Income and Wealth Inequality (Concepts (Private, Public, and National…
Income and Wealth Inequality
Income and Wealth
National income Y = Yd + rNFA
Net foreign asset position of rich countries is small, so national income is approximately domestic output (Y = Yd)
From 1970-2010, with the exception of Australia, countries' Y/Yd are very close to 1
Private, Public, and National Wealth
W = Assets - Liabilities
National wealth Wn = Private wealth W + Public wealth Wg
Beta = Wealth-national income ratio W/Y = Domestic capital-output ratio K/Yd
Beta > 1, as wealth = stock and income = flow (thus there is greater wealth than there is income)
Beta (K/Yd) has
over time. This is due to capital destruction during the world wars
the world wars, from 1970-2010,
private beta (W/Y) has been increasing
, and this can reflect business cycle variations. For instance, of the capital stock is the same, but prices are increasing due to bubbles, we get
betas. This gives some concerns about problems/noise.
Private wealth is increasing, but government wealth is constant/falling.
This can reflect high levels of govt debt.
Relatively flat net foreign wealth
, although increases over the years in some countries (e.g. China).
Despite small net foreign position, there are
large gross foreign positions
which have important political consequences (e.g. European debt crisis).
Net foreign asset positions are nearly 0
because of the end of colonialism. Now, foreign assets and liabilities are nearly equal and thus cancel each other out.
Some countries are rapidly building huge foreign imbalances (e.g. Germany, Japan, Gulf countries)
Foreign asset positions are large affected by fictiotious financial flows due to
. Tax havens fictitiously distort allocation of global real financial flows.
Example: Irish capital account. Irish GDP grew by 20% a year simply because American corporations were relocating to Ireland for tax purposes.
Income = Labour Income + Capital Income
Alpha = Yk/Y = share of capital in national income (~25-30%)
(1 - alpha) = Yl/Y = share of labour in national income (~70-75%)
Income and Wealth
r = average rate of return to wealth = Yk/K
Alpha = r*Beta
r caries a lot across assets and individuals (e.g. different r for housing rental return, stock market returm, bank deposits)
On average, r = 4-5%
Because K income is very unequally distributed (more so than L income), increasing alpha can have big consequences for interpersonal inequality
share of capital in income
, or the
relative importance of capital vs labour income
. If alpha, i.e. capital share increases,
more income is coming in from capital rather than labour
If most capital is owned by a small group of people (which it is), then we have a lot of inequality
In the 1920s, Keynes saw stable factor shares which became a "stylised fact". However, we see that capital share is
High in late 19th century and early 20th century
Declined from 2930s to mid 2970s
Rising globally since mid 1970s, though still lower than a century ago
This led PIketty to talk about the possible
rise of aristocracy
Represents a world with
constant factor shares
With perfect competition, wage rate w = marginal product of labour, rate of return r = marginal product of capital
Capital income Yk = rK = alpha*Y
Labour income Yl = wL = (1-alpha)*Y
Capital and labour shares are
by technology, and do not depend on quantities of capital and labour
Under CD function, elasticity of substitution between K and L = 1.
If r increases by 1%, K decreases by 1% and L increases by 1%.
-Thus, overall factor shares end up becoming constant.
changing factor shares,
Elasticity of substitution between K and L should be
less than 1
With large changes in volume of capital, beta, this will be enough to explain large changes in alpha
Rate of return on private wealth, r, is constant
Meanwhile, beta is increasing
As alpha = r*beta, alpha is increasing
Factor shares are
constant: capital share is rising, labour share is falling
Stock of capital (beta) is growing, rates of return are flat
If capital and labour are relatively substitutable,
a rise in beta will trigger a rise in alpha and little change in r
market power for capital may be rising
(people have more monopoly power, can extract more rent, etc)
Since capital income is unequally distributed, increased alpha will have important consequences for interpersonal inequality
Yl is always less concentrated than Yk
Top 10% share is 20-30% for Yl vs 50-90% for Yk
Bottom 50% share is 20-30% for Yl vs 0-10% for Yk
Gini coefficient: 0.2-0.4 for labour income, 0.6-0.8 for capital
Trends in US
from 1920s vs 2000s,
There was much higher growth in overall top income shares vs growth in Yl shares
In other words, in 1920s, contribution of capital was greater and more important
Now, top 1%'s incomes are driven by executive compensation, which lacks clarity on whether it's capital income or otherwise
Most change in top 10% is
driven by top 1%.
This is shocking; a lot of initial explanations behind income inequality would make more sense if the whole top decile changed as well. The fact that most of the change came from top 1% meant that there are some other explanations for income inequality
Inequality of Yl has grown a lot
Rise in Yl inequality explains a high fraction of increase in total income inequality
Trends in Europe/Japan
Inequality of Yl is quite flat in the long run
Decline in total income inequality over the 20th century comes mostly from the reduction of capital inequality
There were very large declines in income not matched by wage declines, which coincided with the period of WW2. This pointed at
After the war, there could be some legislative changes that led to a decrease in capital inequality, which we see in a
between wage and income.
There was also a fall in rentiers
Education and Technology
Assume technical change i skill-biased (i.e. high skills are increasingly useful over time, so demand for high-skilled labour rises over time)
If supply of high-skilled labour is fixed, relative wage of high-skilled labour (skill premium) will rise over time
Increased education can increase supply of skilled labour
There is a race between education (skill supply) and technology (skill demand)
Policy implication: right way to reduce wager inequality in the long run is
investment in higher education
Starting in 1980s-90s, growth rate of skills has been reduced, leading to rising wage inequality.
Goldin & Katz (2010)
Why did income inequality increased more in the US than elsewhere?
Why is increase in inequality concentrated at the top?
Middle of the income distribution sees relatively little growth compared to the top and bottom of income distribution
Yet, how do we explain the huge increase in the concentrated 1%?
Long decline in real value of US minimum wage (this can explain the middle of the income distribution, but not the top of the income distribution)
Secularly declining membership and bargaining power of labour unions
Pay norms, and board control
Tax and transfer system (there has been a substantial drop in top marginal income tax rates, leading to increasing rent seeking)