Issue 26: 2014

Macro Analysis

Income Inequality: U.S. Versus the World

How American incomes rate among the top 10 rich nations.

Photograph by Andy Ryan

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There is general agreement that income inequality has increased in the developed world over the past 30 years. Reasons for this include globalization and technology, changes in policies and institutions, and differences in education.

Let’s use the 10 biggest economies in the world to illustrate some underlying forces behind rising income inequality. These top 10 economies comprise about two-thirds of the global GDP. To measure income inequality distribution, we use their coefficients from the World Bank’s Gini index.

The Gini coefficient ranges from 0 to 1. If income is divided equally across all households with no variation, it is 0. If one household has all the income in the country and everyone else has no income, the Gini coefficient is 1. For the world as a whole, the Gini coefficient is about 0.40. China and the United States are higher than average, the United Kingdom is about average, and Germany and France are much lower.

We also use the ratio of the average income for the top 10%, or decile, of the income distribution to the average income of the bottom decile. (These can be seen in the chart below along with worldwide Gini coefficients.) In the United States this ratio is 15, indicating that the richest decile average is 15 times the average income of the bottom decile. In Germany, this ratio is half as much. For the world, it’s about 12.

 

The top 10 economies by GDP size vary dramatically in per capita income, from the United States with more than $50,000 per person to India with less than 10% of that. This helps put things in perspective. Research shows that the “rich” in poor countries have to spend more of their incomes for food than the “poor” in the developed world. The average low-income person in the rich world would be among the best off with the same income in a poor country.

It is easy to understand why the United States increasingly relies on immigrants from poorer countries to take low-paying jobs. These jobs often pay multiples of what is possible in their countries of origin. So, most income inequality is overwhelmingly caused by the inequality between rich and poor countries rather than inequality within countries.

By global standards, poverty is minimal in the rich world, which raises an issue of absolute versus relative criteria for judging inequality. Other than the corrosive effects of envy, there is less reason to care if income inequality is high as long as the bottom decile has adequate income.

What causes inequality?

Researchers at the Organisation for Economic Co-operation and Development (OECD) found “trends in technology, policies and education” were the key drivers of changes in wage inequality and employment in the United States, Germany, Norway and other countries. Technological progress or innovation, which is driving globalization, was found to have a statistically significant impact as well. Direct measures of globalization, including trade integration and foreign direct investment, were not significant.


iStock.com

 

Policies and institutional effects such as declining unionization, product market deregulation, declining tax wedges and reduced unemployment-benefit replacement rates were found to raise inequality, but also to increase employment.

Increasing education levels, or upskilling, is also associated with reduced inequality and rising employment. Most economists believe that in a world of rapid technological change and innovation, as the OECD notes, “The growth in average educational attainment appears to have been the single most important factor contributing not only to reduced wage dispersion among workers but also to higher employment rates.”

Shifting demographics have substantial effects on income inequality.

Shifting demographics have substantial effects on income inequality. These include increased female participation, smaller household structure (single parents), increased part-time work versus full-time work, and an increasing disparity in men’s earnings. Assortative mating, an increased tendency of comparably compensated partners to form households, can also add to inequality in a society. (See chart below.)

Income mobility and income inequality

A new study led by Raj Chetty, a professor of economics at Harvard, finds that, contrary to the assertion that upward mobility has declined over time in the United States, it seems to be about the same today as it was 30 and even 50 years ago. In other words, the odds of a young person staying in the bottom decile today are about the same as they were for his or her grandfather. Despite social programs and tax progressivity, globalization and advanced technology seem to have offset policy measures to spur the potential for mobility.

As for the increased mobility in other countries, in some cases it seems to simply be a function of much compressed income variability in more homogeneous populations, such as those in northern Europe. One researcher found that a family can move from the 10th to the 90th income percentile in Denmark with an additional $45,000 of earnings, while an American family would need almost $100,000 to make the same move.

Of the 10 largest economies in the “Wealth Distribution in the World’s Largest Economies” chart, the United States is one of the most diverse in terms of where its population was born. This means a better comparison for the United States is with the overall world population rather than a more ethnically homogeneous country like Germany or Norway, where inequality is relatively low.

