A Level Economics 55: Income Inequality

Income Inequality: Income inequality refers to the unequal distribution of income among individuals or households within a particular economy or society. It is typically measured using indicators such as the Gini coefficient, where 0 represents perfect equality, and 1 indicates maximum inequality.

1. Market Failure: Market failure occurs when the free market mechanism fails to allocate resources efficiently, leading to suboptimal outcomes for society. It can result from various factors such as externalities, imperfect information, or the presence of market power.

Market Failure Arising from Income Inequality: Income inequality can lead to significant market failures, affecting various aspects of an economy. Let's explore how income inequality contributes to market failure:

1. Limited Access to Basic Goods and Services: In a highly unequal society, individuals with lower incomes may struggle to afford basic goods and services, such as education, healthcare, and nutritious food. As a result, their overall well-being and economic productivity are compromised.

   Example: In a society with high income inequality, many low-income individuals may not have access to quality healthcare due to unaffordable healthcare costs, leading to adverse health outcomes and reduced workforce productivity.

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3. Reduced Human Capital Formation: Income inequality can hinder human capital formation as individuals from lower-income backgrounds may face limited access to education and skill development opportunities. This affects the labor force's productivity and long-term economic growth.

   Example: In a society with minimal income inequality, all individuals have equal access to quality education and skill training, leading to a more skilled and productive workforce that drives economic growth.

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5. Lack of Economic Mobility: High income inequality can create barriers to economic mobility, making it challenging for individuals to move up the income ladder. This perpetuates intergenerational poverty and reduces opportunities for social and economic advancement.

   Example: In a society with minimal income inequality, individuals have better chances of upward mobility, regardless of their family background, as equal opportunities for education and employment are available to all.

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7. Decreased Aggregate Demand: When income is concentrated in the hands of a few wealthy individuals, aggregate demand may suffer as the majority of consumers have limited purchasing power. This can lead to reduced economic activity and lower overall output.

   Example: In a society with minimal income inequality, a larger share of the population has disposable income, leading to higher aggregate demand and increased consumer spending, stimulating economic growth.

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9. Social Unrest and Political Instability: Extreme income inequality can create social tensions and lead to political instability, as people may perceive the economic system as unfair and favoring the wealthy elite.

   Example: In a society with minimal income inequality, social cohesion is strengthened, and political stability is enhanced as people perceive a fairer distribution of resources and opportunities.

Illustration with Minimal Income Inequality: In a society with minimal income inequality, resources are more equitably distributed, leading to improved social welfare and economic efficiency. In such a scenario:

• All individuals have access to quality education, healthcare, and other essential services, leading to better health outcomes, increased human capital, and higher productivity.

• Economic mobility is enhanced, allowing people to rise out of poverty through education and hard work, leading to greater economic opportunity for all.

• A larger proportion of the population has the means to afford goods and services, leading to higher aggregate demand and increased economic growth.

• Social cohesion and trust in institutions are strengthened, fostering political stability and cooperation.

• In summary, minimal income inequality promotes a fairer and more inclusive society, mitigating market failures and promoting greater overall economic prosperity.

Inflation - do we have a choice?

 

Why are corrupt politicians popular in India

This is an excerpt from a speech by India’s Reserve Bank of India chairman Raghuram Rajan. The full text is available here.


Even as our democracy and our economy have become more vibrant, an important issue in the recent election was whether we had substituted the crony socialism of the past with crony capitalism, where the rich and the influential are alleged to have received land, natural resources and spectrum in return for payoffs to venal politicians.

By killing transparency and competition, crony capitalism is harmful to free enterprise, opportunity, and economic growth. And by substituting special interests for the public interest, it is harmful to democratic expression. If there is some truth to these perceptions of crony capitalism, a natural question is why people tolerate it. Why do they vote for the venal politician who perpetuates it?

A hypothesis on the persistence of crony capitalism

One widely held hypothesis is that our country suffers from want of a “few good men” in politics. This view is unfair to the many upstanding people in politics. But even assuming it is true, every so often we see the emergence of a group, usually upper middle class professionals, who want to clean up politics. But when these “good” people stand for election, they tend to lose their deposits. Does the electorate really not want squeaky clean government?

Apart from the conceit that high morals lie only with the upper middle class, the error in this hypothesis may be in believing that problems stem from individual ethics rather than the system we have. In a speech I made before the Bombay Chamber of Commerce in 2008, I argued that the tolerance for the venal politician is because he is the crutch that helps the poor and underprivileged navigate a system that gives them so little access. This may be why he survives.

