s established possible avenues through which inequality may have a positive effect on economic development. According to a 1955 review, savings by the wealthy, if these increase with inequality, were thought to offset reduced consumer demand. A 2013 report on Nigeria suggests that growth has risen with increased income inequality. Some theories popular from the 1950s to 2011 incorrectly stated that inequality had a positive effect on economic development. Analyses based on comparing yearly equality figures to yearly growth rates were misleading because it takes several years for effects to manifest as changes to economic growth. IMF economists found a strong association between lower levels of inequality in developing countries and sustained periods of economic growth. Developing countries with high inequality have "succeeded in initiating growth at high rates for a few years" but "longer growth spells are robustly associated with more equality in the income distribution."

Mechanisms

According to economist Branko Milanovic, while traditionally economists thought inequality was good for growth

"The view that income inequality harms growth – or that improved equality can help sustain growth – has become more widely held in recent years. ... The main reason for this shift is the increasing importance of human capital in development. When physical capital mattered most, savings and investments were key. Then it was important to have a large contingent of rich people who could save a greater proportion of their income than the poor and invest it in physical capital. But now that human capital is scarcer than machines, widespread education has become the secret to growth."

"Broadly accessible education" is both difficult to achieve when income distribution is uneven and tends to reduce "income gaps between skilled and unskilled labor."

The sovereign-debt economic problems of the late twenty-oughts do not seem to be correlated to redistribution policies in Europe. With the exception of Ireland, the countries at risk of default in 2011 (Greece, Italy, Spain, Portugal) were notable for their high Gini-measured levels of income inequality compared to other European countries. As measured by the Gini index, Greece as of 2008 had more income inequality than the economically healthy Germany.

Equitable growth

Main article: Inclusive growth

While acknowledging the central role economic growth can potentially play in human development, poverty reduction and the achievement of the Millennium Development Goals, it is becoming widely understood amongst the development community that special efforts must be made to ensure poorer sections of society are able to participate in economic growth. The effect of economic growth on poverty reduction – the growth elasticity of poverty – can depend on the existing level of inequality. For instance, with low inequality a country with a growth rate of 2% per head and 40% of its population living in poverty, can halve poverty in ten years, but a country with high inequality would take nearly 60 years to achieve the same reduction. In the words of the Secretary General of the United Nations Ban Ki-Moon: "While economic growth is necessary, it is not sufficient for progress on reducing poverty."

Housing

See also: Georgism

In many poor and developing countries much land and housing is held outside the formal or legal property ownership registration system. Much unregistered property is held in informal form through various associations and other arrangements. Reasons for extra-legal ownership include excessive bureaucratic red tape in buying property and building, In some countries it can take over 200 steps and up to 14 years to build on government land. Other causes of extra-legal property are failures to notarize transaction documents or having documents notarized but failing to have them recorded with the official agency.

Rent controls in Brazil dramatically reduced the percentage of legal housing compared to extra-legal housing, which had a much better supply to demand balance.

A number of researchers (David Rodda, Jacob Vigdor, and Janna Matlack), argue that a shortage of affordable housing – at least in the US – is caused in part by income inequality. David Rodda noted that from 1984 and 1991, the number of quality rental units decreased as the demand for higher quality housing increased (Rhoda 1994:148). Through gentrification of older neighbourhoods, for example, in East New York, rental prices increased rapidly as landlords found new residents willing to pay higher market rate for housing and left lower income families without rental units. The ad valorem property tax policy combined with rising prices made it difficult or impossible for low income residents to keep pace.

Aspirational consumption and household risk

Firstly, certain costs are difficult to avoid and are shared by everyone, such as the costs of housing, pensions, education and health care. If the state does not provide these services, then for those on lower incomes, the costs must be borrowed and often those on lower incomes are those who are worse equipped to manage their finances. Secondly, aspirational consumption describes the process of middle income earners aspiring to achieve the standards of living enjoyed by their wealthier counterparts and one method of achieving this aspiration is by taking on debt. The result leads to even greater inequality and potential economic instability.

Poverty

Oxfam asserts that worsening inequality is impeding the fight against global poverty. A 2013 report from the group stated that the $240 billion added to the fortunes of the world's richest billionaires in 2012 was enough to end extreme poverty four times over. Oxfam Executive Director Jeremy Hobbs said that "We can no longer pretend that the creation of wealth for a few will inevitably benefit the many – too often the reverse is true."

