Definitions and distribution of income and wealth

Income and wealth represent key economic resources, but they are not spread evenly across populations in market economies like the UK. This uneven spread contributes to broader issues of inequality and poverty.

Income

Income refers to the money received by individuals over a fixed period, such as weekly or annually.

It arises from various sources, including:

• Wages from employment
• Interest earned on savings accounts
• Dividends paid on share investments
• Rent collected from owned properties

Wealth

Wealth measures the monetary value of assets owned by individuals.

Common assets include:

• Property and land
• Cash holdings
• Shares in companies
• Other valuables that can be converted to money

In most economies, including the UK, both income and wealth show significant disparities, with some groups holding much more than others.

Factors affecting the distribution of income and wealth

Several elements influence how income and wealth are divided, often leading to greater inequality in wealth compared to income. These factors highlight why some people accumulate more resources over time.

Factors influencing income distribution

• Wage differences - Skills in high demand command higher pay, while less valued skills result in lower earnings.
• Reliance on state benefits - Groups without wages, such as the unemployed or retirees, depend on government support, which typically provides lower income levels.
• Progressive taxation and benefits - In systems like the UK's, higher earners pay a larger percentage of tax on earnings above thresholds. These taxes fund benefits redistributed to groups like the jobless or those with disabilities.
• Sectoral variations - On average, public sector workers earn more weekly than those in the private sector.
• Regional disparities - Earnings vary by area; for example, in 2019, London and the South East had the highest average full-time incomes, while the North East and Northern Ireland had the lowest.

Reasons for greater inequality in wealth distribution

• Income generation from wealth - Assets like shares can grow in value and produce further income, allowing reinvestment (e.g., buying additional shares) that compounds wealth. Those with low initial wealth have limited opportunities for such growth.
• Faster asset appreciation - The value of assets often rises more quickly than typical income levels.
• Taxation differences - Income faces taxation, aiding redistribution, but wealth is not taxed directly in the UK, making wealth harder to equalise.

Using Lorenz curves to show inequality

Lorenz curves provide a graphical way to illustrate the degree of inequality in income or wealth distribution within a country. They help visualise how far a society's distribution deviates from perfect equality.

Key features of a Lorenz curve

• The horizontal axis shows the cumulative percentage of the population (from 0% to 100%).
• The vertical axis shows the cumulative percentage of income (or wealth) (from 0% to 100%).
• A diagonal line from (0,0) to (100,100) represents perfect equality, where each percentage of the population holds the same percentage of income (e.g., 30% of people hold 30% of income).
• The actual Lorenz curve bows below this diagonal; the greater the curve's sag, the higher the inequality.
• For example, if the curve shows that the bottom 50% of the population holds only 8% of total income, this indicates significant inequality, with the top 50% holding 92%.

Lorenz curves can represent either income or wealth distribution, with wealth curves often showing more pronounced inequality.

Calculating and interpreting Gini coefficients

The Gini coefficient offers a numerical summary of inequality, derived from the Lorenz curve. It quantifies the gap between perfect equality and the actual distribution.

Formula for the Gini coefficient

$\text{Gini coefficient}=\frac{\text{area A}}{\text{area A + area B}}$

Where:

• Area A = The space between the line of perfect equality and the Lorenz curve
• Area B = The space below the Lorenz curve

Interpreting Gini coefficient values

• A value of 0 indicates perfect equality (everyone has identical income or wealth).
• A value of 1 indicates perfect inequality (one individual holds all income or wealth).
• Higher values reflect greater inequality; for instance, the UK's income Gini coefficient increased from 0.25 in 1977 to 0.35 in 2019, showing rising income disparity since the 1980s.
• Gini coefficients apply to both income and wealth, with many countries, including the UK, experiencing growing inequality in both since the early 1980s, driven by rapid gains among top earners.

Worked example - Calculating a Gini coefficient

Suppose a Lorenz curve analysis shows area A as 0.32 and area B as 0.48. Calculate the Gini coefficient and interpret its meaning.

Step 1: Identify the values

• Area A = 0.32
• Area B = 0.48

Step 2: Apply the Gini coefficient formula

$\text{Gini coefficient}=\frac{0.32}{0.32+0.48}$

Step 3: Perform the calculation

$\text{Gini coefficient}=\frac{0.32}{0.80}=0.40$

Step 4: Interpretation

A Gini coefficient of 0.40 indicates a relatively higher level of inequality, where income or wealth is considerably unevenly distributed.

The impacts of inequality on economic development and society

While some inequality may be unavoidable or even beneficial in market economies, extreme levels can hinder progress and create social issues. Development may reduce gaps between countries, but internal inequality persists and can exacerbate problems.

Inequality in developing and developed countries

• In developing nations, low-income groups face severe hardship from events like poor harvests or falling demand for goods.
• In developed nations like the UK, absolute poverty is rarer, but relative poverty affects many, leading to social exclusion (limited access to jobs, healthcare, or other societal resources).
• Extreme poverty can coexist with wealth if development benefits mainly the affluent.

Arguments on inequality and development

• Pro-inequality views - Some argue inequality is a natural outcome of development, as individuals differ in success. It may incentivise innovation and efficiency under capitalism.
• Anti-inequality views - High inequality can impede development by:
  • Limiting business startups among the poor due to scarce resources, low savings, and poor credit access (e.g., lack of collateral for loans, especially in remote or costly banking areas).
  • Encouraging high earners to spend on imports or invest abroad, draining money from the domestic economy.

Social consequences of inequality

Inequality and exclusion often correlate with issues like elevated crime rates and health challenges, affecting overall societal well-being.

Causes of inequality across countries

Although causes differ by nation, common factors include:

• Wage and tax structures
• Unemployment rates
• Education access and quality
• Property ownership and inheritance rules
• Levels of government benefits