Causes Of Inequality
Definition
Income inequality: the uneven distribution of income across the households or individuals in an economy over a given period.
Wealth inequality: the uneven distribution of the stock of assets owned across households or individuals at a point in time.
- Inequality of income and wealth has several linked economic causes.
- Differences in the labour market explain most of the gap in income.
- Differences in the ownership of assets explain most of the gap in wealth.
Key Idea
- Unequal pay reflects differences in skills, qualifications, productivity and the demand for labour.
- Unequal wealth reflects unequal ownership of assets and the passing on of inheritance.
Labour Market Causes
- Workers with more education, skills and training tend to have higher productivity.
- Higher productivity means these workers add more value to their firm, so firms will pay them more.
- Scarce skills that are in strong demand command a wage premium, widening pay gaps.
- Unemployment removes wage income entirely, pushing affected households towards the bottom.
- Discrimination can hold down the pay and job chances of particular groups.
Example
- A surgeon whose scarce skills are in high demand earns £120,000 a year, while an unskilled labourer earns £24,000.
- The surgeon earns 5 times as much, because higher productivity means firms will pay more for the value added, and scarce supply adds a wage premium.
Wealth And Inheritance
- Wealth is far more concentrated than income because assets can be accumulated and passed on.
- Households that own property, shares and businesses earn income from those assets.
- That asset income can be saved and reinvested, so wealth compounds over time.
- Inheritance transfers large stocks of wealth to the next generation, entrenching the gap.
- This is the main reason wealth is distributed more unequally than income.
Example
- A family inheriting property and shares worth £500,000 starts far ahead of a family that begins with no assets.
- The inherited assets generate rent and dividends of about £20,000 a year, so the head start compounds across generations.
Other Factors
- The tax and benefit system can narrow the gap through progressive taxes and transfers, or widen it if taxes are regressive.
- Regional differences mean a declining industrial area can fall behind a fast-growing city.
- Differences between countries add a global dimension to inequality of income and wealth.
- Some inequality rewards effort and risk, which aids efficiency, so cutting it involves an equity–efficiency trade-off, and how far to go depends on how much of the gap comes from unequal opportunity rather than choice.
Note
- Some inequality provides incentives to work hard, gain skills and take risks, which supports efficiency.
- But extreme inequality can become self-reinforcing through inherited wealth and unequal access to education.
Exam technique
- Group the causes into labour-market, asset-and-inheritance and government-policy factors.
- Separate causes of income inequality from causes of wealth inequality where the question allows.
Common Mistake
- Do not treat inequality as simply the result of differences in individual effort.
- Do not ignore inherited wealth, which matters as much as skills and pay in explaining the gap.
Self review
- Give three labour-market causes of income inequality.
- Why is wealth more unequally distributed than income?
- How can the tax and benefit system change inequality?
- Give one way in which inequality can be self-reinforcing.
