Economic Theory 1 A – Week 2

Inequality, Policy

and Government

Outline

1. Measuring the degree of inequality: the Lorenz curve and the Gini coefficient
2. Inequality and policy interventions: Redistribution and Predistribution
3. Global inequality: Between people and between nations
4. Accidents of birth, endowments and intergenerational inequality
5. Government’s role in the economy

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Covering the following units in “The Economy” textbook

5.1 5.12 5.13 19.1 19.2 19.5 19.8 22.1

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Remember to use the Glossary section on www.core-econ.org

• https://core-econ.org/the-economy/book/text/50-02-glossary.html#glossary

endowment

• The facts about an individual that may affect his or her income, such as the physical wealth a person has, either land, housing, or a portfolio of shares (stocks). Also includes level and quality of schooling, special training, the computer languages in which the individual can work, work experience in internships, citizenship, whether the individual has a visa allowing employment in a particular labour market…

human capital

• The stock of knowledge, skills, behavioural attributes, and personal characteristics that determine the labour productivity or labour earnings of an individual. Investment in this through education, training, and socialization can increase the stock, and such investment is one of the sources of economic growth….

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Measuring the degree of inequality�The Lorenz Curve and the Gini Coefficient

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By careful of averages…

• Which group is better off?
• Group A

10 people all receiving income of R5 000 a month

i.e. average income is R5 000 a month

• Group B

10 people with 5 receiving income of R10 000 a month and 5 receiving R500 a month

i.e. average income is R5 250 a month

((5 x R1000 + 5 x R500))/10 = R5250

• The average income for Group B is higher then for Group A
• But due to a high degree of inequality the average income measure does not accurately describe welfare levels in these groups.
• This shows us that per capita GDP can’t tell us anything about how income is distributed. It is the average income, but cannot indicate the variation in income within the society.
• To measure income distribution we need tools such as the Lorenz curve and Gini coefficient.

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Lorenz Curve

• Invented in 1905 by Max Lorenz (1876–1959), an American economist (while he was still a student!)
• A graphical representation of inequality of some quantity such as wealth or income.
• A useful tool for representing and comparing distributions of income or wealth, and showing the extent of inequality
• How does the Lorenz work:
• The Lorenz curve shows the entire population lined up along the horizontal axis from the poorest to the richest.
• The height of the curve at any point on the horizontal axis indicates the cumulative fraction of total income received by the fraction of the population up to that point on the horizontal axis.

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Perfect equality

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• For complete equality of income the Lorenz curve is a straight line with a slope of one (or 45 degrees).
• When there is complete equality of income
• the first 10% of the population receives a cumulative 10% of income
• the first 50% of the population receives a cumulative 50% of income, etc.
• The Lorenz curve allows us to see how far income distribution departs from this line of perfect equality.
• The extent to which the Lorenz curve falls below this perfect equality line is a measure of the degree of inequality in a particular population.

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Lorenz curve

A Lorenz curve for wealth ownership

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• In a village of 100 people and 100ha of land:
• 10 landowners owning 10 hectares each
• 90 farmer workers who own no land.
• The Lorenz curve is the blue line.
• Lining the population up in order of land ownership, the first 90% of the population own nothing, so the curve is flat.
• The remaining 10% own 10 hectares each, so the ‘curve’ rises in a straight line to the point where 100% of people own 100% of the land.

Gini Coefficient

• The Lorenz curve provides a good graphical representation of inequality.
• But how can you summarise this information in one number?
• A coefficient that tells you the degree of inequality.

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• The Gini coefficient (g) is approximated with the following formula:

g ≈ A / (A + B)

• Note that the Lorenz curve contains more information than the Gini
• The curve allows you to observe the whole distribution (which enables you to see patterns of inequality – rich, middle class and poor, etc)
• The Gini reduces this to one number (which makes for easier comparisons)

Approximating Gini from Lorenz Curve

• Perfect inequality (one person receives all and A fills the entire area under the line of perfect equality)

A = 0.5 (because the area of a triangle = ½bh)

B = 0

Gini = A / (A + B) = 0.5 / (0.5 + 0) = 1

• Perfect equality (each person receives and equal share)

A = 0 (as the Lorenz curve is the perfect equality line)

B = 0.5 (the entire area under the perfect equality line = ½bh)

Gini = A / (A + B) = 0 / (0 + 0.5) = 0

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• The degree of inequality rises as A / (A + B) rises
• Remember that the axes are percentages – so they range from zero to one (100% = 1)
• The area A represents the degree of deviation from perfect equality. The degree of inequality rises as area A gets larger.

