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The Distribution of Income and Poverty Essay Sample

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The Distribution of Income and Poverty Essay Sample

Abstract

Today, the world witnesses great disparities in income and wealth between individuals- inter country, intra country and inter region.  How rich are the rich countries compared to the poorest? Why does half the world — nearly three billion people — live on less than two dollars a day. And why is the GDP (Gross Domestic Product) of the poorest 48 nations (i.e. a quarter of the world’s countries) is less than the wealth of the world’s three richest people combined. These questions present an ugly truth for humanity behind the garb of glamour and globalization.  In this report, we study income distribution and trace the root causes behind this phenomenon. We also study some of the tools, theories and methodologies that make such an analysis possible. Finally, we study the current situation of Poverty and the limitations it brings in for economic growth and human existence.

Introduction

Poverty and Income inequality have become the state for the majority of the world’s people and nations. Why is this? Is it enough to blame poor people for their own predicament? This is true, however we also see that power, politics and globalization plays a significant role to this effect. We study in this report- The How’s, Why, the economic theories behind and latest trends and statistics in the income situation globally.

Income inequality

The term refers to disparities in the distribution of economic assets and income. The term typically refers to inequality among individuals and groups within a society, but can also refer to inequality among nations. There is debate as to what equality should mean.

Source: http://siteresources.worldbank.org/DATASTATISTICS/Resources/reg_wdi.pdf

The above data shows the statistics on income differences for various regions in the world as measured by World Bank for the year 2004, where we see that as per the Atlas method- The Latin America and the Caribbean region has the highest gross national income (GNI) per capita of all developing countries and South Asia has the lowest.
According to Wikipedia, the Encyclopedia, the primary factors contributing to income inequality fall in six areas-

  • Labour market: One of the major reasons there is economic inequality is because of wage differences within modern market economies. Wages are determined by a market, and are influenced by supply and demand. A job where there is high supply and a relatively less demand will have lower wages. An example of this would be low-skill jobs such as customer service. A job where there are few willing workers (low supply) but a large demand for the skills will result in high wages for that job. But, we also witness that highly skilled computer programmers in western countries have seen their wages suppressed by competition from equally skilled workers in India because of the reason that Indians are willing to accept a lower wage.
  • Innate ability: Many people believe that there is a connection between differences in innate ability, such as intelligence, strength, or charisma, and between an individuals level of wealth. Relating these innate abilities back to the labor market suggests that such innate abilities are in high demand relative to their supply and hence play a large role in increasing the wage of those who have them.
  • Education: Education, especially education in an area where there is a high demand for workers, creates high wages for those with this education. On the other hand, those who are unable to afford an education generally receive much lower wages. Many economists believe that a major reason why the world has experienced increasing levels of inequality since the 1980s is because of an increase in the demand for highly skilled workers in high-tech industries.
  • Gender, race, and culture: The existence of different genders, races and cultures within a society is also thought to contribute to economic inequality. Scientists such as Richard Lynn argue that there are innate group differences in ability that are partially responsible for producing race and gender group differences in wealth. Culture and religion also play a role in creating inequality by either encouraging or discouraging wealth-acquiring behavior and providing a basis for discrimination.
  • Development patterns: Simon Kuznets saw a curve-like relationship between level of income and inequality known as the Kuznets curve. Here we say that 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 a variety of possible redistribution mechanisms such as trickle down effects and social welfare programs, more developed countries move back to lower levels of inequality.
  • Wealth condensation: 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. Related to wealth condensation are the effects of inter generational inequality.

Lorenz Curve and Gini Coeffecient :The Lorenz curve was developed by Max O. Lorenz in 1905 for representing income distribution. It is a graphical representation of the cumulative distribution function of a probability distribution. It is often used to represent income distribution, where it shows for the bottom x% of households, what percentage y% of the total income they have. The percentage of households is plotted on the x-axis, the percentage of income on the y-axis. It can also be used to show distribution of assets and to represent social inequality. Every point on the Lorenz curve represents a statement like “the bottom 20% of all households has 10% of the total income”. A perfectly equal income distribution would be one in which every person has the same income. This can be depicted by the straight line y = x; called the line of perfect equality or the 45° line. While, a perfectly unequal distribution would be one in which one person has all the income and everyone else has none. In that case, the curve would be at y = 0 for all x < 100, and y = 100 when x = 100 called the line of perfect inequality. For any distribution, the Lorenz curve L(F)  is written in terms of the cumulative distribution function (F(x)) as: where x(F) is the inverse of the cumulative distribution function F(x)

