Introduction
The nature of inequality is very broad and therefore, I have tried to categorise the topic into themes. Furthermore, I have decided to include both wealth and income inequality in the piece as they both play an important role in overall financial inequality. It is based on why inequality is so high and how it can be reduced. In this review of literature, the following themes can be identified:
(i) Economic theory of inequality
(ii) Measurement of inequality
(iii) Government policies to reduce inequality
(iv) Examples of government policies in action: China
I have first looked at the economic theory of inequality. This explains why inequality is currently high and why it still has not been reduced. There is a particular focus on the Kuznets’ hypothesis. Secondly, I have looked at the various ways of measuring inequality and data that presents the various levels of inequality around the world, with the main way being the Gini Index. Current or proposed government policies that should, in theory, reduce inequality was the next theme. As well as this, I looked at Piketty’s work, which suggests worldwide policies to reduce the levels of inequality. Finally, I researched works that centred around China’s growing difficulties with inequality. This focused on both proposed policies that they could attempt to implement and policies that they have already introduced. Many of the sources do suggest that China has tried to improve income inequality, however, due to its immense size, it has been difficult to reduce it to more globally accepted levels.
(i) Economic theory of inequality
There are many theories on income inequality such as Ricardian, Marxist and Neo-classical (Gallo, 2001). These theories suggest links between economic growth and income distribution. For example, the Lewis’ Model in terms of how an economy develops from a traditional one into a modern one (Gallo, 2001). However, one of the most important theories suggested in terms of income inequality is the Kuznets’ hypothesis.
The Kuznets’ hypothesis was fist developed in 1955 by Simon Smith Kuznets (Melikhova and Čížek, 2014). It was the first suggestion that there was a link between income inequality and income per capita. The graph below is an example of the Kuznets’ hypothesis produced using data from the World Bank. It shows the pattern that the Kuznets’ hypothesis suggests, which is the theory of the inverted U-curve (Melikhova and Čížek, 2014). This arises from the suggestion that income inequality is low when an economy is undeveloped and increases as the economy develops but once it has finished developing then the change is reduced.
There are many arguments that also suggest that the Kuznets’ hypothesis is an inaccurate suggestion because the data that it is based on is historical data (Ganaie & Kamaiah, 2015). As the theory is based on data that comes from the last century which may not be correct. However, the graph above uses data from a wide range of countries in different economic situations. This may therefore be subjected to less reason to believe its false. This is instead of looking at one particular country over the time of it’s development. Furthermore, many developed nations have since seen a dramatic rise in income inequality since the 1990s, which goes against the Kuznets’ hypothesis theory (Chang, 2014).
Different countries may follow the Kuznets’ hypothesis more closely than others. It is likely that countries with less social support (redistribution of income) will follow it more closely (Melikhova and Čížek, 2014). China is currently developing and it’s current extremely high inequality which has risen dramatically could suggest that up to its current point, China has kept in line with the Kuznets’ hypothesis. In 2005, the GINI coefficient reached 0.5 (Chan & Kulkarni, 2006). China’s unique history over the past 30 years influenced the current high levels of inequality as Deng Xiaoping’s policies brought rapid change to China and developed some parts much faster than others (Chan & Kulkarni, 2006).
On the other hand, another theory to do with the way income inequality develops in countries as they themselves develop is the Ricardian theory. The original theory was that the demand for low-skilled workers in a country will increase as richer countries demand cheaper labour, therefore, low-skilled worker’s wages will increase but high skilled wages won’t increase at such a high rate, therefore, income inequality will decrease (The Economist, 2014). However, it is argued that this is incorrect as income inequality is increasing in many developing countries. A theory to correct the current Ricardian theory is one suggested by Eric Maskin (The Economist, 2014). It suggests that more high skilled workers are working more with developed countries more than low-skilled workers leading to them improving their skills more and earning more money, increasing the wage gap.
(ii) Measurement of income inequality
There are many ways to measure income inequality. Firstly, I simply used data that I obtained from the Central Intelligence Agency, 2015. I plotted the Gini index of these countries aqainst the GDP per capita. I wanted to see what the general pattern was, following on from the idea of the Kuzents’ hypothesis in which richer countries should be less uneqal than poorer countries which is what the graph appears to suggest.
The most popular method of measuring income inequality is the Gini coefficient (De Maio, 2007) and is closely linked with the Lorenz curve. The Lorenz Curve is a visual representation of the GINI index. The Lorenz curve has the percentage wealth on the y-axis and the percentage households on the x axis. The line is constructed as the certain percentage of the population will own a certain percentage of the wealth. This line is drawn up to 100% of the population earning 100% of the wealth. Assuming the country is completely equal the line is known as the line of absolute equality which is a straight line from the origin which has a gradient of 1 (Economics Network).