Jared Bernstein and Elise Gould of the Economic Policy Institute suggest that poverty in the United States could have been significantly mitigated if inequality had not increased over the last few decades.

Relative poverty is connected and related to inequality. Greater inequality correlates with greater relative poverty.

Greater inequality correlates with greater percentage of people living in poverty.

Environment

The smaller the economic inequality, the more waste and pollution is created, resulting in many cases, in more environmental degradation. This can be explained by the fact that as the poor people in the society become more wealthy, it increases their yearly carbon emissions. This relation is expressed by the Environmental Kuznets Curve (EKC). It should be noted here however that in certain cases, with great economic inequality, there is nonetheless not more waste and pollution created as the waste/pollution is cleaned up better afterwards (water treatment, filtering, ...).... Also note that the whole of the increase in environmental degradation is the result of the increase of emissions per person being multiplied by a multiplier. If there were fewer people however, this multiplier would be lower, and thus the amount of environmental degradation would be lower as well. As such, the current high level of population has a large impact on this as well. If (as WWF argued), population levels would start to drop to a sustainable level (1/3 of current levels, so about 2 billion people), human inequality can be addressed/corrected, while still not resulting in an increase of environmental damage.

War, terrorism and political instability

One study finds that income inequality increases political instability: "more unequal societies are more politically unstable". A 2016 study finds that interregional inequality increases terrorism. A lack of reliable data makes it difficult to study the relationship between inequality and political violence.

John A. Hobson, Rosa Luxemburg, and Vladimir Lenin argued that WWI was caused by inequality. Economist Branko Milanovic claims that there is credence to this argument in his 2016 book Global Inequality: A New Approach for the Age of Globalization.

Perspectives

Socialist perspectives

Socialists attribute the vast disparities in wealth to the private ownership of the means of production by a class of owners, creating a situation where a small portion of the population lives off unearned property income by virtue of ownership titles in capital equipment, financial assets and corporate stock. By contrast, the vast majority of the population is dependent on income in the form of a wage or salary. In order to rectify this situation, socialists argue that the means of production should be socially owned so that income differentials would be reflective of individual contributions to the social product.

Marxist socialists ultimately predict the emergence of a communist society based on the common ownership of the means of production, where each individual citizen would have free access to the articles of consumption (From each according to his ability, to each according to his need). According to Marxist philosophy, equality in the sense of free access is essential for freeing individuals from dependent relationships, thereby allowing them to transcend alienation.

Meritocracy

Meritocracy favors an eventual society where an individual's success is a direct function of his merit, or contribution. Economic inequality would be a natural consequence of the wide range in individual skill, talent and effort in human population. David Landes stated that the progression of Western economic development that led to the Industrial Revolution was facilitated by men advancing through their own merit rather than because of family or political connections.

Liberal perspectives

Most modern social liberals, including centrist or left-of-center political groups, believe that the capitalist economic system should be fundamentally preserved, but the status quo regarding the income gap must be reformed. Social liberals favor a capitalist system with active Keynesian macroeconomic policies and progressive taxation (to even out differences in income inequality).

However, contemporary classical liberals and libertarians generally do not take a stance on wealth inequality, but believe in equality under the law regardless of whether it leads to unequal wealth distribution. In 1966 Ludwig von Mises, a prominent figure in the Austrian School of economic thought, explains:

The liberal champions of equality under the law were fully aware of the fact that men are born unequal and that it is precisely their inequality that generates social cooperation and civilization. Equality under the law was in their opinion not designed to correct the inexorable facts of the universe and to make natural inequality disappear. It was, on the contrary, the device to secure for the whole of mankind the maximum of benefits it can derive from it. Henceforth no man-made institutions should prevent a man from attaining that station in which he can best serve his fellow citizens.

Robert Nozick argued that government redistributes wealth by force (usually in the form of taxation), and that the ideal moral society would be one where all individuals are free from force. However, Nozick recognized that some modern economic inequalities were the result of forceful taking of property, and a certain amount of redistribution would be justified to compensate for this force but not because of the inequalities themselves. John Rawls argued in A Theory of Justice that inequalities in the distribution of wealth are only justified when they improve society as a whole, including the poorest members. Rawls does not discuss the full implications of his theory of justice. Some see Rawls's argument as a justification for capitalism since even the poorest members of society theoretically benefit from increased innovations under capitalism; others believe only a strong welfare state can satisfy Rawls's theory of justice.

