Inequality and Redistribution

Theil (1967)

- n possible events are the n people in society and pi refers to the share of person I in total income - Subtracting the actual entropy of the income distribution from the maximum possible value of this entropy, we have Theil's Entropy measure

Strong reciprocity

A propensity to cooperate and share with others, even at a personal cost, and a willingness to punish those who violate cooperative and other social norms, even when punishing is personally costly and cannot be expected to result in net personal gains in the future - Different than reciprocal altruism - Evidence: biological, historical, experimental, survey

Dimensions that should be taken into account when designing suitable migration policies (other than impact of immigrants on wages)

Housing market, price of goods, availability of public services, the fiscal system

Capital in the 21st Century (Thomas Piketty)

Income inequality is nor only high but is increasing gradually, and will continue to increase since it has been driven by fundamentals of our economic system regarding capital accumulation and growth

Ordinal equivalence

Indices rank all states in the same order - One index is a monotonic transformation of the other

Social welfare approach to inequality analysis

Making inequality judgements and deriving inequality measures from social welfare functions - The social welfare function itself may be supposed to subsume values of society regarding equality and justice, and thus the derived inequality measures are given a normative basis

Skill-biased technological change (SBTC)

Technology affects the world of work, devaluing and revaluing skills, and creating whole new skills and jobs as well as destroying the existing ones - Jan Tinbergen: "The race between technology and education" - Goldin and Katz: "When technological advance vaults ahead of educational change, inequality generally rises. By the same token, when increases in educational attainment speed up, inequality often declines"

Relative mean deviation

The average absolute deviation from the mean expressed as a proportion of the mean Issue: Insensitive to changes that happen on either side of the mean - Stays the same even with redistribution

Gini Coefficient

The average absolute difference between all possible pairs of incomes in the population expressed as a proportion of total income - Most commonly used income inequality index - Not decomposable Main weakness: - Reaction to transfers is more effective in middle income levels

Utilitarianism

The best state is the one that maximizes the sum-total of utilities - Dividing a cake among a group of individuals - Each person gets utility only from her share of the cake - Concave and increasing utility functions: diminishing marginal returns - At the ideal: equality of marginal utility of everyone Critiques (Sen): - The outcome is completely egalitarian only if all utility functions are the same! 'Egalitarianism by serendipity' - Pays no attention to the force of one's claim arising from disadvantage

Earnings mobility

The degree to which individual economic fortunes can change over time

Social capital

The unquantifiable resources available through social networks, trust and reciprocity: fosters cooperation within communities, reduces transaction costs, promotes civic engagement, government efficiency and growth as a result

The income share of the top 1 percent exhibits a ________________ pattern...

U-shaped: falling from the 1950s to the 1970s, and rising from the 1970s to present

Inequality and growth: Upper class

Wealthy entrepreneurs with big investments, big savings, big capital accumulation foster growth - Kuznets 1953, Dynan 2004: Saving-income ratio is increasing with income.. - And then trickle down economics - But, high levels of inequality undermine a country's institutions; extreme income and wealth concentration combined with rent-seeking and weak institutions create distortions and reduce growth

Discrimination

When members of a group are treated differently (lass favorably) than members of another group (with identical productive characteristics)

Structural approach to inequality analysis

Specify a set of principles or axioms sufficient to determine an inequality measure uniquely - The choice of axioms themselves will be determined by what we think an inequality measure 'should' look like

Coefficient of variation

c = (V^0.5)(Ybar) c = (square of variance)(mean)

Structural approach to inequality measurement (Axiomatization)

Starting from the basic properties that we think inequality measures should satisfy, building a particular class of mathematical functions for use as inequality measures Properties: - Weak Principle of Transfers - Scale Independence - Principle of Population - Decomposability

Median voter mechanism

States that the lower the median income relative to mean income, the stronger the median voter's preference for redistribution

Economists on statistical discrimination

Statistical discrimination is the optimal solution to an information extraction problem - Economists would generally say that employers 'should' statistically discriminate - It is profit-maximizing, it is not motivated by animus, and it is arguably 'fair' since it treats people with the same expected productivity identically - Hence, many economists might endorse statistical discrimination as good public policy'

If social state A dominates the state B according to their quantile ranking, then...

social welfare measured by a function that is non-decreasing, symmetric, and additive is always going to be higher for state A with respect to state B

Meltzer and Richard model (MR)

Higher pre-tax income inequality implies that the median voter demand more redistribution Support: Milanovic (2000) results indicate that market income inequality within countries is positively associated with redistribution

Standard inequality measurement diagrams (four)

- Parade of Dwarfs - Frequency distribution - Lorenz curve - Log transformation

The Family Gap

"Motherhood penalty," "family gap," "mommy track" The emergence of a gender pay gap correlates closely with women's childbearing and childcare years... Why? - Reduction in the accumulation of human capital, loss of firm-specific human capital and lower returns due to actual or perceived lowering of commitment or effort on the job - Maternity leave with job retention partially offers the negative effect of having children - Cultural differences (In the US and the UK, mommy track explains 40-50% of the gender wage gap and none in Sweden)

Rawls Primary Goods

"Things that every rational man is presumed to want" including: - rights - liberties and opportunities - income and wealth - the social bases of self-respect

Bertrand, M. and Mullainathan, S., 2004. Are Emily and Greg more employable than Lakisha and Jamal? A field experiment on labor market discrimination