The United States and United Kingdom, as shown in the chart on page 12, both have more diversity than other countries in incomes as well as people. It may be that the United States, with immigrants from all over the world as well as an unusually big share of the world’s richest, most educated and entrepreneurial citizens, is a microcosm of a globalized economy that approximates what the world economy is evolving toward.

 

What does this mean in America?

American income inequality is the natural outcome of being a land of opportunity. This makes for a more spread-out income distribution with bigger gaps between the poorest and richest. Closing those gaps by moving from the bottom to the top requires a bigger leap in such a diverse society compared with closing the gap in an economy where everyone is making more similar incomes based on less variability in talent and skill sets.

The real issue is raising living standards and making opportunity for advancement as accessible as possible. It’s important that envy and resentment of success not stymie the effort to grow the economy, because the evidence is overwhelming that regardless of inequality trends, it takes a rising tide to lift all boats.

IMPORTANT INFORMATION

Investing involves risk. There is always the potential of losing money when you invest in securities.

Projections made may not come to pass due to market conditions and fluctuations.

Past performance is no guarantee of future results. Asset allocation, diversification and rebalancing do not ensure a profit or protect against loss in declining markets.

Always consult with your independent attorney, tax advisor, investment manager and insurance agent for final recommendations and before changing or implementing any financial, tax or estate planning strategy.

OTHER IMPORTANT INFORMATION

Equities
Equity securities are subject to stock market fluctuations that occur in response to economic and business developments.

International Investing
International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards, and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility.

Other
Technology stocks may be more volatile than stocks in other sectors.

There is general agreement that income inequality has increased in the developed world over the past 30 years. Reasons for this include globalization and technology, changes in policies and institutions, and differences in education.

There is general agreement that income inequality has increased in the developed world over the past 30 years. Reasons for this include globalization and technology, changes in policies and institutions, and differences in education.

Let’s use the 10 biggest economies in the world to illustrate some underlying forces behind rising income inequality. These top 10 economies comprise about two-thirds of the global GDP. To measure income inequality distribution, we use their coefficients from the World Bank’s Gini index.

The Gini coefficient ranges from 0 to 1. If income is divided equally across all households with no variation, it is 0. If one household has all the income in the country and everyone else has no income, the Gini coefficient is 1. For the world as a whole, the Gini coefficient is about 0.40. China and the United States are higher than average, the United Kingdom is about average, and Germany and France are much lower.

We also use the ratio of the average income for the top 10%, or decile, of the income distribution to the average income of the bottom decile. (These can be seen in the chart below along with worldwide Gini coefficients.) In the United States this ratio is 15, indicating that the richest decile average is 15 times the average income of the bottom decile. In Germany, this ratio is half as much. For the world, it’s about 12.

 

The top 10 economies by GDP size vary dramatically in per capita income, from the United States with more than $50,000 per person to India with less than 10% of that. This helps put things in perspective. Research shows that the “rich” in poor countries have to spend more of their incomes for food than the “poor” in the developed world. The average low-income person in the rich world would be among the best off with the same income in a poor country.

It is easy to understand why the United States increasingly relies on immigrants from poorer countries to take low-paying jobs. These jobs often pay multiples of what is possible in their countries of origin. So, most income inequality is overwhelmingly caused by the inequality between rich and poor countries rather than inequality within countries.

By global standards, poverty is minimal in the rich world, which raises an issue of absolute versus relative criteria for judging inequality. Other than the corrosive effects of envy, there is less reason to care if income inequality is high as long as the bottom decile has adequate income.

What causes inequality?

Researchers at the Organisation for Economic Co-operation and Development (OECD) found “trends in technology, policies and education” were the key drivers of changes in wage inequality and employment in the United States, Germany, Norway and other countries. Technological progress or innovation, which is driving globalization, was found to have a statistically significant impact as well. Direct measures of globalization, including trade integration and foreign direct investment, were not significant.


iStock.com

 

Policies and institutional effects such as declining unionization, product market deregulation, declining tax wedges and reduced unemployment-benefit replacement rates were found to raise inequality, but also to increase employment.

