Income, Inequality, and Poverty

1. 15 Income, Inequality, and Poverty

2. US Distribution of Income 1940-2010 (in 2007$)

3. Comparison of US – World Share of Top 1%

4. Basic Theory of Wages • Demand for Labor is • Derived from the demand for the final good • i.e, labor is one of several inputs into the production process • Labor’s value is determined by its productivity • i.e., how much does each additional unit of labor increase output of the final good

5. Basic Theory of Wages

6. Basic Theory of Wages • Labor’s wage is determined by: • Increase in output, or “marginal productivity” of labor (mpL ), and • the market value of the final product • Wage = poutput * mpL • Represents a “cap” or “ceiling on an employee’s wage

7. Historical RelationshipProductivity and Wages

8. Non-Monetary Determinants of Wages

9. Wage Differentials • How do we explain variation in wages between “similar” people? • 1. Compensating Variation • Wage differences resulting from non-monetary characteristics of jobs • E.g. risk, desirability of job • 2. Location • 3. Human capital • Education, job-specific training, experience • $15k-$20k annual salary difference – college grad

10. Wage Differentials • How do we explain variation in wages between “similar” people? • 4. Unions • 10-20% differential • Decreased union membership • Greater unionization in government jobs • 5. Efficiency Wages • Paying above equilibrium wage • Decreases employee turnover, increases productivity, attracts higher skilled employees

11. Wage Differentials • How do we explain variation in wages between “similar” people? • Discrimination • Median black male earns 21% less • Median white female earns 24% less • Educational differences • Median white male 75% more likely to have college • Among whites – men and women equally likely tohave 4-year degree; • but men 11% more likely to have graduate degrees • > this has been changing since the last recession (2007)

12. Wage Differentials • How much do these factors explain the differences in wages between “similar” people? • Wage = a + b*mpl + c*location + … • These factors “explain” (account for) only about 50% of the observed variation in wages

13. Factors accounting for “above” equilibrium wages • Unions • Provide a single source of labor for the firm • Reaction to “monopsony” in some labor markets (e.g., coal mines) • Decrease unionization -> larger gaps in income • Union “premium” declined from 20-30% to 8-15% • Efficiency Wages

14. Efficiency Wages • Efficiency Wages • Wages higher than equilibrium • Offered in hopes of increasing worker productivity • Reduce shirking, reduce turnover • Hopefully efficiency gains are greater than the increase in wage costs • Historically • 1914—Henry Ford: $5.00/day for assembly line workers • Daily turnover decreased from 10% to 1% • Increase in willing workers; Ford was able to pick out and hire the most productive workers

15. Wage Discrimination • Wage discrimination • Occurs when workers of the same ability are not paid the same as others because of their race, ethnicity, sex, age, religion, or some other group characteristic • Today, accounts for 3 to 5% of wage differences. Was a much bigger problem 40 years ago. • Legislation to prevent discrimination • Equal Pay Act of 1963 • 2009 Fair Pay Act—gives employees more time to file a complaint with the government

16. Gender Wage Gap • Today • Female workers earn 23% less than males • Mostly due to compensating differentials rather than discrimination • Explanations • Men more likely to work outdoors (road work, construction) or in more dangerous conditions • Women leave the labor force more (child or elder care) • Trends • Wage gap is shrinking • Women have a 3-to-2 majority in college degrees

17. Other Wage Differential Explanations • Cultural differences • Some cultures place more emphasis on education, which leads to higher human capital, higher productivity, and higher wages • Location • Higher costs of living in cities often translate into higher wages • Life cycle • Wages rise, peak, and then fall as a worker ages • Workers near retirement are less likely to learn new techniques or keep up with technology

18. Median Annual Earnings by Group

19. Occupational Crowding • Imagine a community with only two types of jobs: • A small number in engineering and a large number in secretarial services. • Everyone is equally proficient at both occupations and everyone in the community is indifferent to working either job. • Under these assumptions • We would expect the wages for engineers and secretaries to be the same

20. Occupational Crowding • Occupational crowding • The crowding of a group of workers into a small number of jobs • May occur because certain groups may have limited skills or opportunities to enter a larger variety of jobs • Results? • Supply of labor increases in crowded jobs, decreasing wages for those jobs • Supply of labor may decrease in other jobs, increasing wages for those jobs

21. Occupational Crowding • Now imagine that not everyone in the community has the same set of opportunities. • Suppose women were not allowed to be engineers. • Women who wanted to work could only find employment as secretaries. • Also, suppose the number of jobs as engineers was relatively small compared to the number of jobs as secretaries. • Labor market results • Large supply of secretary labor, low wages • Small supply of engineer workers, high wages

22. Occupational Crowding • Occupational crowding is often referred to within the context of wages for men and women • Women may be crowded into jobs • The higher supply of labor lowers wages • With today’s increased opportunities, why don’t more women leave the lower-paying jobs and become engineers? • Rigidity in changing careers • Social customs • Personal preferences

23. Where the Men Aren’t

24. Economics in Anchorman: The Legend of Ron Burgundy • Occupational crowding • Ron Burgundy loses his job . . . to a woman!