- Applicants with White names need to send about 10 resumes to get one callback whereas applicants with African American names need to send around 15 resumes to get one callback - This 50 percent gap in callback rates is statistically very significant - A White name yields as many more callbacks as an additional eight years of experience - Whites with higher quality resumes receive 30 percent more callbacks than Whites with lower quality resumes, a statistically significant difference - On the other hand, having a higher quality resume has a much smaller effect for African Americans - In other words, the gap between White and African-Americans widens with resume quality - Living in a wealthier (or more educated or more White) neighborhood increases callback rates - But, African Americans are not helped more than Whites by living in a better neighborhood - Discrimination levels are statistically indistinguishable across all the occupation and industry categories covered in the experiment - Federal contractors, who are thought to be more severely constrained by affirmative action laws, do not discriminate less; neither do larger employers or employers who explicitly state that they are an Equal Opportunity Employer in their ads

Evidence that inequality and discrimination skill exist

- Auditioning before blind judges increased female selection for major symphony orchestras (Goldin and Rouse, 2000) - Female pseudo-applicants reciving lower job offers than males with similar resumes (Neumark, 1996) - Systematical adverse treatment of women faculty (MIT, 1999)

Welfarist approach

- Classical micro-economics; "welfare" or "utility" is the key to account for the behavior and the well-being of individuals - The assessment of someone's well-being should be consistent with the preferences revealed by the person's free choices Practical/ethical problems: - Feasibility: Requires sufficiently informative releases preferences - Morality: Sen, 1997: The difficult issue in basing inequality analysis on interpersonal comparisons is not so much the impossibility of making such comparisons but the possibility of being misled by such comparisons; people adapt (deprived people come to terms with their deprivation, and the psychological indictors of please or desire fulfillment may fail to reflect the extent of real deprivation these people suffer), interpersonal comparisons deal with objects of comparisons that are not objects of actual choice (my choices may reveal that I prefer a banana to an annul, but no choice of mine would reveal whether I prefer to be someone else!"; similarity of choice is assumed to imply congruence of utilities, if we were to someone how use different utility functions "why should a 'grumbling rich've judged 'poorer' than a 'contented peasant?," utility cannot, therefore, serve as a satisfactory basis for interpersonal comparison for inequality analysis"

Sen (1980)

- Criticized Rawls for being too concerned with equalizing goods, rather than in equalizing what goods do for people - Said that what should be equalized across persons were their abilities to function (perform certain kinds of tasks necessary for a normal life) - Located, as ethically important, a human state between possessing goods and enjoying welfare - Defined a person's capability as the set of possible functionings that she could achieve, and argued that justice requires only equalizing capabilities across persons - This type of equality would require a preference relation on sets (capabilities), but there is no universal agreement on how to create one (could probably be done with partial orderings) - Initially limited functionings to objectively observable aspects of behavior (health, mobility, literacy) but later added 'happiness' to the list (1992), compromising the objective nature of the proposal, for the degree of a person's happiness is subjective and may be dicult to observe - Argued for his capability proposal by invoking the value of individual choice: what matters is that people have sets of options which are equivalent, not that they indeed choose the same option

How does the economy react to immigration?

- Demand for labour varies for different skill groups - The wage responses will be more pronounced in the parts of the distribution in which immigrants compete with native workers - Effects of immigration on native opportunities also depend on the sensitivity of flows across cities of natives and immigrants - The relative wage between two groups i, j is θi/θj - An increasing income inequality is attributable to increases in within group or residual wage inequality - Residual wage inequality among natives is higher in cities with more immigrants - Causal effects? Unobserved factors at the city level, Using instrumental variable (IV) specification (i.e. earlier immigration settlement patterns)

Standard inequality measurement tools (three)

- Diagrams - Inequality measures - Rankings

Mechanisms through which inequality may affect growth

- Different economic behavior of different income groups (low, middle, high) - The distance between different income groups For lower part of the distribution: - Poverty trap leads to sub-optimal production level with persistent inequality since: 1. Imperfect credit and insurance markets for the poor: no access to higher return investments, forgone opportunities of investment in human capital 2. Effective effort as a function of expected rate of return, both in labor and credit markets 3. Richer rich and poorer poor leads to higher expected return to crime than education or legal activities (opportunity cost of committing a crime is lower) 4. Higher fertility rates among poor leads to many kids with low education

How do (welfare) states redistribute?

- Direct and indirect taxes - Social spending on old-age and disability pensions, unemployment insurance, sick pay and parental leave insurance, family allowances, social assistance, housing subsidies, health care, child care, care for elderly and disabled, active labor market programs etc.

Leximin

- Evaluation according to the least utility delivered - Rawlsian - Ignores claims arising from intensity of one's needs - Insensitive to how much questions: Insensitive to the magnitudes of potential utility gains and losses. (Example: (3,2) over (10,1) and (4,1)) - Insensitive to how many questions: No attention at all to the number of people whose interests are overridden in pursuit of the interests of the worst off

Long-run impacts of immigration on the labour market

- Factor price insensitivity: There is no impact of immigration on wages but outputs and production of goods using unskilled labour more intensively - Regions can absorb endowment shocks without any changes in relative regional factor prices

Neutrality

- The state should not be involved in the business of equalizing welfare, but rather provide inputs so that individuals achieve their own conception of welfare - Suggests responsibility for tastes

Changes in women's status is one of the biggest societal changes of 20th century...