Other measures on income inequality include the Atkinson Index which gives greater sensitivity to inequalities in different areas of the income spectrum, similar to the General Entropy Index which also provides weighting based on location. Another suggested measure is the Kakwani Index which measures the progressivity of a country’s tax system (De Maio, 2007). There is also a ratio suggested by Gabriel Palma that proposes ratio between the income share of the top 10 percent and the bottom 40 percent in order to be more accurate (Chang, 2014). Another, less quantitative measure, is to measure inequality of people’s living standards rather than their income (Roser, 2015). This then relates to the way that people spend money rather than what they receive.
(iii) Government policies to reduce inequality
There many suggested policies that have been put forward to reduce income inequality. One of the most common suggestions is to increase income tax on the higher earners and make the tax system more progressive (Piketty, 2014). However, another suggestion is to also increase capital gains tax to 15%. This would also reduce the amount of income that some people receive from the capital that they own which often provides another stream of income for the wealthier.
There are also policies that have been suggested to reduce income inequality while still promoting economic growth. This acts as an argument against the suggestion that a reduction in income inequality would lead to a slowdown in economic growth. Suggestions for policies were promoting equality in education, reducing the gap between temporary and permanent work and promoting the integration of immigrants (OECD, 2012). These polices are all suggested to improve the quality of the workforce. Other policies along these lines would be to prevent illicit outflows so that less money from those who are more wealthy leaves the country (Galasso & Wood, 2015). Another policy would be to enforce a living wage so that there is almost a restriction on how low a person’s wages can be and therefore a restriction on how extreme the income inequality can be.
Other policies that were suggested were also designed to reduce income inequality before tax as it is currently still high before the implementation of income tax in the majority of countries. These polices suggested are making it easier to start and join a trade union – which gives workers (especially lower salary workers) more power to increase their wages. Another policy is to weaken the dollar (or whichever currency is in question) in order to make exports more affordable abroad and promote manufacturing in the country. A further suggestion includes reforming Intellectual Property laws (Matthews, 2012). These IP laws are often argued to reinforce inequality as they protect powerful businesses and allow them to keep monopolies on their products for long periods of time and make supernormal profit as a result.
There are also those who argue that taxing progressively, although effective, is only a short term solution because it allows for the change of policy once those in government leave. For a proper solution, a social change needs to occur in the economy (Wilkinson & Pickett, 2009). The suggestions made were similar to the policies of John Lewis, in which the private sector is more employee-owned. A further suggestion would be to make it so employees were unable to sell back the shares that they are given as part of their salary.
(iv) Examples of Government Policies in Action: China
China faces an already large income gap that is still growing (Salidjanova, 2013). China’s largest inequality gap is between the East coast and the West, with the East being much richer than the rest. There are certain policies and targets that the government has already implemented to combat this. These include doubling personal income by 2020 and raising minimum wage, restrictions on government officials’ income (which is also an attempt to reduce inflation), another factor is introducing a social safety net, of which China currently has none. A social security net would help to raise the living standards of those on lower income (Gan, 2013). Further suggestions are tax reform, land rights and Residence Permit System (Salidjanova, 2013). However, the majority of these have only been set as targets by the Chinese government and so have not yet been completed.
There are other policies that have been put forward in order to reduce inequality but these policies are simply suggestions and their usage has in no way been confirmed. One suggested policy is regional development strategy which may be to improve the living standards and incomes of those who live in poorer provinces to the West of China (Cheng, 2007). Furthermore, increasing labour mobility has also been suggested so that those in poorer regions do at least have the opportunity to move to the larger and more prosperous East Coast cities to work and maybe find a better paid job.
Another major policy put forward would be to improve education in China (OECD, 2012). Currently, education is seen as the only way that people can obtain a highly paid job and support their parents in the future. Therefore, parents invest a lot of money in education and extra classes in order to give their child the best prospects of getting into a good university. However, this again leads to inequality of opportunity as it exacerbates the income inequality for future generations.
In conclusion, this demonstrates that there is a lot of information available on the topic of inequality. Many major organisations (OECD, World Bank, CIA) have devoted resources towards researching inequality all over the world. As a result, there is a large databank providing information on inequality. In addition, there have been many papers and books written about reducing inequality, that all give me the opportunity to investigate various views and ideas that would decrease inequality, as well as explanations as to why current policies haven’t been able to reduce the levels of inequality.
Throughout this review of literature, I focused on four different themes. Within each of them, I also looked at various ideas. Throughout the economic theory of inequality, I looked proposed theories behind why inequality has increased, looking at thoughts like neo-classicalism, leading on to the Kuznets’ hypothesis and the opposing views to this of Ricardo. Secondly, I looked at the way in which inequality can be measured. This included, the Gini Coefficient, Lorenz Curve and obscure but sometimes more effective ways that income inequality can be measured. As well as this, I gathered data to show the differing Gini coefficient in various countries. Then, I went on to government policies that could reduce income inequality these are from a wide range of sources that give varying suggested polices, some of which have already been implemented, some haven’t. Finally, I focused on China, looking at its current polices on income inequality, previous ones and suggested policies that were tailored to China’s requirements. In addition, I have found much more data to do with the US throughout this piece because the data is readily available.