Income Inequality and Poverty

Income, Inequality, and Poverty What Are the Determinants of Wages? Non Monetary Determinants of Wages ● ● ● ● Compensating differentials: Difference in wages offered to offset the desirability or undesirability of a job ○ Some jobs are more unpleasant, rsky, stressful, inconvenient, or monotonous than others ○ Undesirable: compensating wage positive ○ Desirable: compensating wage negative and lower wages Education and Human Capital ○ Many complex jobs require substantial education, training, and industry experience ○ Relatively few students are able to pursue these degrees and it is expensive ○ Human capital: the set of skills that workers acquire on the job and through education ■ Investments in human capital accrue to the employee ■ Workers with high human capital can market their skills among competing firms ● Engineers, doctors ■ Low skilled workers such as ushers, baggers, and sales associates earn less because human capital required is lower Location and lifestyle ○ People find some locations more desirable than others ○ Where climate is more pleasant, all else equal, people are willing to accept lower wages because the non monetary benefits of enjoying the weather is like a compensating differential ○ Jobs in metropolitan areas – where there is a higher cost of living – have higher wages as a cost of living adjustment ○ Some workers are not specifically concerned with maximizing their income and care more about working for a cause ■ True for employees of nonprofits or religious organizations or people taking care of loved ones ■ For these, lower pay functions as a compensating differential Union: a group of workers who bargain collectively for better wages and benefits ○ Unions are able to secure increased wages by creating significant market power over the supply of labor available to a firm ○ Union’s ability to achieve higher wages ■ Strike: credible threat of work stoppage ○ Because firms cannot do without labor, an effective union can use the threat of a strike to negotiate higher wages for workers ○ The US law prohibits some unions from going on strike, including transit workers, public school teachers, law enforcement officers, and workers in essential services ■ If workers in these industries reach an impasse in wage and benefit negotiations, the employee union is required to submit to the decision of an ● impartial third party → binding arbitration ○ Early studies of the union wage premium found wages to be as much as 30% higher for unionized workers ■ Today, only 1 in 8 workers are part of a union Efficiency wages: when an employer pays its workers more than the equilibrium wage ○ Used to make more profit ○ Above equilibrium wages (1) decrease turnover, (2) increase productivity by attracting a larger applicant pool, (3) increase the cost of being fired because other jobs don’t pay as well ○ Gives greater incentive to work hard ○ Productivity: the effectiveness of effort as measured in terms of the rate of output per unit of input ■ Gains in overall labor productivity are higher than increased cost → greater profit for the firm Wage Discrimination ● ● ● ● ● ● Wage discrimination: when workers with the same ability as others are not paid the same because of their race, ethnic origin, sex, age, religion, or other group characteristic Women and men often hold different types of jobs, and certain jobs pay more than other More women than men take time off to raise a family, meaning they put in fewer years of work experience Gender wage gap stems not from gender discrimination, but work design ○ Men: work the longest and least flexible hours → higher salaries ○ Women: juggle caregiving responsibilities Human capital and the life-cycle wage pattern ○ Workers who are just starting have limited experience ○ As these workers age, they get on the job training and experience that leads them to receive higher wages ○ Gains obtained by older workers are eventually offset by diminishing returns ○ Wages peak when workers are in their early 60s ○ Life-cycle wage pattern: predictable effect age has on earnings over a person’s working life Occupational crowding: how discrimination affects wages ○ Occupational crowding: the phenomenon of relegating a group of workers to a narrow range of jobs in the economy ○ Workers who have limited opportunities find themselves competing with one another, as well as men (ex: if women could only be secretaries and men engineers) ○ Rigidity in changing occupations, social customs, and personal preferences are part of why occupational crowding and wage differentials continue ○ Wage gap will narrow overtime Winner Take All ● ● ● ● Winner-take-all: occurs when extremely small differences in ability lead to sizable differences in compensation Most common in professional sports and the entertainment industry, but also exists in legal professions, medicine, journalism, investment banking, fashion design, and corporate management Being a little better than rivals can be worth a large amount The prospect of a higher pay or bonus motivates employees to exert maximum effort What Causes Income Inequality? Factors that Lead to Income Inequality ● ● ● ● ● Ability: workers who have more ability than less-able workers can earn higher wages ○ Differences in ability → differences in wages ○ More able workers can create larger marginal products than their less-able counterparts Training and education: the acquisition of specific skills through training and additional education enhances each worker’s human capital ○ More human capital → more valuable in the marketplace → higher wages Discrimination: harms the workers who are discriminated against, and makes the overall distribution of income more unequal ○ Workers who are passed over because of their gender, race, age, religion, or anything else that does not reflect their ability, training, or education ○ Acts as a price ceiling that limits some workers’ ability to earn more ○ Concentrated among women and minorities Role of wealth: wealth gives a child from an affluent family access to a better education, private tutoring, a healthier diet, and other intangible benefits that provide a head start in life ○ Leads to high levels of human capital → higher wages Role of corruption in income inequality: ○ Some societies value the rule of law more than others ○ Many countries suffer from corruption, which drain their economic output ○ In societies where corruption is common, working hard or being innovative is not enough, and to get ahead many need to bribe officials to obtain business permits or rid of competitors ○ Dishonest people benefit at the expense of the poor ○ Drives out legitimate business opportunities and magnifies income inequality Measuring Income Inequality ● ● Income inequality ratio: calculated by dividing the top quintile’s income percentage by the bottom quintile’s income percentage Understanding Observed Inequality ○ Poverty rate: percentage of the population whose income is below the poverty threshold ● ● ○ Poverty threshold: the income level below which a person or family is considered impoverished ○ US has a poverty rate similar to Japan ○ A high