- Feminization of the workforce, especially on advanced countries - This shift of women's activity from household to market place increased women's contribution to household's income, enhancing their status and hence bargaining power - Financial independence is key to the transformation of economic and social position NOTE: These numbers understate the contribution in work done since they only consider full-time employment But still lots to achieve (OurWorldInData, 2018)... - Inferior employment opportunities - Underrepresentation in top jobs - Over representation in low-paying jobs - Lower pay for the same job - Lower lifetime earnings, lower pensions, higher risk of poverty in old age

Trickle-down economics

- High inequality at the top end of the distribution may promote economic growth, since it boosts the overall level of savings available for investment - If we allow the rich to get richer, and the inequality to widen, then wealth may trickle down the distribution and allow poor to participate in the distribution - May happen through: 1. Average wage rate or return to education 2. Market return to capital 3. Redistributive policies

Lorenz Curve

- Horizontal axis shows cumulative proportion of population (order people in an increasing level of income, which always produces a convex curve) - Vertical axis shows proportion of income - If everybody had exactly the same amount of income, curve would be the diagonal line - As we go further from the entirely egalitarian distribution, we move towards the origin

Alesina et al. (2018)

- Impacts belief in social mobility on preference for distribution - Individuals with different characteristics possess different perception of intergenerational mobility - Americans view wealth as a reward for ability and effort. In contrast, Europeans believe that poverty is a result of bad luck and an unfair economic system (perceived vs. actual social mobility)

Empirical evidence showing that happiness is measurable and commensurable

- Individuals are good at assessing the reported happiness level of others from a picture or a video - Neuroeconomics: a relationship exists between reported happiness and physical reactions - There is a relationship between reported happiness and actual reaction (divorce, job termination, etc.) - Positive relationship between good health and reported life satisfaction Main critique: Individuals tend to adapt to adverse circumstances

Happiness economics

- Individuals report a subjective well-being evaluation an this has an economic content - In 1990s, states preferences in addition to revealed preferences started to be considered as data - Absolute income is only important for happiness when income is very low

The overall distance between individuals matters since:

- It distorts trust and social capital - It creates polarization, unrest and social conflicts - It creates macroeconomic volatility and bad shock management due to coordination failure of different ministers from different extremes

Why is inequality bad?

- Justice, normative reasons - Fairest way to share scarcity (or is it? an equal distribution may not be the one that maximizes the number of people with satisfactory lives) - Inequality has deleterious effects on human welfare Pickett and Wilkinson, 2009: Beyond basic wealth, the well-being of a society (for all social classes) depends much more on income differences being small than on incomes being high on average (within societies, we are looking at relative income or social status) Issue: causality

Gender gap in employment

- Labor force participation - Occupational distribution (there are more men employed in higher paying jobs and more women employed in lower paying jobs) Women concentrated at lower pay levels than men, gender gap widens over lifetime

Racial profiling

- Limited resources to stopping every individual suspections, need to maximise your productive resources - Although racial profiling is an efficient way to apprehend criminals, it does impose a cost on all group b members, including the innocent (Type I error). If you are a b group member, that may seem patently unfair

Two key characteristics of an income index

- Measurable - Comparable among different persons

Inequality and growth: Middle-class

- Median voter mechanism: if growth is entirely driven by the savings of the rich, inequality has an adverse effect - Smaller middle class calls for a decrease in the overall size of the market demand: A strong demand contributes to productivity gains, encourages R-D and innnovation, in turn lowering prices, raise wages and expand the size of the market

Consumption

- Net income minus accrued savings - Conventional welfarist approach to measuring economic well-being suggests that this is the main variable of interest

Veil of Ignorance (Rawls)

- No one knows his place in society, his class position or social status, nor does anyone know his fortune in the distribution of natural assets and abilities, his intelligence, strength, and the like. I shall even assume that the parties do not know their conceptions of the good or their special psychological propensities - The principles of justice are chosen behind a ____ __ _________ - Inequalities exist! But they are arranged such that they benefit the least-advantaged members of society - Justice as fairness

Why is inequality not that bad?

- Not only healthy and inevitable, but also functional - Creates incentives for higher productivity, skill training, entrepreneurship, etc. - Promotes growth

Wealth

- Not only the flow but the accumulated stock of beings - Since has a major role in economic power towards the top of the distribution and it provides coverage for financial risks

Martin Rein and S. M. Miller's standards of equality (Standards of Income Redistribution)

- One-hundred-percentism - The social minimum - Equalization of lifetime income profiles - Mobility - Economic inclusion - Income shares - Lowering the ceiling - Avoidance of income and wealth crystallization - International yardsticks

Reasons for the sharp decline in real earnings of non-college workers

- Ongoing substitution for computer-intensive machinery for workers performing routine tasks - Globalization of labor markets lowered US manufacturing employment - Decline in the penetration and arguing power of labor unions

Charting inequality

- Parade of Dwarfs - Frequency Distribution - Cumulative Frequency Distribution - Lorenz Curve - Logarithmic Frequency Distribution

The Great Gatsby Curve

- Plot the relationship between income inequality and inequality of opportunity using cross-sectinal data across countries (Income inequality: Gini coefficients, Inequality of opportunity: Coefficients for integenerational mobility (persistence) of income) - Based on models of family investments, skills, social influences, political economy and aspirations - Countries with greater inequality of incomes also tend to be countries which a greater fraction of economic disadvantage is passed on between parents and their children

Why is inequality rising? (OECD, 2011)

- Policies and institutions - Globalization _ Technological change

Equality rankings based on curves

- Quantile rankings - Lorenz rankings

Two ways of looking at inequality that may lead to ambiguous results

- Quantities - Shares

Conventional inequality measures (six)

- Range (R) - Relative mean deviation (M) - Variance (V) - Coecient of variation (c) - Gini coecient (G) - Log variance (v)