Approximating Gini from Lorenz Curve

For a high degree of inequality:

A = area of a triangle ½ b x h

= (0.5)(0.9)(1)

= 0.45

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B = area of a triangle ½ b x h

= (0.5)(0.1)(1)

= 0.05

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Gini = A / (A + B)

= 0.45 / (0.45 + 0.05)

= 0.45 / 0.5 = 0.9

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Four steps to Gini

• The graphical derivation of the Gini coefficient from the Lorenz curve is an approximation (which is relatively close for large populations)
• More precisely, the Gini coefficient is defined as: half the relative mean difference in income among all pairs of individuals in the population
• The Gini coefficient (g) is directly measured as a number between 0 and 1 as follows:
1. Find the difference in income between every possible pair in the population
2. Take the mean of these differences
3. Divide the mean of these difference by the mean income of the population as a whole to get the relative mean difference
4. Divide the relative mean difference by 2 to get the Gini

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Example of measuring the Gini coefficient

• There are three people (a ,b and c) with incomes of R6 000 a month, R10 000 a month and R12 000 a month respectively
• Step 1: Find the differences between every possible pair:

|a – b| = R10000 – R6000 = R4000

|a - c| = R12000 – R6000 = R6000

|b – c| = R12000 – R10000 = R2000

• Step 2: Mean of the differences

(R4000 + R6000 + R2000)/3 = R4000

• Step 3: Relative mean difference

Mean income of the population = 6000+10000+12000/3 = 9333

• then 4000/9333 = 0.429
• Step 4: Divide by 2

0.429/2 = 0.214

• Conclusion: Gini coefficient

g = 0.214

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Inequality and policy interventions�Redistribution and Pre-distribution

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Three dimensions of economic inequality

• Wealth
• The value of the assets owned by a household (net of their debts).
• This could include financial assets like shares in companies
• Or non-financial assets like a house or a farm
• Note that wealth is a stock
• Earnings or income
• Earnings is income from labour, including from wages, salaries, and self-employment
• Market income includes earnings and income from businesses owned by the household or investments
• Note that income is a flow
• Disposable Income
• The income that a family can spend after paying taxes and receiving any cash transfers from the government such a social grants.

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Inequality in the USA, Sweden and Japan

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Dimensions of inequality

• Wealth is much more unequally distributed than earnings
• Earnings are much more unequally distributed than disposable income.
• The differences among the three measures are much smaller in Japan than in Sweden and the US.
• Of the three, Sweden has:
• The highest inequality of wealth
• The lowest inequality of disposable income
• This is due to Sweden’s
1. Relatively high inequality of wealth
2. Its relatively modest inequality in earnings and
3. Its system of taxes and transfers which benefits the less well off.

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Impact of Government policy on inequality

• Governments influence the degree of inequality in the economy. They do this in two ways:
• Redistribution (transfering market incomes from rich to poor)
• Taxes and transfers applied to market incomes that result in a distribution of disposable income that differs from market income
• Expenditure that provides public services to households
• Pre-distribution (shaping patterns of market income for rich vs poor)
• Government affects the distribution of privately held wealth or the distribution of market determined incomes
• By affecting the endowments that people have and the value of those endowments leading to changes in the degree of inequality in market income

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Redistribution �

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• Through tax and transfer policies government can foster a more equal distribution of disposable income.

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• Differences in inequality in disposable income across countries depends (partly) on the effectiveness of these redistribution policies.