The Gini coefficient is a measure of inequality of a income distribution, defined as the ratio of area between the Lorenz curve of the distribution and the curve of the uniform distribution, to the area under the uniform distribution. It is a number between 0 and 1, where 0 corresponds to perfect equality (e.g. everyone has the same income) and 1 corresponds to perfect inequality .The Gini index is the Gini

Source: http://en.wikipedia.org/wiki/Lorenz_curve                               Source: http://en.wikipedia.org/wiki/Gini_coefficient

coefficient expressed as a percentage, and is equal to the Gini coefficient multiplied by 100. Gini coefficient can also be used to measure wealth inequality. This use requires that no one has a negative net wealth. The Gini coefficient is defined as a ratio of the areas on the Lorenz curve diagram. If the area between the line of perfect equality and Lorenz curve is A, and the area under the Lorenz curve is B, then the Gini coefficient is A/(A+B).

It is calculated with the Brown Formula as :

where

  • G is the Gini coefficient,
  • Xk is the cumulated proportion of the population variable, for k = 0,…,n, with X0 = 0, Xn = 1.
  • Yk is the cumulated proportion of the income variable, for k = 0,…,n, with Y0 = 0, Yn = 1.

 Poor countries (those with low per-capita GDP) have Gini coefficients that fall over the whole range from low (0.25) to high (0.71), while rich countries have generally low Gini coefficient (under 0.40). Most developed European nations tend to have Gini coefficients between 0.24 and 0.36, the United States Gini coefficient is above 0.4, indicating that the United States has greater inequality.

Source: http://siteresources.worldbank.org/DATASTATISTICS/Resources/reg_wdi.pdf

The above table measures the Income distribution within selected countries.

Effect of age on Income distribution: We observe an indirect effect of age structure on growth, one that would work through income inequality. This is owing to two reasons as mentioned by Tim Sargent. He says that – “First, an older workforce is a better paid workforce. If countries invest disproportionately in university education then this could actually raise inequality by raising the wages of an elite group of better educated workers.” Another possibility is the raised by David Green and Paul Beaudry in a recent paper.  He says that a society that invests heavily in educating the top part of your skill distribution, can hurt lower paid workers by diverting physical capital away from low skilled workers towards high skilled workers. Thus younger people mean more income inequality.

The Marginal Productivity Normative Standard: This refers to the Marginal revenue productivity theory of wages which provides the determination of wages in a competitive market. According to this theory, The marginal revenue product (MRP) of a worker is equal to the marginal product (MP) that is the extra physical amount produced due to hiring the worker into the price of the product, i.e. it is the increase in revenue when an extra worker is employed. The theory concludes that workers will be hired at the point when the Marginal Revenue Product is equal to the wage rate. There are two method of calculating MRP, one is change in total revenue over change in number of the additional worker, anther one is marginal product (MP) multiplied by marginal revenue (MR). Equilibrium in the labor market requires that MRC=MRP. With the assumption that everyone is a price taker, this condition can be written as-(1) Marginal Product x Price = Wage. If we divide both sides by price, we get(2) Marginal Product = Wage/Price = Real Wage.

The Absolute Income Equality Normative standard: Absolute income equality means a situation , where, everyone, regardless of who they are or how productive they are, would receive the same amount of income. According to Elizabeth Fei , “Assuming people are motivated primarily by income and not an internal drive to just “work,” in this type of society, there would be no incentive or motivation to work by anyone. The lower, presumably less productive, sections would society would be less inclined to work because they know that they are just going to receive the same amount as everyone else. The upper, presumably more productive, sections of society would also work less because they know that the money that they earned will go to someone else. They would be less likely to work overtime or with increased effort because anything they earn above their allotted amount would just go to someone else.” Thus absolute income equality would mean stagnant economic growth.