income inequality ratio can occur if people at the bottom earn very little or if the income of high income earners is much greater than that of others ○ Even though income inequality ratios give us some idea about the degree of inequality in a society, a single number cannot fully reflect the sources of the underlying differences in income The Gini Index: represents the income distribution of a nation’s residents ○ Value fluctuates between 0 (no income inequality) and 100 (extreme income inequality) ○ If every individual’s income is equal, the Gini coefficient/index is 0 ○ A nation where one individual gets income, while everyone else gets nothing, has a Gini index of 100 ○ Average Gini index is 40 ○ Lorenz Curve: visual way of representing the Gini index ■ Represented by a 45 degree line ■ As income distribution becomes more unequal, the Lorenz curve shifts downward and to the right ■ Area A represents the amount of inequality in a society ■ Area B represents the the amount of equality in a society Difficulties in measuring income inequality ○ Gini index and Lorenz curve reflect income before taxes, which do not reflect disposable income ■ Disposable income: portion of income people actually have to spend ○ In-kind transfers: goods and services that are given to the poor instead of cash ■ Ex: government subsidized housing and Subsidized Nutrition Assistance Program (SNAP) ○ Underground economies: less developed countries have more underground economies than developed countries do ○ Income data alone does not capture the value created from goods and services produced in the household ■ In less developed countries, many households engage in few market transactions and produce a larger amount of their own goods and services ● If not counted, overstate ○ The number of workers per household and the median age of each worker differ from country to country ○ If we try to measure these incomes across generations, it can be significantly different ○ Comparing data over the range from 1968 shows an upward trend in income inequality, but also violates ceteris paribus ○ Standard calculations and models assume income distribution is a direct reflection of a society’s well being, but we should not assume well-being only based off of income ■ People value leisure time, non wage benefits, a sense of community, safety from crime, and social networks Income Mobility ● ● ● ● ● ● Income mobility: the ability of workers to move up or down the economic ladder over time Economic mobility reduces inequality over long periods of time Mobility data enables the ability to separate those at the bottom into two groups (1) marginal poor and (2) long term poor ○ Marginal poor: people who are poor at a particular point in time but have the skills to advance ■ Because more young workers expect future higher income, they are willing to borrow more to make a large purchase ■ Middle aged workers save for future ○ Long term poor: people who lack the skills to advance to the next quintile Young people are upwardly mobile, so they spen more than one may expect by borrowing Middle age have relatively high incomes, and spend less because they are saving for retirement Elderly have low incomes, and spend more because they are drawing from retirement How Do Economists Analyze Poverty? Poverty Rate ● ● ● ● To keep up with inflation, the poverty threshold is adjusted each year for changes in the overall price levels of the economy Only includes numbers that is earned by family members in a household ○ Does not include inkind transfers, or adjust for cost of living difference per area Teh stagnant poverty rate suggests that gains from economic growth have accrued to households in the middle and upper quintiles, rather tahn to the poor Poverty is persistent because many low income workers lack the necessary skills to earn a living wage and investments by firms in automation and technology have reduced demand for these workers Poverty Rate ● ● Welfare: an umbrella term for a series of initiatives designed to help te poor by supplementing their income ○ Welfare can be in forms of monetary payments, subsidies and vouchers, health services, or subsidized public and private organizations ○ Intended to help the unemployed, those with illnesses or disabilities that prevent them from working, the elderly, veterans, and households with dependent children ○ Often limited amount of time and valid as long a recipient’s income remains below eligibility cutoff In-kind transfers: the poor can receive direct assistance in the form of goods and services ○ Medicaid: joint federal and state program that helps low income individuals and households pay for costs associated with long term medical care ● ● ○ Communities or cities provide organized assistance like shelters, local community food banks, religious organizations, and private charities ○ Protect reipients from the possibility of making poor decisions if they receive cash instead ○ To limit the likelihood of poor decisions, in-kind transfers can be targeted at essential services ○ Not everyone agrees that in-kind transfers are a good idea ■ Skeptics view them as paternalistic, inefficient, and disrespectful, and can argue that cash payments allow recipients to make choices that fit their needs Earned Income Tax Credit (EITC): Tax credit designed to encourage low income workers to work more ○ EITC offers an incentive to work by supplementing earned income with a tax credit of approximately $6,000 per year ○ Amount is determined by the number of dependent children in the household and location ○ Once reaching an income level above its earnings threshold, EITC is phased out and workers lose tax credit ○ EITC is greatly reduced, so workers do not face a disincentive to work as the program is phased out ○ EITC cretes stronger incentives than those found under traditional antipoverty programs that critics argue discourage recipients from working Minimum wage ○ Minimum wage creates trade-offs ○ Firms respond to minimum wage by hiring fewer workers and using selfcheckout and robotic production ○ Minimum wage does not guarantee employment, but offers low skilled workers higher paychecks ○ Makes minimum wage jobs more difficult to find Problems with Traditional Aid ● ● ● Many welfare programs can create unintended work disincentives Those that provide substantial benefits can discourage participation in the workforce because a recipient who starts to work no longer qualifies for the benefits and loses them Samaritan’s Dilemma: occurs when an act of charity creates disincentives for recipients to take care of themselves ○ Bill Clinton’s 1996 vow “to end welfare as we know it” and for welfare to be “a second chance, not a way of life” attempted to address this dilemma by providing benefits for only a limited period of time ■ Changed the payout structure for federal assistance and encouraged states to require employment searches as a condition for receiving aid ○ TANF program imposed a five-year maximum for the time which a recipient can receive benefits ■ Changed welfare from an entitled ent under the law into a temporary safety net, thereby reducing the Samaritan’s dilemma