Market income

Income from wages, salaries, self-employment, business and investments

Disposable income

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Subtract direct taxes

Add cash transfers

Inequality in the Netherlands

• Market income:
• The poorest 10% of the population earns virtually 0% of income
• The poorest 50% of the population earns less than 20% of income
• The Gini coefficient for market income is 0.47
• Disposable income:

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• The poorest 10% of the population have about 4% of total disposable income
• The poorest 50% of the population receive more than 30% of total disposable income
• The Gini coefficient for disposable income is 0.25
• Conclusion: The degree of inequality is significantly reduced by redistributive policies in the Netherlands (with the Gini coefficient falling from 0.47 to 0.25)

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Cumulative share of the population (ranked by income)

Cumulative share of income

Comparing Market and Disposable Gini

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Comparing Market Gini and Disposable Gini across various countries

• Across countries there are greater differences in disposable income Gini coefficients (red bars) than in market income Gini coefficients (blue bars)
• This indicates that there are income redistribution programmes in all countries, but typically these programmes have a greater impact in high-income economies, such as Sweden and Norway
• The income redistribution policies in countries like China and India have a very small impact on reducing the relatively high degrees of market income inequality in those countries
• Because of its history of racial dispossession, discrimination and exclusion South Africa has very high market income and wealth inequality and even though it has significant income redistribution policies, disposable income inequality remains very high
• South Africa’s key income redistribution policies include:
• state old aged pensions (see slide) and child support transfers, and
• progressive taxation where high income earners pay a higher tax rate than low income earners

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Concentration of revenue and expenditure in South Africa

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Source data: Inchauste et al (2014) appendix table A3.4

South Africa’s redistributive effort in context

World Bank (2014). "Fiscal Policy and Redistribution in an Unequal Society." South Africa Economic Update 6.

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Gini coefficients under different income concepts

Pre-distribution

• Governments can change the distribution of market income or wealth by acting directly ex ante to change market outcomes.
• By changing the basic laws and institutional structure of the economy – by defining and enforcing the legal framework in which employers, banks, employees, unions, borrowers, and other key economic actors interact, governments affect the distribution of market income.
• There are many ways of doing this, including redistribution of wealth, changes to property rights, regulation of private contracts, education and a range of other social and economic policies

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Pre-distribution

• Examples
• Increased education of the workforce: This changes the endowments of employees, adding skills and other work relevant capacities that will affect market incomes.
• Eliminating or reducing labour market discrimination/segmentation: This – and other anti-discrimination policies – will alter the prices (wages) that a person’s endowment will be paid in the labour market. This raises the value of the endowments of people who otherwise would suffer discrimination.
• Land reform: Undertaking land reform to give people increased access to income generating land assets or a greater share of what is produced from the land (see example from West Bengal, India)

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West Bengal: Addressing inequality through changes to property rights

• Before 1973, land distribution in West Bengal was highly unequal. A few landowners (10% of the population) owned all the land.
• The remaining 90% of the population worked the landlords land through a system of sharecropping. There was a very high level of income inequality and 73% of rural people lived in poverty.
• The tradition since the 1700’s was that sharecroppers (bargadars in Bengali) would give landowners half (50%) of their crop in exchange for the right to use the land.
• In 1978, government introduced “Operation Barga”: the law was changed to say that:
• Bargadars could keep up to three-quarters (75%) of their crop
• Bargadars would be protected from eviction by landowners provided they gave landowners 25% of the crop
• The effect of this law was:
• The pie got larger: Agricultural output increased as bargadars had an incentive to work harder: their reward was greater. Their property rights were more secure and they invested in improving the land
• The poor got a bigger slice of the pie: The poorest people experienced rising share of the income produced.

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Operation Barga illustrated on a (hypothetical) Lorenz Curve

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• The figure shows a hypothetical Lorenz curve based on the description of the programme.