Moene and Wallerstein (MW) model

- Social spending not only for redistribution, but also to provide insurance - Individuals not only chose the tax rate, but also choose the unemployment benefits - To insure themselves against the risk of losing their jobs, they demand higher benefits - They demand more insurance, higher the difference between unemployed and employed income - If inequality increases, the tax rate preferred by the median voter goes down (because insurance is a normal good, demand decreases if income decreases; hence, if median voter income declines, while risks covered remain constant, demand for social expenditure/redistribution goes down) Support: - Conventionally, the negative relationship between Gini of wage and social spending as a percentage of GDP signal that more egalitarian states have bigger welfare states

Approaches to inequality analysis

- Social welfare - Information theory - Structural approach

Ingredients of a Principle of Inequality Measurement

- Specification of an individual social unit such as a single person, the nuclear family or the extended family ("persons") - Description of a particular attribute (or attributes) such as income, wealth, land-ownership or voting strength ("income") - A method of representation or aggregation of the allocation of the "income" among the "persons" in a given population

Two main approaches of discrimination

- Taste-based - Statistical

Gary Becker's The Economics of Discrimination (1957)

- Taste-based discrimination - First economic model of discrimination - Employers have a 'taste for discrimination': Hence, minority workers may have to compensate by being more productive at a given wage or accepting lower wage levels for the given productivity

How was the major fall in inequality in post-war Europe achieved?

- Taxes and transfers: A period of expanding welfare state and social provisions financed by progressive income taxation (from mid-1990s to 2005, the redistributive capacity of tax-benefit system was reduced...) - Capital incomes becoming less unequally shared: The share of capital in national income was falling, and the distribution of capital income was becoming less unequal (now is reversed) - Intervention in the labor market reducing the wage dispersion: Minimum wage legislation, incomes policy, equal pay legislation

What are the channels through which globalization may affect earnings inequality?

- Technology and information - Trade - Finance and investment - Production - International migration

Total Utility Equality

- The best state is the one that equalizes the utilities - An egalitarian twist to a utilitarian approach - Uses leximin to rank the states

Interpreting the long-run evidence in income inequality (Piketty and Saez)

- The compression of incomes during the 20th cc occured due to the fall of top capital incomes induced by World Wars, the great Depression, and the regularatory and fiscal policies developed in response to these shocks - There was no structural decline in the inequality of labor income (kill Kuznets!) - What determines level of labor income inequality: Education-technology race... - Yet, this does not explain the variations between countries: long-run eq in Europe and Japan despite similar technological changes, unprecedented rise of very top labor incomes in the US

Inequality is not only a market phenomena: policy has contributed to the rise of income inequality through...

- The decline in the real value of minimum wage - The declining prevalence and bargaining power of labor unions - Mounting international competition that puts pressure on the wages and employment of less educated workers - Sharp returns in top federal marginal tax rates

Female-biased technical change

- The demand for skills is rising, and women are educated enough to meet this demand - Women were able to escape the job destruction mostly in the male dominated manual occupations - Upskilling within the job has taken place in jobs predominantly held by women enhancing women's productivity in traditionally "female" occupations

The Blinder-Oaxaca Decomposition tells us that over the decent decades...

- The gender pay gap in characteristics is narrowing as a result of rising educational attainment and employment continuity (almost the same for young cohorts, still big gap for older cohorts) - The unexplained pay gap has also been declining - OECD (2002) - 15% of male earnings are still unexplained

Median-voter hypothesis

- The median voters must gain from the process of redistribution )the transfers they receive must be greater than the taxes they pay, otherwise the optimal tax rate is t=0) - If inequality is high, the median voter is poor relative to the average income of society, so he has to gain by taxing the rich a lot and looses little by being taxes himself as his pre-tax income is low - We should expect to see more redistribution in unequal societies than in more equal societies - DOES NOT say that the median voter will necessarily gain more than anyone else: we expect the very poor to gain more than the median voter through the transfers received and their low taxes - The poorer in relative terms the median voter, the larger his gain - The decisive voter is median among those that vote, Even the poor vote with lower probability than the rich, redistribution is reduced but the comparative statics still hold, higher in inequality raises political support for redistribution

The Blinder-Oaxaca Decomposition

-Suggested in 1973, still widely used - Disaggregates the observed differential between men's and women's pay into the part which reflects differing characteristics relevant to productivity in work, and the part reflecting the differing rewards for these characteristics

Atkinson's 4 measures of reducing income inequality in OECD countries that not draw on the post-war European experience

1. A minimum inheritance paid to all on reaching adulthood, financed by the lifetime capital receipts tax 2. Government savings accounts with a guaranteed positive real rate of interest up to a maximum per person 3. A participation minimum income as a complement to existing social protection, beginning with an EU-wide child basic income 4. Encouraging innovation in a form that increases the employability of workers

Three Principal Reasons for Economic Equality

1. Justice (Rawls) 2. Equality is the fairest way to share scarcity 3. Inequality (as opposed to poverty) as deleterious effects on human welfare

Atkinson's 4 measures of reducing income inequality in OECD countries that draw on the post-war European experience

1. Restoration of a progressive income tax with rates from 10% to 65% 2. A life time capital receipts tax: the taxation at progressive rates of the total received over a person's lifetime in bequests and gifts 3. Renewal of individual-based social insurance and payment of substantial (taxable) child benefit 4. A national pay policy, a statutory minimum wage and a code of practice for pay above the minimum

