JOHN CABOT UNIVERSITY

Computer Science 110 – 3

Federico Giordani

  1. Introduction...... 3
  2. Global Extent...... 5
  3. Socio-economical causes...... 8
  4. Effect on economic growth...... 10
  5. Effect on wage disparity...... 13
  6. Conclusion...... 18

Economic inequality is the state of affairs in which assets, wealth, or income are distributed unequally among individuals in a group, among groups in a population, or among countries. The issue of economic inequality can implicate notions of equity, equality of outcome, and equality of opportunity.

Opinions differ on the importance of economic inequality and its effects. Some studies have emphasized inequality as a growing social problem. While some inequality may promote investment, too much inequality may be destructive. Income inequality can hinder long term growth, but can also help long term growth. Statistical studies comparing inequality to year-over-year economic growth have been inconclusive; however in 2011, researchers from the International Monetary Fund published work which indicated that income equality increased the duration of countries' economic growth spells more than free trade, low government corruption.

Economic inequality varies between societies, historical periods, economic structures and systems. The term can refer to cross sectional distribution of income or wealth at any particular period, or to the lifetime income and wealth over longer periods of time. There are various numerical indices for measuring economic inequality. A widely used one is the Gini coefficient, but there are also many other methods. Engerman and Sokoloff further explain economic inequality via historical institutions, as demonstrated by European colonial institutions of the Americas. See their "Inequality, institutions, and differential paths of growing among new world economies" 'Journal of Economic Perspectives' 14, no. 3 (2000) for further reading.

A study entitled "Divided we Stand: Why Inequality Keeps Rising” by the Organisation for Economic Co-operation and Development (OECD) reported its conclusions on the causes, consequences and policy implications for the ongoing intensification of the extremes of wealth and poverty across its 22 member nations (OECD 2011-12-05).

•"Income inequality in OECD countries is at its highest level for the past halcentury. The average income of the richest 10% of the population is about nine times that of the poorest 10% across the OECD, up from seven times 25 years ago.

•Wealth inequality in the United States has increased further from already high levels.

•Referring to median incomes for the upper 10% contrasted with medians for the lowest 10%, "Other traditionally more egalitarian countries, such as Germany, Denmark and Sweden, have seen the gap between rich and poor expand from 5 to 1 in the 1980s, to 6 to 1 today."

A study by the World Institute for Development Economics Research at United Nations University reports that the richest 1% of adults alone owned 40% of global assets in the year 2000. The three richest people in the world possess more financial assets than the lowest 48 nations combined. The combined wealth of the "10 million dollar millionaires" grew to nearly $41 trillion in 2008. A January 2014 report by Oxfam claims that the 85 wealthiest individuals in the world have a combined wealth equal to that of the bottom 50% of the world's population, or about 3.5 billion people.According to a Los Angeles Times analysis of the report, the wealthiest 1% owns 46% of the world's wealth; the 85 richest people, a small part of the wealthiest 1%, own about 0.7% of the human population's wealth, which is the same as the bottom half of the population.An October 2014 study by Credit Suisse also claims that the top 1% now own nearly half of the world's wealth and that the accelerating disparity could trigger a recession.

According to PolitiFact the top 400 richest Americans "have more wealth than half of all Americans combined. According to the New York Times on July 22, 2014, the "richest 1 percent in the United States now own more wealth than the bottom 90 percent".Inherited wealth may help explain why many Americans who have become rich may have had a "substantial head start”. In September 2012, according to the Institute for Policy Studies, "over 60 percent" of the Forbes richest 400 Americans "grew up in substantial privilege".

The existing data and estimates suggest a large increase in international (and more generally macroregional) component between 1820 and 1960. It might have slightly decreased since that time at the expense of increasing inequality within countries.

The United Nations Development Programme in 2014 asserted that greater investments in social security, jobs and laws that protect vulnerable populations are necessary to prevent widening income inequality.There is a significant difference in the measured wealth distribution and the public’s understanding of wealth distribution. Michael Norton of the Harvard Business School and Dan Ariely of the Departement of Psychology at Duke University found this to be true in their research, done in 2011. The actual wealth going to the top quintile in 2011 was around 84% where as the average amount of wealth that the general public estimated to go to the top quintile was around 58%.

There are many reasons for economic inequality within societies. Recent growth in overall income inequality, at least within the OECD countries, has been driven mostly by increasing inequality in wages and salaries. Economist Thomas Piketty, who specializes in the study of economic inequality, argues that widening economic disparity is an inevitable phenomenon of free marketcapitalism when the rate of return of capital (r) is greater than the rate of growth of the economy (g).