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• Before the reform:
• Sharecroppers paid 50% of their crops to landowners
• At point K: 90% of the population is getting 50% of the income
• The Gini coefficient was 0.4
• After the reform:
• Sharecroppers paid 25%, retained 75% of the crop output
• At point L: 90% of the population is getting 75% of the income
• Gini coefficient was reduced to 0.15

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A model of the sharecropping Gini

A fraction n are sharecroppers. The sharecroppers receive a share s of total output

The area of square is 1

A+B = 0.5 (where B = B₁ + B₂ + B₃)

A = 0.5 – B

g = A/(A+B) = (0.5 - B)/0.5 = 1 – 2B

= 1 – 2(B₁ + B₂ + B₃)

Calculating Areas

B₁ triangle = ns/2

B₂ rectangle = (1-n)s

B₃ triangle = ((1-n)(1-s))/2

Calculating g

g = 1 – 2(B₁ + B₂ + B₃)

= 1 – 2(ns/2 + (1-n)s + ((1-n)(1-s))/2)

= 1 – (ns + 2s – 2ns + 1 – s – n + ns)

= 1 – (1+ ns + ns – 2ns + 2s – s – n)

= n - s

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A model of the sharecropping : g = n - s

Conclusion

• The Gini coefficient (g) will decrease (and inequality will fall) if:
• n falls (meaning that the fraction of sharecroppers falls and more are landowners)
• s rises (meaning the sharecroppers get a larger share of output)
• The Gini coefficient (g) will increase (and inequality will rise) if:
• n rises (meaning that the fraction of sharecroppers rises and there are u)
• s falls (meaning the sharecroppers get a smaller share of output)

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Minimum wages

• Another important example of pre-distribution by limiting the kinds of contracts that are allowed is a statutory minimum wage.
• The intention of a minimum wage is to guarantee living standards for the low-paid. Many countries, including the UK and the US, (and in SA since 1 January 2019) enforce this with legislation.
• Minimum wages:
• positively affect the value of a worker’s endowment of labour, but
• negatively effect workers if they reduces the likelihood that workers will be able to find a job. The costs of the minimum wage could be fewer jobs.

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Potential impact of minimum wages

• The precise impact of minimum wages on workers (positive or negative) depends on the circumstances of the policy’s implementation.
• For example, raising the minimum wage will have little negative impact on employment and will increase the income of poor workers on average, if:
• Firms will be able to adjust to the minimum wage by increasing prices.
• Demand for goods remains strong
• But employment is likely to fall if:
• If demand is highly sensitive to prices, or
• Firms are likely to respond to the minimum wage by reducing employment levels in order to contain costs e.g. via mechanisation

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Global inequality�Between people and between nations

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Income deciles and the 90/10 ratio (again)

• A handy measure of inequality in a country is called the 90/10 ratio, which we define here as the average income of the richest 10% divided by the average income of the poorest 10%.
• It is more commonly defined as the income of the 90th percentile divided by that of the 10th percentile.
• The 90/10 ratio is high even in relatively equal countries.

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Find out where you fit into the distribution of income at this link:

https://www.saldru.uct.ac.za/income-comparison-tool/

Average income by decile in 2014

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Share of the 1%

• Inequality can also be measured by focussing on the share of the very rich, say, what fraction of total income or wealth belongs to the richest 1% or 10% of the population?
• This indicator has the advantage that it can be measured over hundreds of years, because the very rich have long been required to pay taxes, and hence we have reasonably good inform­ation on their incomes and wealth.
• There are three distinct periods:
• the eighteenth and nineteenth centuries up to about 1910 show increasing wealth inequality (excepting Norway and Denmark),
• the twentieth century until 1980 shows decreasing wealth inequality, and
• the period since 1980 shows a modest increase in wealth inequality
• There are cross-country differences in the level of inequality. The US is much more unequal than China, India, the UK and Germany
• But there are also common trends: there was a fall in income inequality across almost all countries form 1920 to 1980, followed by an increase in income inequality in many countries since about 1980
• Countries differed greatly in what happened after 1980 though
• In many countries there was a sharp U-turn towards greater inequality after 1980
• In other countries inequality remained at historically modest levels.