25. Winner Take All • Winner take all • Exists when relatively smalldifferences in ability lead tolarge differences in compensation • Examples • Professional athletes • Major leaguers earn much more than minor leaguers, even though playing abilities are often not that much different • CEOs • Some CEO salaries today are more than 500 times greater than the average worker for the firm

26. Inequality of Income • Income inequality exists when some workers earn more than others. • Caused by • Compensating differentials • Discrimination • Corruption • Differences in marginal product of labor

27. Factors That Lead to Income Inequality • What would it take to equalize wages? • All workers would have to have same skills, ability, productivity • All jobs must be equally attractive • All workers must be perfectly mobile • Would that be good or bad? • If society’s income structure is too equal, the incentive to work is diminished • Free riding would occur

28. Role of Corruption • Corruption • More widespread in less developed countries • Bribes may be more valued than innovation and work • Assets may not be safe from criminals or government seizure • Implications? • Investors less likely to develop a business • Short run gains may be achieved at the expense of long run costs • People may fight back if the corruption becomes too severe

29. Measuring Inequality

30. Measuring Inequality

31. Understanding Observed Inequality • Why does the United States have a higher inequality ratio than Germany or Canada? • Similar poverty rate (26.3%) to other developed countries • However, the top earners in the United States earn much more compared to other countries

32. Understanding Observed Inequality • High-income inequality also occurs in countries that are very poor and less developed • This is due to the lowest income people having much less income (compared to low-income individuals in developed countries)

33. Difficulties in Measuring Inequality • Income inequality numbers can be unreliable and misinterpreted • Data reflects pretax income, rather than disposable income • Does not account for in-kind transfers, (goods and services given to poor rather than cash) • Does not account for unreported or illegal income. Black markets may play a larger role in less developed countries, further skewing this. • No (monetary) value is placed on goods or services produced at home—child-rearing or growing vegetables

34. Difficulties in Measuring Inequality • Are the shortcomings a serious measurement issue? • Each individual year, probably not • Across generations, maybe so • Comparing inequality today to 50 years agp would probably violate many ceteris paribus assumptions. Birth rates, tax rates, population age, and technology all change. • Need to figure out exactly what causes changes in income inequality; tough to do if many things change • Further problems? • Assuming income distribution is a reflection of welfare; we may also value leisure, safety, community, etc.

35. Income Mobility • Income mobility • The ability to move up and down the economic ladder over time • Higher levels of income mobility? • Give workers an incentive to improve human capital and work harder • Workers have increased change of rewards • Poverty may be only temporary

36. Income Mobility in United States

37. Income Mobility • Marginal poor • Poor at a point in time, but have skills to move up the ladder • Low earnings are the exception • Willing to borrow to make a big purchase • Fit well into life-cycle theory model • Student straight out of college • Long-term poor • People who lack the skills to advance to higher income levels

38. Poverty • Poverty rate • Percent of population whose income is below the poverty threshold • Poverty threshold • The income level below which a person (or family) is considered impoverished • Adjusted each year for inflation • Does not include in-kind transfers • Does not include geographic cost-of-living differences

39. Poverty, Historically • Equal Opportunity Act, 1964 • However, poverty rate has remained stagnant for about 40 years. Why? • Gains from growth have accrued to the middle and upper class rather than the poor • Many low-income workers continue to lack skills to earn higher wages • Solution? • Not easy—perhaps long run investment in education and skills aimed at poor • Job retraining for structurally unemployed

40. Poverty Rate for Households

41. Poverty Rate for Various Groups

42. Poverty Policy • Many policies (each with their costs and benefits) have been designed to address poverty • Two conflicting motivations • We want to give generously • We want the poor to become self-sufficient • Policies • Welfare • In-kind transfers • Earned incometax credit (EITC) • Minimum wage

43. Welfare • Not a government program but a series of initiatives • Monetary payments • Subsidies and vouchers • Health services, housing • Examples: TANF, SSI, SNAP • Who receives this? • Unemployed, disabled, veterans, dependent children • Eligibility is often limited by time and only if income is below a cutoff amount

44. In-Kind Transfers • Direct assistance in the form of goods and services • Food banks, housing shelters, private charities, health care through Medicaid • Why give goods and services rather than cash? • Mainly to prevent the misuse of funds • Possibility of cash transfers going to alcohol, gambling addictions, or expensive clothes • In-kind transfers can be targeted at essential services

45. Earned Income Tax Credit • The EITC is a refundable tax credit designed to encourage low-income people to work more • Can lower taxes as much as $6,000 per year • Helps over 20 million families, making it the largest poverty-fighting policy • Benefits are phased out over higher incomes, so there is no sizeable work disincentive at a specific cutoff • The EITC is a form of a negative income tax • This is a tax credit that is paid to poor households out of taxes collected from middle- and upper-income taxpayers

46. A Negative Income Tax

47. Minimum Wage • Discussed previously—a price floor on wages in labor markets • However, the same problems can be discussed • Low-skill people may be less productive • Firms may hire less low-skill workers • Minimum wage doesn’t guarantee employment

48. Problems with Traditional Aid • There is one glaring problem with assistance for low-income individuals. Many welfare programs create work disincentives! • Often when income is increased, many benefits are severely reduced or eliminated • People may consciously work less to keep their benefit eligibility • The EITC does the best at addressing the work incentive problem by having phased-out assistance

49. Problems with Traditional Aid:A Mathematical Example • Family of five earns $20,000 a year, and qualifies for $10,000 in annual welfare benefits • Total income for the year is $30,000 • What happens if earned income rises to $30,000 per year? • $30,000 earned income disqualifies the family from receiving much of the assistance it previously received. Benefits fall from $10,000 to $2,000 • Family earned $10,000, but lost $8,000 in welfare benefits. That’s similar to an 80% marginal tax rate! • That is a strong disincentive to work!

50. Problems with Traditional Aid • Samaritan’s dilemma • Occurs when an act of charity causes the recipient not to work hard on their own to escape poverty • Another example of an unintended consequence • Addressed by Bill Clinton in 1996 as part of welfare reform • As part of TANF, he encouraged states to require employment searches as a condition for benefits • Also put a five-year maximum on benefits • Changed from entitlement to temporary safety net, reducing the samaritan’s dilemma