Seminar on Equity and Inequalitiespresentedby KC LAM 20080505
(Please DO NOT QUOTE)
Outline
I. Introduction to the topic on Equity and Efficiency
- Relevance and importance of the topic
Polls in HK have consistently indicated inequalities as one of the top social concerns
CE listed the issue of inequalities and poverty as one of his five main policy concerns
- In relation to the rationale, aims and objectives of the new Economics syllabus
“giving students a more comprehensive understanding of contemporary issues facing our society and the country”
“participate as informed and responsible citizens in the decision-making processes of a modern democratic society”
“students develop skills to evaluate information, arguments, proposals and policies from different economic perspectives and make informed judgements”; and
“to communicate economic ideas and informed judgements, in a clear, logical and appropriate form”
- Connection with other topics in the syllabus
For whom to produce
Positive and normative statements
Market intervention
Market structure: perfect competition, monopoly power
Limitation of national income statistics
Growth and development e.g. marketization in Chinese economy
II. Equity and Efficiency in the market economy
- Are market outcomes efficient?
Why market may fail?
Market power
Externalities
Public goods
Incomplete information
Apart from market failures listed above, inefficiencies may result from government policies like taxes, subsidies & quota
- Does efficiency imply equity?
Some efficient allocations may be more fair than others
Difficult to say what is the most equitable allocation
There is no reason to believe that efficient allocation from competitive markets will give an equitable allocation.
Utility possibilities frontier (In Depth)
An inefficient allocation may be regarded as more equitable than the efficient ones
Social welfare functions: weights are applied to individual’s utility to determine what is socially desirable. Different social welfare functions represent different views of equity
Some views of equity do not assign weights, and cannot be represented by a welfare function
- Equity and perfect competition
Q. Must a society that wants to be more equitable necessarily operate in an inefficient world?
A. Second Theorem of Welfare Economics
If individual preferences are convex, then every efficient allocation (every point on the contract curve) is a competitive equilibrium for some initial allocation of goods.
In other words, any equilibrium that is equitable can be achieved by redistributing resources and may be efficient
However, typical ways to redistribute goods are costly and cause inefficiencies
III. Different views of Equity
Many principles (but not all)can broadly be classified as those focusing on results (#1,2,3 ) and those focusing on rules or processes (#4)
1. Utilitarian
the principle states we should strive for the greatest happiness for the greatest number
founded by English philosophers Jeremy Bentham and John Stuart Mill
All humans have the same basic needs and the same desire to enjoy life
The principle of diminishing marginal utility suggests that the entire society would gain utility if there was a transfer of income until the marginal utility per dollar of income was equal across all households.
Conceptual problem: different people have different utility function, problem of interpersonal comparison
Welfare economics
2. Rawlsian
Acontemporary view on utilitarianism originally developed by John Rawls of HarvardUniversity
Government should choose policies deemed to be just, as evaluated by an impartial observer behind a “veil of ignorance”
Public policy should be based on maximin criterion, which seeks to maximize the utility or well-being of the worst-off person in society.
Would allow for the redistribution of income as a form of social insurance
However, this view would argue that any shrinking of the economic pie that would decrease the well being of the poorest would not be fair.
3. Egalitarian
An egalitarian view believes that goods should be equally shared by all individuals in society
more productive people thereby producing more goods and then having more to reallocate to all of society
- Equalizing Opportunities (Libertarian)
The symmetry principle is the requirement that people in similar situations be treated similarly
this would be an equality of opportunity principle, rather than an equality of income principle
Rules must be created and enforced such that individuals have equal economic opportunity
The state must enforce laws that establish and protect private property
Private property may be transferred from one person to another only by voluntary exchange
Fair rules will lead to equal opportunity, but not equal distribution of goods and/or income because households have different preferences
Taxes for redistribution are not seen as fair, since they are an involuntary transfer of private property
Challenges: initial endowments may not result from fair acquisition; opportunities are rarely equal in real world; claim to private property may not be absolute because of social nature of activities
- Other views of justice
(i) Social responsibilities
The rich have responsibilities to take care of the poor and the needy by transfers
Aim not at complete equality but poverty reduction
(ii) Merit & Contribution
(iii) Justice & rights vs compassion & charity
IV. Measuring inequalities (Cowell 1995)
1. Normative or positive?
What is fair is a normative issue, but the measurement and causes of inequalities involve positive analyses; while the choice of measures involves both normative and positive considerations. The major discussions in our syllabus involve positive analyses
2. Three basic elements of an inequality measure
(i). Inequality of what?