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The inequality U-turn in some countries

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… but not others

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A closer look at South Africa:

The market income share of the top 1% (1910 – 2015)

Inequalities between and within nations

• The ‘great divergence’ resulted because the upward tick in the hockey stick for per capita income came early for some countries (Britain, Italy, and Japan), later for others (China and India), and has not yet occurred for others (Nigeria and Argentina)
• The result of the uneven timing of the capitalist revolution around the world was a widening of inequalities among the people of the world, which occurred over the nineteenth and twentieth centuries until very recently.
• Even the poor in North America and Europe became richer than the rich elsewhere.
• So, how do we measure global inequality?
• There are two methods:
• Measuring global inequality between people (people are the basic unit of comparison)
• Measuring inequality between countries (countries are the basic unit of comparison, and we implicitly assume that every person in a country earns the average income of that country)

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Measuring global inequality

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Red line: Gini coefficient of nations (a Lorenz curve of average per capita incomes per country)

Blue line: Gini coefficient for the world population (a Lorenz curve of all individuals)

• Since 1980, among countries inequality fell rapidly,
• Inequality among all the world’s people has also declined
• But within many countries inequality has increased.

Inequality across countries

• The red line focuses on the income differences across countries.
• Imagine that everyone in each country earned the average income for that country. In this thought experiment, everyone in South Africa would earn exactly South Africa’s average income, whereas everyone in China would earn exactly the Chinese average income.
• The red line shows the result of performing this calculation, where the only source of inequality in the world would be inequality between countries.
• Measured in this way, inequality is reduced, but substantial inequal­ities still exist due to the vast differences in income between countries.
• The reason that across country inequality declined (red line from early 1990’s) was because of accelerated growth in decline in the world’s largest poor countries, China and India.
• But inequality within China and India, increased over this period

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Inequality among people

• Think about the Lorenz curve constructed by lining up all the individuals in the world from lowest to highest income, irrespective of the country people live in.
• The poorest 20%—the part of the Lorenz curve extending from zero to 0.20 on the horizontal axis—would be very flat: this would represent most of the populations of Liberia and Nigeria, and middle and lower income people in Indonesia and India
• If we construct the entire Lorenz curve, we can calculate the Gini coefficient for the whole world.
• For example, on the blue line in the figure, in 2003 the worldwide Gini coefficient was 0.69.
• Measured in this way, inequality among the world’s individuals is high but has fallen very recently.

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Interpretation is that most inequality of income is accounted for by inequality across countries

• You can see that the Gini coefficient for all individuals in the world in 1988 (the beginning of the blue line) was 0.69
• This number would have been 0.60 had there been perfect equality within each country (the red line is based on the assumption that everyone in a particular country earns that country’s average income).
• This can be interpreted as follows:
• In 2003, we could argue that 87% of global inequality in income is accounted for by inequality across countries, because 0.60/0.69 = 0.87, or 87%
• By 2013 across country inequality only accounted for 76% of global inequality (0.47/0.62 = 0.76)

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In Summary

• Fact 1

Most of the inequality in the world is between individuals in different countries (the red series is a large proportion of the blue series) and is not between individuals in the same country

• Fact 2:

But this is changing: The world’s two largest and once very poor economies—India and China—raised their average incomes more rapidly than the richer countries, reducing between-country inequality, and because inequalities across individuals in these countries and many other large nations became greater, this has resulted in increasing within-country inequality.

• Fact 3:

Inequality between individuals is declining: The net result of these opposite trends (1) across country inequality falling and (2) within country inequality rising is that inequality among the individuals of the world has started to decline.

• Overall:

as more people experience rising incomes in countries like India and China inequality rises in those countries and this has resulted in less inequality across the world as a whole (comparing the individuals across the world to each other)

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Accidents of birth, endowments and intergenerational inequality

Taking a chance: what do you choose?

• Suppose that all you care about is income, and you can choose either:
• The income decile you are in, but the country you are born in will be decided by chance (The Risk: if you choose top decile you may land up in Nigeria’s top decile which means you will be less well off than if you had chosen to be in a country like Norway, even if you land up in a lower decline in Norway)
• The country you are born in, but the income decile will be decided by chance (The Risk: if you choose to be born in Norway you may be in the lowest decline which means you will be less well off than if you had chosen China or Botswana and you landed up in a high decile in one of those countries)

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2014

ten deciles of income

Accidents of birth

• Much of the inequality in the world today can be traced to differences among people in things over which they have virtually no control, such as their race, sex, nation, or parents.
• These differences are known-as ‘accidents of birth’.
• Inequality can be as result of the place where you are born and live.
• Inequality can be as the result of your gender, race or other category
• Inequalities based on one’s ethnic identity or caste are examples of categorical i.e. Inequality between particular social groups (identified, for instance, by a category such as race, nation, caste, gender or religion).