Let me explain. Our provision of public goods is unfortunately biased against access by the poor. In a number of states, ration shops do not supply what is due, even if one has a ration card – and too many amongst the poor do not have a ration card or a BPL card; Teachers do not show up at schools to teach; The police do not register crimes, or encroachments, especially if committed by the rich and powerful; Public hospitals are not adequately staffed and ostensibly free medicines are not available at the dispensary; …I can go on, but you know the all-too-familiar picture.

This is where the crooked but savvy politician fits in. While the poor do not have the money to “purchase” public services that are their right, they have a vote that the politician wants. The politician does a little bit to make life a little more tolerable for his poor constituents – a government job here, an FIR registered there, a land right honoured somewhere else. For this, he gets the gratitude of his voters, and more important, their vote. Of course, there are many politicians who are honest and genuinely want to improve the lot of their voters. But perhaps the system tolerates corruption because the street smart politician is better at making the wheels of the bureaucracy creak, however slowly, in favour of his constituents. And such a system is self-sustaining. An idealist who is unwilling to “work” the system can promise to reform it, but the voters know there is little one person can do. Moreover, who will provide the patronage while the idealist is fighting the system? So why not stay with the fixer you know even if it means the reformist loses his deposit?

So the circle is complete. The poor and the under-privileged need the politician to help them get jobs and public services. The crooked politician needs the businessman to provide the funds that allow him to supply patronage to the poor and fight elections. The corrupt businessman needs the crooked politician to get public resources and contracts cheaply. And the politician needs the votes of the poor and the underprivileged. Every constituency is tied to the other in a cycle of dependence, which ensures that the status quo prevails. Well-meaning political leaders and governments have tried, and are trying, to break this vicious cycle. How do we get more politicians to move from “fixing” the system to reforming the system? The obvious answer is to either improve the quality of public services or reduce the public’s dependence on them. Both approaches are necessary. But then how does one improve the quality of public services? The typical answer has been to increase the resources devoted to the service, and to change how it is managed. A number of worthwhile efforts are underway to improve the quality of public education and healthcare. But if resources leak or public servants are not motivated, which is likely in the worst governed states, these interventions are not very effective.

Some have argued that making a public service a right can change delivery. It is hard to imagine that simply legislating rights and creating a public expectation of delivery will, in fact, ensure delivery. After all, is there not an expectation that a ration card holder will get decent grain from the fair price shop, yet all too frequently grain is not available or is of poor quality. Information decentralization can help. Knowing how many medicines the local public dispensary received, or how much money the local school is getting for mid-day meals, can help the public monitor delivery and alert higher-ups when the benefits are not delivered. But the public delivery system is usually most apathetic where the public is poorly educated, of low social status, and disorganized, so monitoring by the poor is also unlikely to be effective.

Some argue that this is why the middle class should enjoy public benefits along with the poor, so that the former can protest against poor delivery, which will ensure high quality for all. But making benefits universal is costly, and may still lead to indifferent delivery for the poor. The middle class may live in different areas from the poor. Indeed, even when located in the same area, the poor may not even patronize facilities frequented by the middle class because they feel out of place. And even when all patronize the same facility, providers may be able to discriminate between the voluble middle class and the uncomplaining poor. So if more resources or better management are inadequate answers, what might work?

The answer may partly lie in reducing the public’s dependence on government-provided jobs or public services. A good private sector job, for example, may give a household the money to get private healthcare, education, and supplies, and reduce their need for public services. Income could increase an individual’s status and increase the respect they are accorded by the teacher, the policeman or the bureaucrat. But how does a poor man get a good job if he has not benefited from good healthcare and education in the first place? In this modern world where good skills are critical to a good job, the unskilled have little recourse but to take a poorly-paying job or to look for the patronage that will get them a good job. So do we not arrive at a contradiction: the good delivery of public services is essential to escape the dependence on bad public services?

Money liberates and Empowers…
We need to go back to the drawing board. There is a way out of this contradiction, developing the idea that money liberates. Could we not give poor households cash instead of promising them public services? A poor household with cash can patronize whomsoever it wants, and not just the monopolistic government provider. Because the poor can pay for their medicines or their food, they will command respect from the private provider. Not only will a corrupt fair price shop owner not be able to divert the grain he gets since he has to sell at market price, but because he has to compete with the shop across the street, he cannot afford to be surly or lazy.

The government can add to the effects of empowering the poor by instilling a genuine cost to being uncompetitive – by shutting down parts of the public delivery systems that do not generate enough custom. Much of what we need to do is already possible. The government intends to announce a scheme for full financial inclusion on Independence Day. It includes identifying the poor, creating unique biometric identifiers for them, opening linked bank accounts, and making government transfers into those accounts. When fully rolled out, I believe it will give the poor the choice and respect as well as the services they had to beg for in the past. It can break a link between poor public service, patronage, and corruption that is growing more worrisome over time.