Complete and concise notes for the entire course in Economics of Inequality at UCL. Helpful for economics students as well as students choosing to undertake this introductory course as an optional module. Includes all notes from lectures on the inequality in education, minimum wage and its impact, ...
Topic: An Introduction to Economics of Inequality
Introduction
o Perspectives about whether inequality should be reduced or not (and by how much)
differs a lot based on individual circumstances of people
▪ Accident of birth
• Differences in life prospects that arise from factors you have no
control over, like the wealth or educational attainment of your
parents.
• Other example: Where you were born. The country in which you are
born is one of the strongest predictors of your future economic well-
being. And within countries, the neighbourhood in which you were
born can play a major role in determining the opportunities that
become available to you over the course of your life.
• Other examples include – sex, race, parents’ education and income,
physical attributes like height and skin colour
▪ Inequality
• Inequality refers to differences between people.
• For example, income and wealth are distributed across individuals,
families, households, or other groups in society. When the variance
of the distribution is not zero, there is inequality in that outcome.
• Is inequality good or bad?
• It depends. Some inequality is considered fair, and some inequality
is considered unfair.
o Inequality in outcomes vs inequality in opportunity
▪ Inequality of opportunity refers to differences across people that arise
because of barriers to access, such as school and neighbourhood quality, or
discrimination based on race or gender. Such differences imply that some
are less able to profit from their talents and efforts than others.
▪ Inequality in outcomes refers to differences across people in the material
dimensions of well-being arising from any source, including family
background and individual talent and effort. This view takes an outcome-
oriented perspective, hence the name.
• Some people think that society should primarily focus on equality of
opportunity: inequality arising from individual differences in talent
or effort is acceptable, but inequality arising from ‘accidents of birth’
such as gender, ethnicity, and family background is not acceptable.
Others believe that extreme inequalities of outcome, and the
material and social deprivation associated with them, ought to be
reduced regardless of their source.
o John Rawls’ veil of ignorance
, ▪ The philosopher John Rawls argued that disagreement about what constitutes a just
society arises because the positions we occupy affect our judgements and
perspectives.
▪ He considered an interesting thought experiment: what if we had to decide on the
kind of world we would want to live in if we did not know what our position in it
would turn out to be? That is, behind a veil of ignorance.
▪ We would agree on a set of principles:
• First and foremost, each person would have an equal claim to certain basic
liberties. Second, people would come to occupy positions in society based
on fair equality of opportunity, and the resulting social and economic
inequalities would be “to the greatest benefit of the least advantaged
members of society.” This last criterion is known as the difference principle.
▪ Inequalities in income and wealth are allowed for, provided that similarly motivated
individuals have the same opportunity to reach their full potential.
▪ Example for veil of ignorance:
• Consider which of the following two income distributions would be chosen
under Rawls’ principles of justice:
Economy D: 6, 12, 21, 34, 112
Economy E: 5, 11, 17, 29, 85
• Economy D has more inequality than Economy E, but the least advantaged
person in D is better off materially than the least advantaged in E. In fact,
income is higher in D at every quintile.
• Debra Satz’s metaphor of a room where everyone except one person is
blind. Should we make the non-blind person blind to achieve equality?
• [Side comment: check out IFS’s Deaton Review]
• D is more just according to Rawls’ principles, but only if the most affluent do
not use their income to constrain the liberties of the poorer or to deny
them a fair equality of opportunity.
o Perceptions of Inequality
▪ Back to your mentimeter poll answers: what are the true income shares of the
richest quintile in the UK, US and China?
▪ Our World in Data Link
UK: 41.26%
US: 46.45%
China: 47.85%
▪ Research shows that most people do not have an accurate understanding of the
disparities within their own country and across the world, nor do they have a good
sense of their position in life relative to others (link to paper).
▪ This could bias their attitudes and beliefs about what is fair and reasonable and
about what policies they want to support.
▪ Dr. Paul Hufe co-authored a ground-breaking paper on how to measure inequality
that is perceived as unfair (link to paper). He will explain his research in a guest
lecture in this module.
o Consequences of inequality
▪ Economic inequality contributes to political inequality, which can, in turn,
exacerbate economic inequality. For instance, high income individuals can
, contribute to political campaigns, and be rewarded for this by tax cuts that leave
them even better off.
▪ High levels of inequality could stand in the way of economic growth by keeping
people from economic opportunities and success: Prof. Lisa Cook’s video
▪ Extreme inequality can further result in the misallocation of investment, where
people can’t get financing for promising projects, and it can also lower
macroeconomic aggregate demand, making business cycles worse.
▪ But: Very high levels of redistribution could lower the returns to effort and
innovation, or the returns to investment in the development of skills, and could
lower total output (e.g. suppose all students received the same grade regardless of
effort and performance).
▪ Levels of inequality can be amplified from one generation to the next, as accidents
of birth accumulate and are transmitted within families and neighbourhoods. Even
complete equality of opportunity in one generation must give way to unequal
opportunity in the next, as those with greater talent or effort in the first provide
advantages to their children in the next.
o Policies tackling inequality
▪ Pre-distribution: change prices and wages in the market so that people’s incomes
are less widely dispersed. For example: minimum wage, protection of unions, land
reform, and expansion of educational access and quality.
▪ Redistribution: take the market wages and prices as given, but try to redistribute
income using the tax system. A wide variety of taxes are in place in almost every
contemporary economy, and they have different effects on inequality.
• The primary tools for redistribution are income taxes and government
expenditures.
• In general, more affluent individuals are taxed at higher rates than those
who are less affluent (progressive taxation), though quirks and loopholes in
the tax code exist that individuals of considerable wealth can exploit. See
Saez and Zucman’s book.
• Tax revenues, in combination with government borrowing, are used to fund
public goods and transfers to the poor and unemployed. The after-tax
income distribution is thus more equal than the pre-tax distribution.
• Redistributive policies: disposable and market income inequality in the US
and Sweden, 1979-2013
, Alternative policy-categorisation
• Prof. Dani Rodrik and Prof. Stephanie Stantcheva propose a new policy categorisation: A Policy
Matrix for Inclusive Prosperity:
Redistributive policies: how to tax capital?
• Capital is extremely concentrated, more concentrated than labour income: very few
people own a very large fraction of capital.
• What is the optimal level of capital taxation?
• The optimal level depends on:
o How concentrated capital ownership is
o Efficiency: How elastic capital is to the tax rate (Will it go abroad? Will taxes be
evaded? Will less capital be accumulated?)
o Social judgement on fairness: should we tax the ant to compensate the
grasshopper?
• Watch minutes 45:55-54:22 of this video
Lecture 2
Topic: Literature and discussions on the impact of the minimum wage
Introduction
• Great interest for more than a century now (Leonard, 2000)
• Fierce debate that always was more than simply about minimum wages
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