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Gender inequality

• The most common form of categorical inequality is that between men and women.
• There are many economic differences between men and women on average.
• This is surprising because men and women have similar parents, similar schools (in most countries), similar genetic inheritance on matters affecting intellectual skills and so on.
• But it is clear that the society treats men and women differently, and this is reflected in economic outcomes. This is much more true in some countries than in others, but it is true for all countries.
• Income disparities between men and women among otherwise similar individuals are one measure of this inequality.

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Gender inequality in the USA

• The figure shows the expected lifetime earnings (labour income) of men and women in the US, who work full time from the time they leave school until retirement.
• Any differences in the figure are not due to women having more time out of the labour force (on average) because of child rearing. Nor, are they due to difference in access to education (see following figure).

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Ratio of girls to boys schooling

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Intergenerational inequality

• In addition to categorical differences such as nation, gender, race, or ethnic group, a second source of economic inequality within a nation is inherited. You may be rich or poor simply because your parents were rich or poor.
• Two hundred years ago, in most countries it was taken for granted that somebody would expect a life of poverty simply because her parents had been poor.
• But this has changed with the spread of public education and, in many countries, with the decline in discrimination against poor people due to their race, religion, or simply their humble origins.
• In some countries, the economic status of one’s parents matters a great deal for the economic success of their children; in other countries, differences among parents are only weakly transmitted to their offspring.

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Intergenerational inequality

• The expression intergenerational transmission of economic difference is the processes by which the economic status of the adult sons and daughters comes to resemble the economic status of the parents
• Intergenerational inequality: The extent to which differences in parental generations are passed on to the next generation.
• The transmission process takes many forms:
• Children inherit the wealth of their parents.
• Through parental influence in child rearing, parents and children tend to share similar preferences, social norms, and knowledge, skills and social connections acquired outside formal schooling.

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Measuring intergenerational inequality

• The figure is based on labour earnings (wages or salaries). The tall bar on the left in the US panel means that among those whose fathers were in the bottom fifth of the earnings distribution, 40% were themselves in the poorest fifth, while 7% ended up in the top fifth of the earnings distribution.
• By contrast, 36% of those born to the richest fifth were themselves in the richest fifth—the tall purple bar on the right.

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Comparing intergenerational inequality in the US and Denmark

• The earnings of parents and their children appear to be similar in the US, partly because children of well-off parents receive more, higher-quality, schooling.
• They also benefit from the networks and connections of their parents, which improve access to the labour market.
• The data from Denmark in the right panel suggests a more level playing field.
• Only 25% of those born to parents in the poorest fifth of the population end up in the poorest fifth themselves, compared to 40% in the US.
• This suggests that those born to relatively poor parents are less disadvantaged in Denmark.
• Similarly, 33% of those born to parents in the richest fifth end up in the richest fifth themselves, compared to 36% in the US
• Based on this data, we would conclude that intergenerational inequality is lower in Denmark than in the US, though it still does not appear to be a completely level playing field.

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Intergenerational elasticity

• The intergenerational elasticity measures how much richer the child of the well off father will be than the child of the poorer father.
• An elasticity of 0.5, for example, means that if one father is 10% richer, then his child, when grown up, will be on average 5% richer than the other child.
• An elasticity of 2, for example, means that if one father is 10% richer, then his child, when grown up, will be on average 20% richer than the other child.
• The higher the intergenerational elasticity,
• the greater the degree of intergenerational transmission of economic status and
• the greater the level of intergenerational inequality.
• In a society with a high intergenerational elasticity intergenerational mobility is slow.

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Factors influencing endowments and inequality

• Intergenerational inequality is likely to be greater where:
• inheritances are not heavily taxed
• education policies allow the wealthy to acquire more and better education for their children.
• marriage customs result in spouses having similar levels of wealth—called ‘positive assortment’—this will contribute to inequalities in endowments.
• elite universities, for example, contribute to positive assortment because like exclusive social clubs, they provide meeting and matching oppor­tunities for the sons and daughters of the wealthy.
• If the economy operates on winner-take-all forms of competition. In this setting, a few people—the winners—will end up with substantial endowments in the form of valuable financial or real assets, while the rest end up with little.