The Rawlsian Normative Standard: This theory is known as “Justice as Fairness” by John Rawls. Rawls derives his two famous principles of justice: the liberty principle and the difference principle. According to Wikipedia, the encyclopedia, “ The liberty principle said that each person is to have an equal right to the most extensive basic liberty compatible with a similar liberty for others. The basic liberties of citizens are, “roughly speaking”, political liberty (i.e., to vote and run for office); freedom of speech and assembly, liberty of conscience and freedom of thought, freedom of the person along with the right to hold (personal) property; and freedom from arbitrary arrest. Rawls’ claim in the difference principle is that departures from equality of a list of what he calls primary goods – ‘things which a rational man wants whatever else he wants are justified only to the extent that they improve the lot of those who are worst-off under that distribution in comparison with the previous, equal, distribution. His position is thus egalitarian, with a provision that equality is not to be achieved by worsening the position of the worst-off.”

What is Poverty? Poverty in known to be a condition where one possesses an income insufficient to maintain a minimal standard of living. The definitions of poverty are culturally specific, and therefore relative to the social norms and lifestyle expectations of a given nation-state. However, the condition of absolute poverty referring to lacking the income to maintain a minimum diet is acknowledged globally.

Poverty is usually defined by a poverty line, ie if a household earns an income lower than a set amount, that household and its members are deemed to be living in poverty. The poverty line varies according to the size of the household and its age composition and changes over time.

According to the Water Page website, Poverty affects all levels and all aspects of society from the public institutions of government to the individual level.

Institutional poverty has the following effects:-

  • Public institutions are not able, because of the poverty of individuals and the corporate private environment, to raise funds from taxes and revenues.
  • extremely low salaries and inadequate working conditions,
  • public spending on basic necessities such as education and health care are very low,
  • it is difficult to attract and keep good calibre
  • fertile grounds are laid for corruption and graft,
  • systems of patronage and nepotism often result in political interference,
  • mounting foreign debt is accompanied with an inability to compete on international markets,
  • the gap of technological advancement is ever widening.

Individual poverty has the following effects:-

  • Very low levels of formal employment, particularly in rural areas and poor urban fringes.
  • Access to basic services is very difficult and is often comparatively very expensive.
  • For the vast numbers of people surviving below the poverty line each day requires enormous skill and creativity in order to survive.
  • Disease and poor health are constant realities.
  • Even minimal costs for basic services represent a large proportion of disposable income.
  • Education, if available, is of a very low standard and literacy levels are very low

Conclusion

Global income inequality is an important economic issue that we face today. It involves both international inequalities and inequalities within countries, which are actually quite complex and diverse. In trying to improve the former, a lot can be done by the people and the government to undertake welfare programs, such as spreading education- the biggest tool to empower the poor. And as Rawls says, the only objective should be to improve the lot of the poorest, therefore to fight absolute poverty. The subject of inequalities and poverty is now firmly set on the agenda of economic research; it now needs to come in its implementation phase.

References

[1] Definition of Poverty, retrieved from    media.pearsoncmg.com/intl/ema/uk/0131217666/student/0131217666_glo.html

[2] Causes of Poverty by Anup Shah, April 15, 2006, retrieved from http://www.globalissues.org/TradeRelated/Poverty.asp

[3] Economic Democracy: The Political Struggle of the 21st Century by J.W. Smith, retrieved from http://www.globalissues.org/TradeRelated/Poverty/EconomicDemocracy.asp

[4] Economic Inequality, retrieved from http://en.wikipedia.org/wiki/Economic_inequality

[5] The Water Page, retrieved from http://www.thewaterpage.com/poverty.htm

[6]  Facts and Figures from World Development Indicators 2006, retrieved from http://siteresources.worldbank.org/DATASTATISTICS/Resources/reg_wdi.pdf

[7] Demographics, Non-Working Time, Inequality and Growth by Tim Sargent published on Friday, January 26, 2001, retrieved from http://www.irpp.org/events/archive/jan01/sargent.pdf

[8] To Equate or Not to Equate: The Role of Government in Income Inequality by Elizabeth Fei, retrieved from http://minneapolisfed.org/econed/essay/results/2-04adv.cfm

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