Three facts about inequality in the long run

1. Whereas income inequality was larger in Europe than in the US a century ago, it is currently much higher in the US 2. The share of total net private wealth owned by the top 10% was notably larger in the Europe than in the US a century ago, while the opposite is true today - Wealth concentration is always much higher than income concentration - US wealth inequality levels have still not reached the record levels of Europe before WW1 - In the US there always have been a 'wealth middle class', but there was none in Europe - Now the wealth middle class in Europe has more share than that of the US - US wealth inequality is lower than that of 1913 Europe. Why is income inequality high? Top US incomes today are composed equally of labor income and capital income 3. In Europe, the aggregate wealth-income ratio has followed a U-shaped pattern. In the US, it is much flatter. European wealth/income ratios fell because... - Direct war related physical destruction of domestic capital assets - Lack of investment - A fall in relative asset prices (due to rent control, nationalization, capital controls, and other financial repression policies) It took too long but eventually wealth-income ratio recovered because.... - Harrod-Domar-Solow formula - Capital is back because low growth is back - Intuitively, in a low-growth society, the stock of capital accumulated in the past can be very important. - This explains why the US accumulates structurally less capital wrt Europe and Japan: US population growth rate > 1%, US productivity growth≈ 1.5%. In Europe and Japan, almost no population growth, productivity growth ≈ 1.5%, US saving rates are lower than that of Europe and Japan

The changes in women's status is one of the biggest societal changes of the ____ century

20th

Atkinson (2015): Approximation 5 percentage point increase in tax rate corresponds with...

3 percentage point decrease in Gini

Generalized Entropy Measures

An inequality I satisfies Weak Principle of Transfers, Scale Independence, Population Principle, and Decomposability if and only if it is expressible in the form __________ ______ _________

Weak Principle of Transfers

An inequality measure I satisfies ____ _________ __ _________ if any transfer of income from a rich individual to a poorer one that does not change the ordering of the income levels should decrease inequality Theorem: Suppose that the total income in social state A and B is the same and the Lorenz curve for A lies wholly inside that of B. Then, as long as an inequality measure I satisfies the ____ _________ __ _________, we have I(A) < I(B) Satisfied by: V, c, G, T, Aε, Dε Not satisfied by: R, M, y

Scale Independence

An inequality measure I satisfies _____ ____________ if everyone's income changes by the same proportion, the value of the inequality measure remains the same - Relative inequality vs. absolute inequality Not satisfied by: V, Dε

Principle of Population (PP)

An inequality measure I satisfies _________ __ __________ if the population is replicated, keeping the proportions of income the same, the value of inequality remains the same Satisfied by: - Almost all measures - Theil only with β = 0 satisfies

Decomposability

An inequality measure I satisfies ______________ if the overall inequality in a population can be expressed as an aggregation of the inequalities within its subgroups and between them - Consistency is required between inequality in the whole of society and inequality in its constituent parts - Gini is not decomposable

Kuznets Curve

An inverted-U relation between inequality and economic growth is hypothesized In transition economies from agricultural to industrial urban...

World Values Survey

Asks "Taking all things together, would you say you are: very happy; quite happy not very happy; not at all happy?" and "All things considered, how satisfied are you with your life as a whole?"

Fehr and Schmidt (F&S) Inequality Measures

Assumes that subjects dislike a payoff difference to any other individual - Implies subject would clearly prefer that all subjects get the same - In reading "Inequality Aversion, Efficiency, and Maximin Preferences in Simple Distribution Experiments" (Tutorial 1), performs better than Bolton and Ockenfels (ERC) in a direct comparison (appears to be due to being in line with maximin preferences) - In a real-life situation, predicts that the middle class would tax the upper class to subsidize the poor, whereas ERC does not

Bolton and Ockenfels (ERC) Inequality Measures

Assumes that subjects like the average payoff to be as close as possible to their own payoff - Implies a subject would be equally happy if all subjects received the same payoff if some were rich and some were poor as long as she received the average payoff - In a real-life, situation, does not predict that the middle class would tax the upper class to subsidize the poor (unlike F&S)

The American Dream

Being able to accomplish almost anything you want with hard work; immigrants at the bottom of the income distribution can have children that succeed - However, the empirical evidence seems to suggest that more inequality of incomes in the present is likely to make family background play a stronger role in determining the adult outcomes of young people, with hard work playing a weaker role - The interaction between families, labor markets and public policies structure child's opportunities and determine the extend to which adult earnings are related to family background, but relation varies across national contexts

Rawl's Theory of Justice

Calls to maximize the bundle of goods which the worst-off group receives - Utility or well-being should not be the currency of the justice; primary goods should be - Justice is not achieved by maximizing the sum of well-being (or even primary goods) but rather maxi-minning (equalizing) the distribution of primary goods across individuals (Difference principle) - Argued for neutrality, the view that the state should not be in the business of equalizing welfare, but rather providing individuals with he inputs that everyone needs for achieving his own concept of welfare

Dalton's Inequality Index (Dε)

Captures how far actual average social utility falls short of potential average social utility (if all income were distributed equally), given the level of inequality aversion ε - Not scale invariant - "You tell me how strong society's aversion to inequality is, and I will tell you the value of the inequality statistic"

Atkinson Index (Aε)

Criticizes Dalton's Inequality Index (Dε) for being sensitive to the level from which social utility is measured (add a constant to all Us, Dε changes); suggests to go back to the 0y axis to make the comparisons - Ordinally equivalent to Dε, but performs better in terms of cardinal properties - The higher the ε, the higher the value of inequality measured for Aε for any given distribution - "You tell me how strong society's aversion to inequality is, and I will tell you the value of the inequality statistic"