Another cause is the rate at which income is taxed coupled with the progressivity of the tax system. A progressive tax is a tax by which the tax rate increases as the taxable base amount increases. In a progressive tax system, the level of the top tax rate will often have a direct impact on the level of inequality within a society, either increasing it or decreasing it, provided that income does not change as a result of the change in tax regime. Additionally, steeper tax progressivity applied to social spending can result in a more equal distribution of income across the board. The difference between the Gini index for an income distribution before taxation and the Gini index after taxation is an indicator for the effects of such taxation.

There is debate between politicians and economists over the role of tax policy in mitigating or exacerbating wealth inequality. Economists such as Paul Krugman, Peter Orszag, and Emmanuel Saez have argued that tax policy in the post World War II era has indeed increased income inequality by enabling the wealthiest Americans far greater access to capital than lower-income ones.

In 2014, economists with the Standard & Poor's rating agency concluded that the widening disparity between the U.S.'s wealthiest citizens and the rest of the nation had slowed its recovery from the 2008-2009 recession and made it more prone to boom-and-bust cycles. To partially remedy the wealth gap and the resulting slow growth, S&P recommended increasing access to education. It estimated that if the average United States worker had completed just one more year of school, it would add an additional $105 billion in growth to the country's economy over five years.

In the 1960s, economist Arthur Melvin Okun argued that there was a "trade-off" between economic growth and equality. Pursuing equality could reduce efficiency (the total output produced with given resources) by reducing incentives to work, save, and invest and through the “leaky bucket” of wasteful government efforts to redistribute (such as a progressive tax code and minimum wages). Some resources “will simply disappear in transit, so the poor will not receive all the money that is taken from the rich”.Along the same lines, earlier writers had argued that wealthier individuals save proportionally more of their incomes, so that more inequality would lead to higher overall savings and thus capital accumulation and growth. On the other side OzanHatipoglu argues that is important to reduce the income inequality since “Inequality between rich and poor plays an important role for technological progress, because by determining who are able to afford newer goods, it affects incentives for innovative activity.”

Many authors have empirically examined the relationship between economic growth and income inequality in a large group of countries. Following the broader economic growth literature, the typical approach was to relate countries' real GDP per capita growth over a long period of time (e.g., 1965 through 1990) to the income distribution at the start of the period, simultaneously taking into account other standard determinants such as the initial level of real GDP per capita. A typical conclusion was that more unequal countries tend to grow slower (Alesina and Rodrik, 1994), though the evidence was contested.

Because of general dissatisfaction with the empirical approach, including difficulties in determining causality and capturing country-specific factors, attention turned to the analysis of how changes in the income distribution affected the growth rate in subsequent time period (usually five years) in a large group of countries. Forbes (2000) found that an increase in inequality tends to raise growth during the subsequent period. This literature did not go too far as Banerjee and Duflo (2003) found a complex relationship between inequality and growth, in which changes in inequality in either direction lowered growth subsequently. They interpreted this finding as supporting the notion that redistribution hurts growth, at least over the short- to medium-run, but also cautioned about interpreting income distribution-economic growth analysis of this type.

In recent years, the economic growth literature has recognized that growth in most countries does not follow a smooth path, but is characterized by sharp turning points – periods of sustained growth and stagnation. The interesting empirical questions, then, are about the determinants of the turning points (Pritchett, 2000).

Along these lines, Andrew Berg and Jonathan D. Ostry (2011) examined the question of what sustains long periods of strong growth, and found that one of the most robust and important determinants is the level of income inequality. In particular, they found that high 'growth spells' were much more likely to end in countries with less equal income distribution, and that the measured effect was large. For example, they estimate that closing half the inequality gap between Latin America and emerging Asia would more than double the expected duration of a 'growth spell.' Their findings were robust to the inclusion of other variables in the model, and to alternate definitions of growth spells. According to their study, which has featured prominently in the financial press, inequality is of course not the only thing that matters but it clearly belongs in the "pantheon" of well-established growth factors such as the quality of political institutions or trade openness.

Ostry and Berg (2011) studied factors affecting the duration of economic growth in developed and developing countries. They found that income equality has a more beneficial impact than trade openness, sound political institutions, and foreign investment.

Berg and Ostry postulate that high levels of inequality might damage long term growth by amplifying the potential for financial crisis, discouraging investment because of political instability, making it more difficult for governments to make difficult choices (such as raising taxes or cutting public expenditure) in the face of shocks, or by discouraging investment in education and health for the poor.

In 2013 the average American CEO was paid 331 times what the average worker in the United States earned and 774 times what full-time minimum wage workers made, according to a new analysis released Tuesday by the AFL-CIO, the nation’s largest labor union.Chief executives took home on average a haul of about $11.7 million in 2013, while the average employee earned $35,293. To calculate the CEOs’ earnings, the AFL-CIO relied on filings with the Securities and Exchange Commission as well as the website Salary.com, which provides compensation figures for chief executives for 3,000 firms. Data about workers’ wages were drawn from the Bureau of Labor Statistics.