Classical liberal Milton Friedman believed that if government action is taken in pursuit of economic equality then political freedom would suffer. In a famous quote, he said:

A society that puts equality before freedom will get neither. A society that puts freedom before equality will get a high degree of both.

Economist Tyler Cowen has argued that though income inequality has increased within nations, globally it has fallen over the last 20 years. He argues that though income inequality may make individual nations worse off, overall, the world has improved as global inequality has been reduced.

Social justice arguments

Patrick Diamond and Anthony Giddens (professors of Economics and Sociology, respectively) hold that 'pure meritocracy is incoherent because, without redistribution, one generation's successful individuals would become the next generation's embedded caste, hoarding the wealth they had accumulated'.

They also state that social justice requires redistribution of high incomes and large concentrations of wealth in a way that spreads it more widely, in order to "recognise the contribution made by all sections of the community to building the nation's wealth." (Patrick Diamond and Anthony Giddens, June 27, 2005, New Statesman)

Pope Francis stated in his Evangelii gaudium, that "as long as the problems of the poor are not radically resolved by rejecting the absolute autonomy of markets and financial speculation and by attacking the structural causes of inequality, no solution will be found for the world’s problems or, for that matter, to any problems." He later declared that "inequality is the root of social evil."

When income inequality is low, aggregate demand will be relatively high, because more people who want ordinary consumer goods and services will be able to afford them, while the labor force will not be as relatively monopolized by the wealthy.

Effects on social welfare

In most western democracies, the desire to eliminate or reduce economic inequality is generally associated with the political left. One practical argument in favor of reduction is the idea that economic inequality reduces social cohesion and increases social unrest, thereby weakening the society.

There is evidence that this is true (see inequity aversion) and it is intuitive, at least for small face-to-face groups of people. Alberto Alesina, Rafael Di Tella, and Robert MacCulloch find that inequality negatively affects happiness in Europe but not in the United States.

It has also been argued that economic inequality invariably translates to political inequality, which further aggravates the problem. Even in cases where an increase in economic inequality makes nobody economically poorer, an increased inequality of resources is disadvantageous, as increased economic inequality can lead to a power shift due to an increased inequality in the ability to participate in democratic processes.

Capabilities approach

Further information: Capability approach

The capabilities approach – sometimes called the human development approach – looks at income inequality and poverty as form of “capability deprivation”. Unlike neoliberalism, which “defines well-being as utility maximization”, economic growth and income are considered a means to an end rather than the end itself. Its goal is to “wid[en] people’s choices and the level of their achieved well-being” through increasing functionings (the things a person values doing), capabilities (the freedom to enjoy functionings) and agency (the ability to pursue valued goals).

When a person’s capabilities are lowered, they are in some way deprived of earning as much income as they would otherwise. An old, ill man cannot earn as much as a healthy young man; gender roles and customs may prevent a woman from receiving an education or working outside the home. There may be an epidemic that causes widespread panic, or there could be rampant violence in the area that prevents people from going to work for fear of their lives. As a result, income and economic inequality increases, and it becomes more difficult to reduce the gap without additional aid. To prevent such inequality, this approach believes it’s important to have political freedom, economic facilities, social opportunities, transparency guarantees, and protective security to ensure that people aren’t denied their functionings, capabilities, and agency and can thus work towards a better relevant income.

Policy responses intended to mitigate

A 2011 OECD study makes a number of suggestions to its member countries, including:

• Well-targeted income-support policies.
• Facilitate and encourage access to employment.
• Better job-related training and education for the low-skilled (on-the-job training) would help to boost their productivity potential and future earnings.
• Better access to formal education.

Progressive taxation reduces absolute income inequality when the higher rates on higher-income individuals are paid and not evaded, and transfer payments and social safety nets result in progressive government spending. Wage ratio legislation has also been proposed as a means of reducing income inequality. The OECD asserts that public spending is vital in reducing the ever expanding wealth gap.