Increasing education levels, or upskilling, is also associated with reduced inequality and rising employment. Most economists believe that in a world of rapid technological change and innovation, as the OECD notes, “The growth in average educational attainment appears to have been the single most important factor contributing not only to reduced wage dispersion among workers but also to higher employment rates.”

Shifting demographics have substantial effects on income inequality.

Shifting demographics have substantial effects on income inequality. These include increased female participation, smaller household structure (single parents), increased part-time work versus full-time work, and an increasing disparity in men’s earnings. Assortative mating, an increased tendency of comparably compensated partners to form households, can also add to inequality in a society. (See chart below.)

Income mobility and income inequality

A new study led by Raj Chetty, a professor of economics at Harvard, finds that, contrary to the assertion that upward mobility has declined over time in the United States, it seems to be about the same today as it was 30 and even 50 years ago. In other words, the odds of a young person staying in the bottom decile today are about the same as they were for his or her grandfather. Despite social programs and tax progressivity, globalization and advanced technology seem to have offset policy measures to spur the potential for mobility.

As for the increased mobility in other countries, in some cases it seems to simply be a function of much compressed income variability in more homogeneous populations, such as those in northern Europe. One researcher found that a family can move from the 10th to the 90th income percentile in Denmark with an additional $45,000 of earnings, while an American family would need almost $100,000 to make the same move.

Of the 10 largest economies in the “Wealth Distribution in the World’s Largest Economies” chart, the United States is one of the most diverse in terms of where its population was born. This means a better comparison for the United States is with the overall world population rather than a more ethnically homogeneous country like Germany or Norway, where inequality is relatively low.

The United States and United Kingdom, as shown in the chart on page 12, both have more diversity than other countries in incomes as well as people. It may be that the United States, with immigrants from all over the world as well as an unusually big share of the world’s richest, most educated and entrepreneurial citizens, is a microcosm of a globalized economy that approximates what the world economy is evolving toward.

 

What does this mean in America?

American income inequality is the natural outcome of being a land of opportunity. This makes for a more spread-out income distribution with bigger gaps between the poorest and richest. Closing those gaps by moving from the bottom to the top requires a bigger leap in such a diverse society compared with closing the gap in an economy where everyone is making more similar incomes based on less variability in talent and skill sets.

The real issue is raising living standards and making opportunity for advancement as accessible as possible. It’s important that envy and resentment of success not stymie the effort to grow the economy, because the evidence is overwhelming that regardless of inequality trends, it takes a rising tide to lift all boats.

IMPORTANT INFORMATION

Investing involves risk. There is always the potential of losing money when you invest in securities.

Projections made may not come to pass due to market conditions and fluctuations.

Past performance is no guarantee of future results. Asset allocation, diversification and rebalancing do not ensure a profit or protect against loss in declining markets.

Always consult with your independent attorney, tax advisor, investment manager and insurance agent for final recommendations and before changing or implementing any financial, tax or estate planning strategy.

OTHER IMPORTANT INFORMATION

Equities
Equity securities are subject to stock market fluctuations that occur in response to economic and business developments.

International Investing
International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards, and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility.

Other
Technology stocks may be more volatile than stocks in other sectors.

Let’s use the 10 biggest economies in the world to illustrate some underlying forces behind rising income inequality. These top 10 economies comprise about two-thirds of the global GDP. To measure income inequality distribution, we use their coefficients from the World Bank’s Gini index.

The Gini coefficient ranges from 0 to 1. If income is divided equally across all households with no variation, it is 0. If one household has all the income in the country and everyone else has no income, the Gini coefficient is 1. For the world as a whole, the Gini coefficient is about 0.40. China and the United States are higher than average, the United Kingdom is about average, and Germany and France are much lower.

We also use the ratio of the average income for the top 10%, or decile, of the income distribution to the average income of the bottom decile. (These can be seen in the chart below along with worldwide Gini coefficients.) In the United States this ratio is 15, indicating that the richest decile average is 15 times the average income of the bottom decile. In Germany, this ratio is half as much. For the world, it’s about 12.