Inequality aversion

Disutility arising from differences between one's own payoff and others' payoffs

Short-run impacts of immigration on the labour market

Due to the influx of immigrants with different skill endowments, there will be an excess supply of labour at the going rates Changes in wages and employment levels of different skilled types: - Influx of unskilled workers When the adverse effects may not occur?: - Skill distribution of immigrants is equal to that of natives and capital supply is fully elastic → scale up the economy through an increase in output

Fundamental drivers of gender gap

Education and technology - The upsurge in women's educational attainment is the key driver - In developed economies, women are more educated than men - In schools, girls are outperforming boys in basic skills

Milanovic (2000)

Estimates fixed-effect models with redistribution as the dependent variable and different measures of inequality as the main regressor Method: - Redistribution measured by 2 variables: the income share gain of the (1) bottom half (50th) and (2) the bottom quintile (20th) - Control variables: share of elders, openness to trade, GDP per capital Results: - Indicate that market income inequality within countries is positively associated with redistribution (MR model)

Cumulative distribution function

F(y) = p Gives the fraction p of individuals with at most y level of income - Horizontal axis shows income levels - Vertical axis shows cumulative proportion of society from 0-1 - Inverse of quantile function

Income Inequality Index

Gives a scalar numerical representation of the interpersonal differences in income within a given population for a given time period - Scalar refers to a single number (a single point on a scale) - Summarizes things quite a lot (and not always very successfully) but is still functional and useful

Disposable (net) household income

Gross household income minus outgoing private transfers (e.g. gifts to private individuals or child support payments) and income taxes and social insurance contributions

Inequality in the long-run: Wealth inequality (Piketty and Saez)

How can we account for the very high level of wealth concentration that we observe in historical series, and what does this tell us about the future? - r > g, where r is the average annual rate of return on capital and g is the growth rate of world output - A higher r − g tends to amplify initial wealth inequalities, since past wealth is capitalized at a faster pace - r − g was very large during most of human history - It explains why wealth concentration was so high until WW1 and why it was smaller in the US, where g is higher

Monotonic transformation

If a function is a _________ _____________ of the another function, then it means it is ranking all of the inputs in the same way - Can check with first derivative (dI1/dI2>0)

Statistical discrimination

Imperfect information about the skills/productivity of the applicants, hence employers infer the expected productivity by using easily observable characteristics such as race or gender (assuming they are correlated to productivity) - The distintion between group vs individual discrimination is not always clear in the literature (Aigner and Cain, 1977) - Economists would argue that it is optimal and profit-maximizing, but it is illegal and arguably unfair - Generally unlawful; It is illegal to make hiring, pay or promotion decisions based on predicted performance where predictions are based on race, sex, age or disability - Minorities, women, those over age 40, and the disabled are protected groups, employers are not permitted to hire and fire them at will. However, an employer presumably can statistically discriminate among non-disabled, white males under age 40 - Difficult to detect, and so it is plausible that despite the law, it occurs frequently

Welch, In Defense of Inequality (1999)

Inequality is not only healthy and inevitable, but also functional: Growing inequality has created opportunities that have been exploited by many and that gains are not restricted to the traditional elite 1. In the abstract, without inequality there would be no economics (Edgeworth box) 2. "One man's poison can be another's meat:" Post 1950s rise in employment of women and immigrants (skilled labor) thanks to the tails of the wage distribution 3. Inequality creates incentives for skill training and education (returns to education is high so we should go to school so that we can make high wages) Mincerian equations: log(wi)=a+bSi+cXi+dXi^2+ui a - constant bSi - schooling/education cXi - experience in job once schooling has ended (no. years) dXi^2 - squared experience (don't worry) ui - error term IMPORTANT: de-compose variance into some parts, compute variance by finding average mean wage in social group, find and sum the squared deviation from mean and divide by N for each individual ((indivdiual wage-average wage)^2/N), find variances: within schooling and within experience, across experience within schooling, and across schooling, sum all variances Theory: most inequality can be explained by differences/changes in experience and education 4. Inequality in wages may be hurting for some in the short-time, but good for the well-being of all in the long-run "Consider the extreme: supposed the residual has no variance. In this depiction, an individual makes only one decision that affects his wage: when to lead school...nothing else matters.... can you imagine a more horrible more deadening experience?" - The growth in wage inequality is almost certainly a result of growth in the demand for skill - Part of that growth is related to the changing composition of economic activity, to the increasing importance of educational-intensive industries such as professional (financial, health, and educational) services and to the declining importance of agriculture and personal services - Skill-biased technological change - As a result "increase in school-competition levels" but also "reduction in time worked by men with low wage potential" - Increasing inequality within groups distinguished by race and gender coincided with reduced inequality between same groups

Variance

Issue: Not scale invariant

A model of the demand side of the labor market (Card, 2009)

Labor consists of natives and immigrants Immigrants and native workers are not always perfectly substitute, depending on the level of education - Workers with a high school education or less are perfectly substitute - Workers with a high school equivalent and college equivalent are imperfect substitute - Within broad education classes: large but finite elasticity of substitution

Logarithmic frequency distribution

Logarithmic transformation of the income frequency distribution - Allows to see what is happening at the tails (extremes) - Log function is strictly concave

