Unit 4: Income inequality - a must read!

This is an excellent article looking at all aspects of poverty and wealth.....so much evaluation for a Unit 4 question, a must read!!!!

Robert Peston has an excellent new blog to accompany a Radio 4 programme on inequality. He examines whether the ‘Great Recession’ has sharpened the debate on inequality so that the conventional wisdom has shifted. Even the International Monetary Fund are now arguing that income inequality may be a cause of slower economic growth.

There are various lines of reasoning involved.

Keynesians argue that the poor have a greater marginal propensity to consume- they are much more likely than the rich to spend the extra £1 they earn. This way, redistribution from rich to poor via progressive income tax can boost consumption and therefore aggregate demand, raising GDP. 

Peston points out that the incomes of America's poorest 20% of households fell by 8% between 2010 and 2013. He goes on to examine the link between this and sub prime lending in the lead up to the 2008 financial crash- so called NINJA loans- to those with no job, income or assets. This left those on lower income with debts they found hard to pay back, resulting in a lower level of consumption in the US.

The wealthy also have a lower marginal utility of money. That is they place less value on the next pound they earn. This way, the theory of diminishing marginal utility also applies to earnings. It might explain Mario Balotelli’s alleged trip to John Lewis and his decision to have an in-house firework display. 

It might also explain the tastes of the Mexican drug barons who had a house with various items in gold. And kept a pet cheetah...

There are also the negative externalities associated with low income- cycles of poverty: the unemployment and the poverty traps mean families can stay on low income for generations. Research also suggests those on lower income need more frequent hospital treatment. This places a longer-term burden on government spending.

On the other hand, the Neo-Classical arguments of economists such as Friedman and Lucas are that lower wages provide incentives for the poor to work harder. Wage differentials also allow the free market to attract labour to where there are shortages and to ensure vacancies are filled, boosting the supply potential of the economy. There’s a classic Milton Friedman video on why the market can solve problems of poverty here, including why the minimum wage is a bad idea.

This links to the idea of ‘trickle down’ economics, that if Roman Abramovich buys a new yacht, it creates jobs in the yacht company so that employees on lower incomes earn more. They might also get a share of the company profits too. So overall spending in the economy increases.

This argument was famously criticised by J K Galbraith, who said it was like saying “if you feed enough oats to the horse, some will pass through to feed the sparrows”…