The difference between equality and equity

Equality

Equality in economics is the way the economic outcomes for different people in society are the same. We often consider equality in the way the income generated by the economic activity of a country is shared out amongst the country’s population. We know from the circular flow of income model that the GDP of a country produces an income that is distributed to different households of that country. But the model does not tell us how the income is shared out.

Many economists, leaders in industry and politicians take the normative view that a more equal distribution of income in society is a good thing.  The reality of the world economy is the widening of income inequality. All nations experience income inequality to a greater or lesser extent, where income is distributed unevenly amongst the population with a minority of high-income households accounting for a relatively high proportion of the income or wealth generated by a country.

Equity

Equity in Economics is about fairness in terms of everyone in society having an equal opportunity to achieve an economic outcome.  This is another normative economic concept and takes the view that all individuals should have the opportunity to achieve a certain economic outcome. This might mean an individual has the opportunity to get a job that allows them to achieve a certain quality of life. Inequity is unfairness in society that prevents individuals from achieving a particular economic outcome. This might mean a group in society cannot access certain jobs because of their ethnicity, gender or socioeconomic group.  

Inequality in the distribution of income and wealth

In all countries, there is an unequal distribution of income and wealth. Although they are quite similar principles there is a distinct difference in terms of:

• An unequal distribution of income means that a greater proportion of the income of the economy goes to the richest households than the rest of the population.
• An unequal distribution of wealth means that a greater proportion of the value of assets in a country is owned by the richest households compared to the rest of the population.

Income is the money a person earns, and wealth is the value of assets a person owns. Examples of the assets people own include houses, shares, bonds and money in the bank.

Measuring economic inequality

There are two indicators economists use to measure income inequality in a country.

The Lorenz curve

The Lorenz curve is a graphical illustration of the income distribution of a country.

The Lorenz curve divides the population into quintiles and then shows the cumulative percentage of income accounted for by each quintile. The table sets out the income data for Country A and Country B. Each country’s households are set out in ascending order from the poorest quintile to the richest quintile.

The Lorenz curve graphs the distribution of income by plotting each quintile with the cumulative percentage income. These Lorenz curves for Country A and B are shown in diagram 3.28. From the data in the table, Country B has greater income inequality, and this is shown by the larger deviation its Lorenz curve has compared to Country A from the line of perfectly equal income distribution.

Gini coefficient

The Gini coefficient can be used to measure the size of a country’s income inequality.  It can be calculated by using the Lorenz curve. In diagram 3.29 the area above the Lorenz curve and below the line of perfect income equality is calculated as a proportion of the total area below the line of perfect income equality. In diagram 3.29 this is calculated by the equation:

 area A / area A + area B = Gini coefficient

This Gini coefficient value can either be considered as a percentage or a value between 0 and 1. If the answer is 0 there is perfect equality and the closer the Gini coefficient is to 1 the more uneven the income distribution of a country. The table opposite shows the 10 countries in the world with the highest Gini coefficient values. 

Meaning of poverty

The United Nations defines poverty as the ‘denial of choices and opportunities and a violation of human dignity. A household in poverty lacks the basic capacity to participate effectively in society’. This definition of poverty can be viewed as households in a country lacking the income needed to achieve a basic standard of living.

Poverty can be considered in two ways:

Absolute poverty

Absolute poverty exists when household income is below the level needed to meet a person’s basic needs of life including housing, food, safe drinking water, education and healthcare, etc. It is difficult to state an income level where someone experiences absolute poverty, but an income of less than $700 a year or $2 a day is given by the UN, although this will vary from country to country because of different price levels.

Relative poverty

Relative poverty is where a household’s income is significantly below a country’s average income.  Many countries define relative poverty as a person that earns less than 50 per cent of the average household income.  Households in this position may not be in absolute poverty, but they often do not have enough income to afford anything more than the basic goods and services needed to sustain their lives.

Measuring poverty

Countries can measure poverty using the following approaches:

Poverty lines

A poverty line is the minimum level of income needed for a basic standard of living in a country. The World Bank international poverty line is set at an income of $1.90 per day. Different nations set their own poverty lines based on relative poverty. For example, a country might set a relative poverty line at 50 per cent of average incomes and then the percentage of people who fall below this level is used to measure the level of relative poverty.

