The term “income distribution” is a statistical concept. It shows how a nation’s total income is distributed among its population. The distribution may be equal or unequal, even or uneven. If unequal, there will be few rich and a vast majority will be poor. Their consumption pattern would differ. While poor would have limited choice, the rich would be fortunate to have a large range of goods and services at their disposal.
INCOME AND WEALTH
Income and wealth are two different concepts. These are not interchangeable. Income is a flow whereas wealth is a stock. Income measures the receipt of money within a period of time. The wealth represents money earned and saved at a some point of time. One who earns a good income would not be necessarily wealthy as one can overspend and be burdened with debt. On the other hand, a prudent person may not have high income initially but may raise wealth level through savings and investments which would eventually raise the income level.
What is a fair distribution and what is mal-distribution ?
If a family has a 10 members and 10 cars, there could be two extremes. Everyone has one car or only one of them has all the cars. Same situation may arise in a society. Everyone may be earning the same amount of money or no one earns except for one person who earns all the money. In such situations, the distribution could be fair or unfair. In mathematical terms, most fair distribution is expressed as ‘0’ while most unfair as ‘1’. As such, the indicators used like Gini Ratio range from 0 to 1. Sweden is said to have fair income distribution with a ratio of 0.23 while Namibia has the worst at 0.70. Ensuring fair income distribution is an important task for any government. It has a direct bearing on social justice and stability. The people’s income should increase with the economic growth.
What are the effects of income inequality
There are different views on income inequality and its impact on economic growth. Higher inequality tends to retard growth in poor countries but encourages growth in well developed regions. But at the same time such inequalities lead to (i) erosion of social cohesion, and (ii) increase in social unrest. This would certainly result in loss of productivity and damages to property. In any case income inequality should be kept within tolerable limits.
Area under the cuve
There are various indicators of income inequality. Most common is Gini Index, also called Gini Ratio or Gini Coefficent. It is calculated as follows:
- Taking a random sample of a reasonable number of families and their total income such as wages and salaries, income from self-employment, investment income like interest, dividend and rental, pensions, unemployment allowance.
- Classifying families from poorest to the richest.
- Classifying them further into 5 groups, known as "quintiles," each representing 20% of all families.
- Absoute income earned by each group is plotted on a chart on cumulative basis.
- Area under the curve presented 'real position' which has been described as "B".
- By deducting "B" from 0.5, area under "A" is computed.
- Now A would be divided by 0.5 which would generate the Gini Rati.
- "A" could be described as a buldge. The great the buldge, the further from 'equitable distribution' shown as a straight-line.
But it may be noted that such a ratio does not measure inequality of opportunity. Some countries may have a social structure that presents barriers to upward mobility for certain class of people. A rich country and a poor country may have the same Gini Index as it is reflecting two different things. In a rich country it shows distribution of luxury goods beyond the basic necessities while in a poor country it reflects inequality in material life quality.
Other indicators of in-equality of income
In addition, there are other measures of inequality as discussed below:
which also take into account factors like life expectancy, education and living standard. Later, it was supported by "Quality of Life Index" which also includes law and order situation and basic human rights.
Human Poverty Index
It measures poverty by focusing on economic deprivation such as (i) percentage of people likely to die before the age of 60,(ii) percentage of people have inadequate education, (iii) parentage of the population having disposable incomes of less than 50% of the medium, and (iv) proportion of long term unemployed (12 months of more)
Robin Hood Index
The Robin Hood Index indicates income with the wealthy group and calls for redistribution of income from richer to poor. It is just opposite of Gini Ratio. For example, Namibia has Gini Index of 0.70, it means 30% of the people earn 70% of the national income while 70% are earning just 30%. If some portion of income earned by richer is taken away and passed on to the poorer, it would reduce income-disparity accordingly.
Some related terms
Purchasing Power Parity of PPP
In order to rank countries according to their per-capita income, a theory of exchange called ‘Purchasing Power Parity or (PPP) is used. This theory is based on the ‘law of one price’ which says that identical goods should sell for the same price in two separate markets when there are no transportation costs and no differential taxes. Most famous example of PPP is the Big Mac Index which shows cost of a McDonald’s sandwich in various countries. If Big Mac costs US $ 3 in USA but Rs.110 ($1.3 equivalent) in Pakistan, the PPP would workout at 2.3. This concept is further expanded to long-run exchange rate between the countries. Of course, this a simplified example as the exchange rate will vary based on the basket of items and not just one time.
Pakistan income per capita income in 2008 stood at US$ 1,102 in nominal dollars but the same is US$ 2,625 in PPP$ as reported by the World Bank.
Absolute Poverty & Relative Poverty
How to reduce income-disarity
Common measures are (i) sustained economic growth, (ii) reducing unemployment and (iii) progressive taxation and (iv) social safety net.
SUSTAINED ECONOMIC GROWTH
A sustained economic growth should benefit some poor due to spill-over or neighborhood effect. Rich:Poor gap narrows when (i) industrial units are setup in new area, (ii) new kind of goods are introduced in the market (iii) when new sponsors enters the fields. Consider case of a textile unit at Karachi setup by the famous Dawood Family of Pakistan. It would hardly have any effect on Rich:Poor Gap as neither the area is new, nor the product has any novelty and also the sponsors old and established industrialist. As against a marble processing plant at Tharparker, Sindh floated by a local entrepreneur will have all the ingredients of narrowing down Rich:Poor Gap though only by a fraction. But if more projects are encouraged in the way, there would be visible impact in the long run.
The economic policy makers should stress on job-creation keeping in view availability of labor in a particular area. The program should be long-ranged. It should start by establishing institutions or workshops for skill development and enhancement. Later, it should encourage those industrial units which use local raw materials, labor and technology.
A common to reduce income-inequality is to introduce progressive taxation where higher income groups would pay a higher % of taxes than the lower one. But it has its own problem, as it would discourage investment and all tax evasion. Also people in the low-come bracket would be reluctant to work extra hours or striving for a higher paid jobs as extra income will taken away in lost benefits or higher taxes. This phenomena is known as ‘poverty trap’.
The government or charities may provide to the poor relief in the shape of hard cash, food stamps, in-kind transfer such as school books and uniform, subsidies on public transport or concessions in health-care and utilities.
Income disparity is also reflected in rich-poor gap which is becoming wider year by year. This is due to a number of reasons such as lack of education, impact of globalization, economic liberalization, gender difference, culture and personal preference for work, leisure and risk.
The government may take initiative to reduce rich: poor gap by public education which would increase supply of skilled labor, progressive taxation, minimum wage legislation and nationalization and subsidization of products and services