Source: Wikipedia, CIA; data as of 2013.

The top 10 economies by GDP size vary dramatically in per capita income, from the United States with more than $50,000 per person to India with less than 10% of that. This helps put things in perspective. Research shows that the “rich” in poor countries have to spend more of their incomes for food than the “poor” in the developed world. The average low-income person in the rich world would be among the best off with the same income in a poor country.

It is easy to understand why the United States increasingly relies on immigrants from poorer countries to take low-paying jobs. These jobs often pay multiples of what is possible in their countries of origin. So, most income inequality is overwhelmingly caused by the inequality between rich and poor countries rather than inequality within countries.

By global standards, poverty is minimal in the rich world, which raises an issue of absolute versus relative criteria for judging inequality. Other than the corrosive effects of envy, there is less reason to care if income inequality is high as long as the bottom decile has adequate income.

What causes inequality?

Researchers at the Organisation for Economic Co-operation and Development (OECD) found “trends in technology, policies and education” were the key drivers of changes in wage inequality and employment in the United States, Germany, Norway and other countries. Technological progress or innovation, which is driving globalization, was found to have a statistically significant impact as well. Direct measures of globalization, including trade integration and foreign direct investment, were not significant.

Policies and institutional effects such as declining unionization, product market deregulation, declining tax wedges and reduced unemployment benefit replacement rates were found to raise inequality, but also to increase employment.

Increasing education levels, or upskilling, is also associated with reduced inequality and rising employment. Most economists believe that in a world of rapid technological change and innovation, as the OECD notes, “The growth in average educational attainment appears to have been the single most important factor contributing not only to reduced wage dispersion among workers but also to higher employment rates.”

Shifting demographics have substantial effects on income inequality.

Shifting demographics have substantial effects on income inequality. These include increased female participation, smaller household structure (single parents), increased part-time work versus fulltime work, and an increasing disparity in men’s earnings. Assortative mating, an increased tendency of comparably compensated partners to form households, can also add to inequality in a society. (See chart below.)


Source: OECD Database on Household Income Distribution and Poverty, 2011.

Income mobility and income inequality

A new study led by Raj Chetty, a professor of economics at Harvard, finds that, contrary to the assertion that upward mobility has declined over time in the United States, it seems to be about the same today as it was 30 and even 50 years ago. In other words, the odds of a young person staying in the bottom decile today are about the same as they were for his or her grandfather. Despite social programs and tax progressivity, globalization and advanced technology seem to have offset policy measures to spur the potential for mobility.

As for the increased mobility in other countries, in some cases it seems to simply be a function of much compressed income variability in more homogeneous populations, such as those in northern Europe. One researcher found that a family can move from the 10th to the 90th income percentile in Denmark with an additional $45,000 of earnings, while an American family would need almost $100,000 to make the same move.

Of the 10 largest economies in the “Wealth Distribution in the World’s Largest Economies” chart, the United States is one of the most diverse in terms of where its population was born. This means a better comparison for the United States is with the overall world population rather than a more ethnically homogeneous country like Germany or Norway, where inequality is relatively low.

The United States and United Kingdom, as shown in the chart on page 12, both have more diversity than other countries in incomes as well as people. It may be that the United States, with immigrants from all over the world as well as an unusually big share of the world’s richest, most educated and entrepreneurial citizens, is a microcosm of a globalized economy that approximates what the world economy is evolving toward.


iStock.com

What does this mean in America?

American income inequality is the natural outcome of being a land of opportunity. This makes for a more spread-out income distribution with bigger gaps between the poorest and richest. Closing those gaps by moving from the bottom to the top requires a bigger leap in such a diverse society compared with closing the gap in an economy where everyone is making more similar incomes based on less variability in talent and skill sets.

The real issue is raising living standards and making opportunity for advancement as accessible as possible. It’s important that envy and resentment of success not stymie the effort to grow the economy, because the evidence is overwhelming that regardless of inequality trends, it takes a rising tide to lift all boats.