The economists Emmanuel Saez and Thomas Piketty recommend much higher top marginal tax rates on the wealthy, up to 50 percent, or 70 percent or even 90 percent. Ralph Nader, Jeffrey Sachs, the United Front Against Austerity, among others, call for a financial transactions tax (also known as the Robin Hood tax) to bolster the social safety net and the public sector.

The Economist wrote in December 2013: "A minimum wage, providing it is not set too high, could thus boost pay with no ill effects on jobs....America's federal minimum wage, at 38% of median income, is one of the rich world's lowest. Some studies find no harm to employment from federal of state minimum wages, others see a small one, but none finds any serious damage."

General limitations on and taxation of rent-seeking are popular across the political spectrum.

Public policy responses addressing causes and effects of income inequality in the US include: progressive tax incidence adjustments, strengthening social safety net provisions such as Aid to Families with Dependent Children, welfare, the food stamp program, Social Security, Medicare, and Medicaid, organizing community interest groups, increasing and reforming higher education subsidies, increasing infrastructure spending, and placing limits on and taxing rent-seeking.

Mitigating factors

Countries with a left-leaning legislature have lower levels of inequality. Many factors constrain economic inequality – they may be divided into two classes: government sponsored, and market driven. The relative merits and effectiveness of each approach is a subject of debate.

Typical government initiatives to reduce economic inequality include:

• Public education: increasing the supply of skilled labor and reducing income inequality due to education differentials.
• Progressive taxation: the rich are taxed proportionally more than the poor, reducing the amount of income inequality in society if the change in taxation does not cause changes in income.

Market forces outside of government intervention that can reduce economic inequality include:

• propensity to spend: with rising wealth & income, a person may spend more. In an extreme example, if one person owned everything, they would immediately need to hire people to maintain their properties, thus reducing the wealth concentration.

See also

• Cycle of poverty
• Donor Class
• Equal opportunity
• Great Divergence, disproportionate economic advancement of Europe
• Human Development Index
• Income distribution
• List of countries by distribution of wealth
• Social inequality

Further reading

Books

• Atkinson, Anthony B. (2015). Inequality: What Can Be Done? Cambridge, Massachusetts: Harvard University Press. ISBN 0674504763
• ISBN 9780945466246

Articles

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• Similar paper from August 2002: Sex, equality, and growth (in that order)
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Papers

• Policy research report on gender and development working paper series, no. 1.
• Ravallion, Martin (2005). World Bank, 5 May, Policy Research Working Paper no. WPS 3579, A poverty-inequality trade-off?
• Sawhill, Isabel. "Do We Face a Permanently Divided Society?" The Economics of Inequality, Poverty, and Discrimination in the 21st Century Ed. Robert S. Rycroft. The University of Mary Washington, 2012.
• Smeeding, Timothy and Thompson, Jeffrey. "Inequality in the Great Recession – The Case of the United States". FRDB International Income Inequality Project (July 2011). Working paper.
• Voitchovsky, Sarah. "The effects of inequality on growth: perspectives from the theoretical literature." Working paper.

External links

• Media related to at Wikimedia Commons
• A portal dedicated to the topic of economic inequality
• Small Inequality Measures Calculus (and On-Line Calculator)
• The UC Atlas of Global Inequality explores some aspects of inequality using online, downloadable maps and graphics.
• Population Health Forum website – group seeking to improve health by addressing inequality.
• The Inequality Predicament United Nations Report on the World Social Situation 2005
• Two Americas: One Rich, One Poor? Understanding Income Inequality in the United States
• Has U.S. Income Inequality Really Increased? Accessed 2007-06-11.
• Measuring Trends in Leisure: The Allocation of Time Over Five Decades studies the trade-offs between earning income and enjoying leisure
• Data from the Inequality Survey
• Decreasing Inequality Under Latin America's "Social Democratic" and "Populist" Governments: Is the Difference Real? from the Center for Economic and Policy Research
• Wealth and Poverty: Center for Global Studies at the University of Illinois
• Thomas Piketty's presentation Inequality & Capitalism in the Long-Run based on Capital in the Twenty-First Century
• "Wealth Gap" – A Guide (AP News – January 2014).
• Economic and Social Inequality in Asia and Pacific: 12 Things to Know Asian Development Bank
• As inequality soars, the nervous super rich are already planning their escapes. The Guardian. 23 January 2015.
• Asia’s Wealth Inequality Problem. The Diplomat. October 23, 2015.