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Government’s role in the economy

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Government as an actor in the economy

• Government is the only entity within a territory that can dictate what people must do/not do. It can legitimately use force and restraints on an individual’s freedom to achieve that end.
• The government is different from other economic actors:
• Much larger – size of most governments have grown over time.
• Engage in activities that can improve quality of life for citizens
• Unlike private firms, government has an obligation to citizens
• To realize these obligations, governments use tax funds to provide services such as national defence, police protection, and schooling.
• It can use coercion to force people to pay taxes.
• These services are often provided without restrictions to those who use them, and without charging a price.
• People differ in the taxes they pay in line with their income and wealth, but because they are citizens, they are equally entitled to many of the services of the government.

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Britain: Taxation as a share of GDP

• The rise of capitalism has been associated with a sustained increased in the size of government

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• As per capita incomes rise, the size of government has increased.
• Other factors that have influenced the size of government include:
• War
• Democracy and universal suffrage
• Aging populations

USA: Government spending as a share of GDP

Even in the USA – generally regarded as the most “free market” society – government now accounts for 40% of GDP

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Source data : Mauro et al (2013)

War of 1812

Civil War

WW1

WW2

Vietnam

India: Government Spending as a share of GDP

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South Africa: Government spending as a share of GDP

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Source data : Mauro et al (2013)

Government policies as part of the solution

• Governments may adopt the twin objectives:
• ensuring that the mutual gains possible through our economic interactions are as large as possible and are fully realized
• sharing these gains in a fair manner
• Examples of policies to address market failures and unfairness include:
• Public provision of healthcare or compulsory insurance.
• Minimum wage laws: That prohibit contracts that pay below a stated minimum.
• Competition policies: To reduce the price-setting powers of monopolies.
• Environmental policies: To reduce emissions of pollutants.

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Government as part of the problem

• To accomplish these valuable policies, governments must have extraordinary powers to acquire information and to compel compliance.
• This creates a dilemma. For the government to be a successful problem-solver, it must also be powerful enough to potentially be a problem itself.
• Examples from history, and today’s news, show governments using their monopoly on the use of force to silence opposition and to acquire huge personal wealth for their officials and leaders (“corruption”).
• Well-governed societies have devised ways to limit the damage that the use of government powers can inflict without undermining the government’s capacity to solve society’s problems. These have generally included a combination of:
• Democratic elections
• Institutional checks and balances

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Main points again

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Inequality, Policy and Government

• The Measure of GDP per capita is an average which does not give a sense of the degree of inequality in a society
• The Lorenz curve and Gini coefficient are measure which give a clearer picture of the degree of inequality
• Government ex post redistribution policies and ex ante predistribution policies can assist in reducing inequalities of income and wealth, as well as categorical inequality (such as inequality based on race and gender) and inter-generational inequality
• Globally, as more people experience rising incomes in countries like India and China inequality rises in those countries and this has resulted in less inequality across the world as a whole

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Inequality, Policy and Government

• A government allows people to do things together that they could not do individually, notably going to war. But governments in a mixed economy also engage in activities that vastly improve living standards and the quality of life for their citizens.
• Examples include:
• Poverty: Fifty years ago, even in rich countries, many retired or elderly people were trapped in poverty. For example, in 1966, 28.5% of US citizens aged 65 and over were classed as ‘poor’. Government transfers in many countries have virtually eliminated serious economic deprivation among the elderly. In 2012 just 9.1% of elderly people in the US were poor.
• Economic security: The increased size of government spending, as well as the policy lessons from the Great Depression and the golden age of capitalism, have reduced economic insecurity by making the business cycle less volatile. See Diagram.
• Increased life expectancy and the dramatic reduction in child mortality in many countries: When these occurred in the late nineteenth and early twentieth century, they were not primarily the result of advances in medicine, most of which came later. They followed government policies that improved sanitation and water supply.
• In some senses government is part of the solution and in some senses government is part of the problem

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