Roemer's Economic Model of the Equality of Opportunity for Welfare

Looks for a policy that equalizes the outcome for individuals putting the same effort independent of their types - Choose the policy that maximizes the area under the lower envelope of the function v - If the type space becomes increasingly fine, then equal opportunity policy will approach the Rawlsian policy - If all individuals are seen as a member of a single type, the policy becomes utilitarian - u is type dependent - u depends on effort and gov. policy - Assumption: u is an increasing function of e (u is not a utility function) - Given policy, the distribution of effort among the individuals of type t is denoted by F - Key point: F is a characteristic of type (not the individual) - A measure of a person's effort is her rank in the distribution of effort of her type - Equality of opportunity is sustained if for any rank π ∈ [0,1], all those at rank π in the different types acquire the objective at the same level (for people that have the same rank in their respective distributions, we would like to equalize the outcome) - Let v denote the average value of the objective fr type t who lie at rank π of F - A policy equalizes opportunities if: for all π ∈ [0,1], for all t1, t2 ∈ T, vt1=vt2 - But that would be a magical policy! Compromise needed: for all t1, t2 ∈ T, average local income = average immigrant income (with assumption average local is putting in same amount of effort of average immigrant in their own distributions/types) - Circumstances: Aspects of people for which they are not responsible - Effort: Actions people take for which they are responsible - Type: Set of individuals are partitioned into types according to their circumstances - Objective: The condition for which the acquisition of opportunities is to be equalized - Policy: The intervention of the agency that is employed to equalize opportunities for the acquisition of the objective

Maximin

Maximize payoff for poorest person

Efficiency

Maximize total payoff

Difference Principle (Rawls)

Maximizing the minimum bundle of primary goods across individuals; the priority is on the interests of the worst-off - Maxi-min formula might permit considerable inequality, if the elasticity of supply of highly talented labor is high

Information theory approach to inequality analysis

Method is to see the quantification of inequality as an offshoot of the problem of comparing probability distributions - To do this we draw upon a fruitful analogy with information theory

Fairness

Minimize difference between difference

Inequality and growth: What is going on?

No consensus in the literature Theoretical literature: - Inequality can both facilitate and weaken growth - Most of the positive mechanisms can be linked to inequality at the top end of the distribution - Most of the negative effects can be linked to bottom-end inequity or high overall inequality Empirical literature: - Linear regression methods, with one single coefficient on inequality in a growth regression - Very different effects estimated depending on the data and estimation method

Easterlin Paradox

No link between the level of economic development of a society and the overall happiness of its members - The timeline happiness data revels no correlation between income per head, increased leisure time, crime, declining infant mortality, increased longevity, unemployment, declining inequalities between the sexes, public spending... Explanation: - Individuals adapt to changing conditions quickly - As the neath of individuals and societies increases, they adapt to new, higher living standards and adjust expectation upwards. "hedonic adaptation"

Cardinal equivalence

One index is a linear transformation of the other

Inequality good or bad?: lower part of distribution

Poverty trap leads to sub-optimal production level with persistent inequality since... - Imperfect credit and insurance markets for the poor: no access to higher return investments, forgone opportunities of investment in human capital - Effective effort as a function of expected rate of return, both in labor and credit markets - Richer rich and poorer poor leads higher expected return to crime than education or legal activities - Higher fertility rates among poor lead many kids with low education

Inequality and growth: Lower class

Poverty trap leads to sub-optimal production level with persistent inequality since: - Imperfect credit and insurance markets for the poor: no access to higher return investments, forgone opportunities of investment in human capital - Effective effort as a function of expected rate of return, both in labor and credit markets - Richer rich and poorer poor leads higher expected return to crime than education or legal activities - Higher fertility rates among poor lead many kids with low education

W has constant elasticity (constant relative inequality aversion) if...

Proportional decrease in the weight U' for a given proportional increase in income should be the same at any income level - If a person's income increases by 1%, her welfare weight drops by ε% of its former value - The higher the ε is, the father the rate of proportional decline in welfare weight to proportional increase in come (ε captures inequality aversion)

Quantile function (Parade of Dwarfs)

Q(p) = y Quantile function gives the value of income y for which a fraction p of individuals is found under of equal to - Emphasis on extremes - Inverse of cumulative distribution function

Social welfare function

Ranks all the possible states of society in the order of society's preference: If state A is preferable to state B the, and only then, the _____ _______ ________ has a higher value for state A than that for state B Properties: - W is non-decreasing (monotonicity) if it doesn't decrease as the income vectors increase; if income vector B is greater than or equal to income vector A, then the social welfare measured by the function W for State B is always going to be greater than the social welfare measured by the function W for State A; means that none of the entries (incomes) of State B are smaller than the entries (incomes) of State A - W is symmetric (anonymity) if, for any state, the naming/ordering of individuals does not matter - W is additive if it can be written as the sum of the social welfares of individuals measured as a function of their own income - If all of the 3 above properties are satisfied, the entire social welfare in the society can be expressed as an additive function of the same functional form U, which is an increasing function of income (yi)

Standardized variation

Scale invariant (invariant under proportional increases in all incomes) Types: - Coefficient of variation - Logarithmic variance Weaknesses: - Coefficient of variation: The reaction of the inequality function is exactly the same independent of which part of the income distribution we are talking about (should be more sensitive to changes) - Logarithmic variance: For a transfer in high income levels, inequality might even increase

Alesina et al 2004

Test for two reasons why inequality may affect individual well-being: - A taste for equality - Regard for inequality as an indicator of future income Key is mobility: "Thus, comparing the effect of inequality on happiness across societies with different levels of mobility, actual or perceived, and across different income and ideological groups will provide a way to distinguish between these alternative theories" Results (US): - Negative association between. inequality and unhappiness (unemployment rate explains this) - Men are less happy - Older people are less happy - More education, more happiness - Marriage and happiness, divorce and unhappiness - Children negatively associated with happiness - Believe efforts (mobility) have big effect on determination in society - Left-sided people are more affected by inequality and unemployment rates Results (Europe): - Being unemployed is negatively related to happiness - Males are unhappier - Older people less happy - Children associated with happiness - Left-sided people care more about inequality Results (Summary): - Everyone cares about inequality - Left-sided people care more about inequality - Rich in US care more about inequality - Poor in Europe care more about inequality Findings (Cardinal approach): - No strong link between inequality in happiness and average happiness

Engelmann, D. and Strobel, M., 2004. Inequality aversion, efficiency, and maximin preferences in simple distribution experiments. American economic review, 94(4), pp.857-869.