The AFL-CIO's figures were in line with other analyses of executive pay. A survey of the CEOs of the 100 largest publicly traded companies by the firm Equilarfor the New York Times found the median pay for top executives was $13.9 million in 2013 — an increase of 9 percent from the previous year.The rising levels of executive compensation have been a well-documented phenomenon since the late 1980s, when shareholders began to offer CEOs ever more generous compensation packages, including stock options. A separate analysis done by the left-leaning Economic Policy Institute shows the explosive trajectory over time: In 1968 the top CEOs were paid only about 20 times what workers earned.

SALARY CHANGE ADJUSTED FOR INFLATION
YEAR / INFLATION RATE / CEO SALARY INCREASE / WORKER SALARY INCREASE
1995 / 2.80% / n/a / n/a
1996 / 3.00% / 22.73% / 1.89%
1997 / 2.30% / 41.80% / 3.54%
1998 / 1.60% / 15.41% / 3.63%
1999 / 2.20% / 27.73% / 3.37%
2000 / 3.40% / 49.77% / 2.13%
2001 / 2.80% / NO INCREASE / NO INCREASE
2002 / 1.60% / NO INCREASE / NO INCREASE
2003 / 2.30% / NO INCREASE / 0.14%
2004 / 2.70% / 3.20% / 1.95%
2005 / 3.40% / 46.43% / 0.26%
2006 / 3.20% / NO INCREASE / 1.40%
2007 / 2.80% / 31.35% / 1.74%
2008 / 3.80% / NO INCREASE / NO INCREASE
2009 / -0.40% / NO INCREASE / NO INCREASE
2010 / 1.60% / NO INCREASE / 0.76%
2011 / 3.20% / 7.14% / NO INCREASE
2012 / 2.10% / 9.30% / 1.02%

Critics, including the AFL-CIO, say that such plush salaries for the nation’s CEOs are helping widen an already yawning income and wealth gap in the United States. Moreover, many find the packages particularly galling, since many of the firms with the highest-paid CEOs operate with thousands of low-wage employees.James Skinner, CEO of McDonald’s, for instance, made a total of $27.7 million in 2013, according to the data. Michael T. Duke of Walmart Stores Inc. hauled in $20 million in 2013, and Larry Merlo of the CVS Caremark Corp. had a salary of $31 million. Those figures are dwarfed by what Larry Ellison, the CEO of software company Oracle and the best-compensated executive in the country, made last year: $78 million.To put those numbers in perspective, a minimum wage employee would have to work 1,372 hours to make what Duke earns in a single hour in his job at the helm of Walmart.

The steadily increasing disparity between CEO and worker salaries means it takes minimum wage workers hundreds of hours to equal the pay of just one CEO hour.Source: AFL-CIO“In recent decades, corporate CEOs have been taking a greater share of the economic pie while wages have stagnated and unemployment remains high,” the AFL-CIO report stated. “Even as companies argue that they can’t afford to raise wages, the nation’s largest companies are earning higher profits per employee than they did five years ago.”Defenders of the current system argue, however, that executive higher salaries allow firms to recruit the best candidates, who are then given incentives to produce the best results for the company. In the end, the performance of top-caliber CEOs benefits both shareholders and employees.

Another body of research disputes that thinking. A review of executive pay done by J. Scott Armstrong, a professor at the Wharton School of Business, and Philippe Jacquart, an assistant professor at L’École de Management de Lyon, found no correlation between pay and performance of top CEOs.“Higher pay fails to promote better performance,”they wrotein their paper in Interfaces, a peer-reviewed journal on organizational research. “Instead, it undermines the intrinsic motivation of executives, inhibits their learning, leads them to ignore other stakeholders and discourages them from considering the long-term effects of their decisions on stakeholders.Also, many chief executives do not suffer the consequences when they prove themselves poor stewards. For instance, Jamie Dimon, CEO of JP Morgan Chase, earned a 74 percent pay raise in 2013, the same year that the company paid $20 billion in fines for regulatory wrongdoing and barely escaped criminal penalties.

Nell Minow, an expert on corporate governance and a longtime critic of compensation packages, said that although there was cause to be concerned about wealth further consolidating in the hands of the country’s richest executives, the bigger issue was that bloated pay packages do not produce better outcomes.“That’s an important argument to make. Unfortunately, it feeds into the response from the other side — ‘It’s about populism and class warfare’ — which has nothing to do with it,” she said. “It has to do with the future of capitalism and whether we’re on a sustainable path.”

Federico Giordani / 1