Description ofAttribute:e.g. wealth vs income
(ii). Specification of an individual social unit: household vs person
(iii). Method of representation of the allocation of income or wealth
e.g. a scalar numerical representation (3rd element) of the interpersonal differences (2nd element) in income (1st element) within a given population
3. Four basic principles of inequalities measures
(i). Principle of transfer: a hypothetical transfer of income from a rich person to a poor person should reduce measured inequality
(ii). Scale independence: The measured inequality of the slices of the cake should not depend on the size of the cake e.g. if income of all people has doubled, inequality measure should remain the same.
(iii). Population principle: the inequality of the cake distribution should not depend on the number of cake-receivers
(iv). Decomposability: there should be a coherent relationship between inequality in the whole society and inequality in its constituent parts
4. Different measures of inequalities
Want a way of looking at inequality that reflects both the depth of poverty of the ‘have nots’ and the height of well-being of the ‘haves’
Three broad categories of methods to present income distribution: (A) diagrams, (B) inequality measures and (C)rankings
A. Diagrams
Data often presented in frequency tables
( e.g.Table 3.2 of 2006 census report on income distribution )
(1) Frequency distribution of income. Number of households/persons within a certain income bracket( e.g. Plot Table 3.2 of 2006 census report )
(2) Cumulative frequency distribution
(3) The Lorenz curve
imagine that you lined up all the households in ascending order of incomes
divided the households into 10 equal groups (bottom decile, … top decile)
computed the share of the total income that each group of household received.
Plotted cumulative % of income against cumulative % of households
if income were equally distributed across all households, each decile (10%) of families would receive one-tenth (10%) of total income
line of perfect equality : diagonal
in reality, always convex toward the origin
(e.g. can be computed from Table 3.4 of 2006 census report)
if Lorenz curve is farther away from the line of equality everywhere, inequality is greater
greatest inequality, one person gets 100% of total income
difficulties in interpretation when two Lorenz curves cross over
B. Inequality measures
(1). Range R = ymax– ymin
(2). Gini coefficient G
Let A=area between the line of equality and the Lorenz curve,
B = area of the lower triangle
Then G = A/B
Absolute equality; implies A=0 and G=0
absolute inequality; implies A=B and G=1
Lorenz curve above indicates that Gini coefficient of wealth distribution is greater than Gini of income distribution
advantages: independent of income scale & population size; range in [0,1] interval
Limitations: Weak principle of transfer;not decomposable
Limitations in interpreting the size of Gini Coefficient and its changes in HK (ref. CoP paper no.20 & 22)
Adjusted Gini coefficient is smaller: adjusted for taxes, education, medical & housing benefit, CSSA
changes over time affected by changes in household size, higher education, prolonged economic downturn
(3). Variance V
V = 1/n ∑ [yi–y‾]2
Measures deviations from the sample mean
Satisfies strong principle of transfer; decomposable
Unsatisfactory; doubling everyone’s income and V would quadruple.