Tested to what extent inequality aversion is dominated by: - Efficiency concern: Sum of all payoffs ⇒ care for total gains - Maximin: Maximise the minimal payoffs in the group ⇒ care for the poorestSelfishness ⇒ care for your gain Comparing two theories in explaining inequality aversion based on: - Fehr and Schmidt (1999) - F&S - Bolton and Ockenfels (2000) - ERC Set up: - Assume a scenario where we have 3 people that we need to distribute money to - There are 3 different allocations of money (i.e. A, B, C) between 3 people - We will carry out 11 experiments Experiments: - You will pick 1 allocation of your choice - Do not compare your answer with your classmates such that your decision reflects your own preference

Social marginal utility of i (welfare weight of i)

The first derivative of the U function (used to calculate social welfare) with respect to income - Cannot be negative - W is strictly concave if the welfare weight always decreases as income increases - Second derivative is negative

Welfarism

The goodness of a state of affairs can be judged entirely by the goodness of the utilities in that state - Utilitarianism

Income

The increase in a person's command over resources during a given period of time Disadvantages: - Relates only to an arbitrary time unit (such as one year) and - Thus excludes the effect of past accumulations except in so far as these are deployed in income-yielding asset Merits: - If it includes unearned income, capital gains, and 'income in kind' as well as earnings, then it can be claimed as a fairly comprehensive index of a person's well-being at a given moment; - Information on personal income is generally more widely available and more readily interpretable than for wealth or lifetime income

Intergenerational mobility

The likelihood that children born to low income families become high income adults and vise versa - Problematic if high inequality serves to reduce this - Countries with high returns to education tend to have lower mobility because education is highly persistent in families

Ronald Dworkin

The right egalitarian currency is resources (not just wealth and commodities, but internal traits of persons that determine or limit what they can accomplish, and the environments and families into which they are born) - The natural distribution of resources is unjust, because it is unequal, but once equality of initial resources has been implemented, inequalities in outcomes which emerge from the exercise of choices emanating from preferences are morally acceptable - Focused upon the responsibility of individuals for their choices Argued that: 1. Equality of welfare is incoherent, because of the incommensurability across persons of conceptions of well-being 2. Even if comparisons were possible, it would be ethically undesirable to equalize welfare because of the phenomenon of expensive tastes 3. Individuals are responsible for their preferences, if, indeed, they identify with them

Gross household income

The sum, across all household members, of: - labor market earnings from employment or self-employment - income from savings and investments - incoming private transfers such as receipts of gifts or alimony - public transfers such as social insurance or social assistant benefits

Strong reciprocity games and responses

Ultimatum game: - Homo-economicus response is to offer one penny - Yet, in many experiments, the vast majority of the proposers offer between 40% and 50%, and when offered less than 20%, the offers are rejected - "They are afraid that the respondents will consider low offers unfair and reject them as a way to punish their unwillingness to share" - The rejection of positive offers is substantially less when the game is altered so that rejection does not punish the proposer - Offers generated by a computer rather than another person are significantly less likely to be rejected Dictator game: - Homo-economicus response is to offer nothing - Yet, in many experiments a majority of the proposers give positive amounts, typically ranging from 20% to 60% of the total - More generosity towards worthy recipients (3 times more to American Red Cross than to anonymous subject) n- player public good experiments: - Mostly, in the early stages of the game, people contribute half of their money. In the later stages, the contributions decay - One explanation is strong reciprocity. Andreoni (1995): public spirited contributors want to retaliate against free-riders, and the only way available to them in the game is by not contributing themselves - If players are permitted to retaliate directly against non-contributors, but at a cost to themselves, they do so - In this situation, contributions rise in subsequent rounds to near the maximal level. Moreover, punishment levels are undiminished in the final rounds, suggesting that disciplining norm violators is an end in itself and, hence, will be exhibited even when there is no prospect of modifying subsequent shirking

Nozick (1974)

Utopia, an anti-egalitarian manifesto: - Any outcome resulting from voluntary exchanges, from initially just endowments, is just - Only a minimal state, just to protect property rights, but no forced redistribution - Thesis of self-ownership: a person has a right to use her own powers for personal benefit - Privatization of the unowned resources in the external world as long as consequently the others are not worse-off - Justice as property rights - Theory of distributive justice combines the thesis of self-ownership with a particularly inegalitarian rule for privatization of the external world - Principle of acquisition of unowned resources is arbitrary Anti-Rawlsian view: - Even though certain assets (e.g., genetics, family) are not chosen, the individual may still be rightly held responsible for what he or she does with them - As long as requirements of non-discrimination and equality of opportunity are met, unequal outcomes are morally acceptable - Even if equality is deemed desirable, implementing it might impoverish everyone, because of deleterious incentive effects

Density function

f(y) Shows the frequencies of income levels (for a discrete distribution, it shows the fraction of individuals with income level y) - Emphasis on middle income levels

High generational elasticity means...

rich sons have rich fathers, hence implies lower mobility

Let state A and B have the same amount of total income. State A Lorenz dominates state B if and only if...

the welfare of state A is greater than the welfare of state B for any non-decreasing, symmetric, additive and strictly concave social welfare function W (and vise versa; goes both ways)