Functional Income inequality and the post 2015 Agenda

Rolph van der Hoeven, ISS

DSA Conference Birmingham

16 November 2013

Session 25

Organised by the Broker

Why income inequality matters

• Where markets are underdeveloped, inequality inhibits growth through economic mechanisms;

• Where institutions of government are weak, inequality exacerbates the problem of creating and maintaining accountable government, increasing the probability of economic and social policies that inhibit growth and poverty reduction;

• Where social institutions are fragile, inequality further discourages the civic and social life that underpins effective collective decision making that is necessary to the functioning of healthy societies.

(Income) Inequality: Various Forms

Asset Distribution (Land, Education, Health)

Functional distribution(Share in GDP of Labour , Land and Capital)

Personal(household) income distribution: Primary distribution

Before Taxes and Transfers Secondary distribution

After taxes and transfers Tertiary distribution

Including imputed value of acces to Government( Social) Services

3

Why Increased attention Functional Income Distribution?

• to make a link between incomes at the macroeconomic level (national accounts) and incomes at the level of the household;

• to help understand better inequality in the personal distribution of income;

• to address the concern of social justice with the fairness of different sources of income.

Effect of the 2008 crisis on various socioeconomic groups

Drivers and functional inequality

• Neo classical economist argued labour share constant

• Functional income inequality determinant for Household income distribution

• Factual wrong: Labour share affected by Changes capital output ratios Capital controls, Exchange rate crisis Trade volumes Weaker bargaining power labour

Importance of Top incomes

• Share of top-income increasing Higher capital share Higher wages executives

• Better documented in OECD countries( Piketty,Atkinson), but more information now becoming available for developing and emerging countries

( UNU WIDER and Credit Suisse)

Wealth Inequality

• One of the important drivers of factor or functional inequality is the large inequality in wealth and in human capital.

• Wealth is distributed far more unequally than incomes in all countries for which data are available.

• the Gini-coefficient of the distribution of personal wealth ranges from 0.55 to 0.80 which is in all countries higher or much higher than for the distribution of primary (market) income

• inheritance is an important component of wealth. • Equally dominant is the effect of acquirement of

human capital.

Decline in wage share in both developed and developing countries

Decline of Wage share in developing countries

Decline of wage share in developed

countries

Decline in China

Decomposition

Financialization and changes in the wage share

Wage inequality

share of wages in National income declined but also the distribution of wages themselves has also become more unequal

Consequence of mix of openness, skill premiums and institutional factors ( incl. gender)

Schooling often not able to offset

Tinbergen theory of 1975 race between technology and education relevant again

Macro Polices and Functional Inequality

Macro Economic policies:• preventing crises (from external shocks) is achieved by

controlling foreign indebtedness, controls on portfolio flows, a managed exchange rate regime) and macro prudential banking regulation.

• ensuring a reasonable macroeconomic balance (low inflation, control of aggregate demand with employment and distributive concerns) is achieved by a balanced current account policy, countercyclical fiscal policies( with social safety nets as automatic stabilizers), greater use of progressive taxation as well as moderate ,countercyclical monetary policy.

• promoting equitable growth is achieved by a managed exchange regime, managed open trade policy and fiscal policy.

Example of Latin American path ways ( Cornia )

• The ‘competitive real exchange rate-unemployment reduction-inequality pathway.

• The higher taxation-redistribution pathway.

• The growth-inequality pathway.

• The prevention of external crises - lower instability – inequality pathway.

• The banking regulation- domestic banking stability-

inequality pathway.

In Short

Financialization and skills based technical change have been important drivers of functional and wage inequality. These drivers have in various cases also strengthened existing patterns of inequality through a still stubbornly high wealth inequality and through intergenerational transfers of inequality through skewed access to higher-level education.

National policies, including the a strengthening of institutions to deal with inequality can be important drivers of income distribution. Several countries in Europe manage to drive a high primary income distribution down to a modest or low level of secondary and tertiary income distribution, however functional inequality is increasing and redistributive policies are weakening

Various Latin American countries have been able to arrest the upward trend of growing inequality and to drive inequality in the region( the highest in the world ) down to lower, but still at yet high levels of inequality. They used an extended mix of macro economic, exchange rate , structural and social policies to that end.

Post 2015 development agenda goal on inequality

• Inequality target based on Palma ratio:• Ratio share top 10 % income earners to

the bottom 40%• Full equality 0.25 but for more equal

societies around 1. • In unequal society ratio can go up to 7

HLP report (spring 2013)

When everyone, irrespective of household income, gender, location, ethnicity, age, or disability, has access to health, nutrition, education, and other vital services, many of the worst effects of inequality will be over (p.16).

The report looks at inequality purely from a supply side argument and fails to recognise the importance of economic and social transformation in bringing about employment and income equality

Furthermore for emerging and developed economies the issue of inequality is perhaps more important than the issue of poverty alleviation. It remains thus important to include a goal on reducing inequality, with appropriate indicators, in a post 2105 system