One way round is to standardize V
(4) Coefficient of variation c :
divide square root of V by mean of y
Satisfies strong principle of transfer; decomposable;independent of income scale & population size
(5). Log variance v
Fails principle of transfers; not decomposable;
but independent of income and population size
C. Rankings
(1).Quantiles
absolute value of quantiles, e.g. earnings at 10th, 50th or 90th percentile:Y10, Y50,Y90
quantile ratio of earnings e.g. Y90/ Y10
i.e. ratio of earnings at 90th percentile to earnings at 10th percentile
(e.g. Bernanke 2007; HK data 1986-2001)
(2). shares
Share of income by a certain group of household, e.g. share of labor income vs share of capital income
Choice of measures often depends on the situation and what you want to study
E.g. Gini coefficient is often used in comparing countries of different sizes, or changes over time; the measure is widely used and available
In public policies that involves transfers, principle of transfer is important
V. Sources of income inequalities
Have implications on whether income inequalities are justified
Demand and supply factors in the market
Demand side: Value of marginal product: price of the product and marginal product of a factor
Supply side: e.g. immigration across the border resulting in an increase in supply of low skilled workers may depress wages for low-skilled workers
Labor earnings
- human capital
nature of capital investment: expenditure of resources at one point in time to raise productivity in the future
e.g. schooling, post-schooling on the job training, health, appearances
( e.g. Table 3.6 of 2006 census report on income distribution.)
Current income vs lifetime income
Observed income of a young worker is lower since he is investing a greater share of his earnings potential at young age, and also his accumulated human capital is smaller
Implication: observed current income differentials cannot be interpreted as unfair
- Compensating differentials – differences in tastes and job characteristics
a difference in wages that arises from non-monetary characteristics of different jobs.
E.g. higher pay for risky jobs
Free choice of occupation as a result of matching tastes of workers and productivity of firms
Implication: earnings differentials are not unfair
- discrimination
meaning: the marketplace offers different opportunities to similar individuals who differ only by race, ethnic group, sex, age or other personal characteristics (unrelated to market productivity) (Mankiw)
type of discrimination: competitive vs non-competitive
competitive: prejudice of consumers, employers and workers; statistical discrimination
non-competitive: crowding (e.g. women crowded into low pay jobs); collusive behavior
difficulties in measuring discrimination : observe wages, but other things are not the same, there may be unobservables or left out variablesso that earnings differentials may be the result of unobserved skills or qualities (e.g. better work ethics, higher EQ)
How significant is discrimination in a competitive market?
For competitive discrimination: firms that do not discriminate will be more profitable than those firms that do discriminate, thus competitive markets tend to limit the impact of discrimination on wages
Non-competitive discrimination may persist due to social custom or market power; call for government intervention
- Ability, effort, attitude and chance
- Signaling
Sheep skin effect
Firms use educational attainment as a way of sorting between high-ability and low-ability workers.
i.e. productivity is not raised by education as claimed by human capital theory
It is rational for firms to interpret a college degree as a signal of ability.
- The superstar phenomenon
Every customer in the market wants to enjoy the good supplied by the best producer
The good is produced with a technology that makes it possible for the best producer to supply every customer at a low cost
Other non-labor income: rent, interest, profit
unequal ownership of capital or initial wealth
Q. Are inequalities listed above ‘fair’?
Considerations:
1. What kind of inequality ?
2.What are theunderlying principles of equity?
3. Should compare like with like
4.Family income depends on resource prices, resource endowment and choices
5. Changes in income thus depends on the changes of the these factors
6.Mobility, intergeneration mobility and inequalities
7. Inequalities vs poverty : not possible to eliminate relative poverty
VI. Different views on equity have different implications on policies
E.g. those emphasizing equal opportunities may think it’s fair that some people who have invested a lot on human capital or work harder earn higher wages, with a possible implication that redistribution is neither needed nor desirable
People emphasizing charity may vote for policies for economic transfers to the needy who are in absolute poverty for whatever reasons
Policies are not the subject of discussion in this seminar
References
Mankiw, N. Gregory,Principles of Microeconomics,4 ed. chapters 19,20.
Parkin, Michael, Economics 7 ed., Addison Wesley
Cowell, Frank, Measuring Inequalities, 2nd ed. Prentice Hall/Harvester Wheatheaf. 1995
Census and Statistics Department, Report of the Population Censuses
Sen, Amartya (1995), Inequality Reexamined, Harvard/Russell Sage Foundation.
Arthur, John and William H. Shaw (1991), Justice and Economic Distribution, NJ: Prentice Hall.
Bernanke, Ben S.(2007) , “The level and distribution of economic well-being”, Remarks given before the Greater Omaha Chamber of Commerce, Omaha, Nebraska, The Federal Reserve Board, February 6, 2007.
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