Multidimensional Poverty Index (MPI)

The Multidimensional Poverty Index (MPI) uses a number of weighted criteria to measure poverty in a country based on a survey of households.  This data is aggregated to give a national measure of poverty. The lower the MPI of a country the greater the level of poverty.

The criteria used to measure the MPI are set out in the table. These criteria are used to measure poverty by applying a set minimum level for each indicator. For example, the standard of living poverty indicator, cooking fuel, would measure poverty based on the number of households cooking with dung, wood, charcoal or coal and the nutrition indicator would be based on the number of people in a household who are undernourished.

Problems of measuring poverty

The following factors make it difficult to measure the level of poverty in a country:

• Like a lot of economic data, measuring poverty is based on a survey which means using a sample of households to represent the whole population. All samples come with a sampling error, so there is inevitably some inaccuracy in the data.
• The variety of different methods used to define poverty such as relative and absolute poverty make it difficult to measure. Using the phrase ‘to meet a person’s basic needs’ is open to a variety of interpretations. We know access to basic food and shelter is a basic need but is owning a mobile phone?
• Some of the most powerful human feelings associated with poverty are almost impossible to measure. The anxiety of not knowing where your next meal is going to come from is real, but measuring that anxiety is extremely difficult.
• Governments draw lines of absolute and relative poverty but they are very difficult to apply in reality. A certain level of income per day might be a very low but sustainable income in some countries, but completely inadequate to live on in others.
• Poverty data is open to manipulation by governments who want to show a falling level of poverty in their country. The income value of absolute poverty should rise with inflation, but it is in the interests of governments not to do this because it might make the numbers in absolute poverty increase.
• Attempts to use a weighted index to measure poverty, such as the MPI, are effective in representing the broad-based nature of poverty, but increasing the number of indicators and then weighting them is always going to create difficulties. For example, how do you decide on the weighting of asset ownership or sanitation in measuring poverty?

Causes of inequality and poverty

It is possible to combine the causes of inequality and poverty in society because the cause of both is so closely related. For example, if one person is the owner of a highly valued property then they might earn plenty of income from renting the property. If another person owns no property then instead of earning rent they will pay rent and this would lead to a high level of inequality between two people. The person who owns no property is also more likely to live in poverty.

Inequality of opportunity

Inequality of opportunity means people do not have the same access to a good quality of life in terms of income, education, employment and healthcare. Without these opportunities, people get stuck in low-paid work with little chance of progression, and this means they cannot access good healthcare and education. Lack of opportunity can come from a parental background, education, gender, ethnicity and social class. High-income households, for example, can pay for the best education for their children who will go on to the best universities, which in turn secures them highly-paid employment and they can then do the same for their own children.

Resource ownership

Low-income households own very little or no capital at all. This means their only source of income is from low paid work. High-income households on the other hand often own assets and are holders of wealth. This can be in the form of property or shares in companies that earns them a stream of income in the form of rent on property and dividend on shares. Wealthy individuals can use their surplus income to buy more assets which earns them even more income.

Human capital

High-income individuals tend to work in high-skilled jobs producing products for firms that can make those businesses high profits. Skilled workers in these situations are valued highly by the businesses that employ them and they are paid a high wage for the work they do. Low-income individuals are often in low-skilled jobs doing work that does not bring as much profit to the business that employs them, and they are paid a lower wage. Another important aspect of this is that highly skilled workers are scarcer in the labour market than the low skilled worker, which gives the highly skilled worker a stronger bargaining position when negotiating their wages.

Discrimination

Inequality can occur because of discrimination by employers. This can be based on ethnicity, gender, age and socioeconomic status. Women in most countries are paid significantly less than men partly because of discrimination. Inequality can also take place in education. Universities in some countries have been accused of not allowing access to students from ethnic minorities and low-income households.

Status and power

The Billionaire Murdoch family who own the influential Newscorp organisation

High-income individuals often reach position of political influence. This can be done by directly running for office and gaining political power. Donald Trump and Hilary Clinton both come from wealthy backgrounds and spent about $100 million each on their campaigns for the last Presidential election in 2016. It is much more difficult for low-income individuals to reach positions of power. Wealthy people can also influence the political process by lobbying and financing politicians to make decisions that favour them and their organisations.

Government policies

Government can make policy decisions that can widen income inequality. Reducing direct taxation will normally favour high-income households because they earn much more taxable income than poorer households. Cutting income tax tends not to benefit low-income households that much because they are probably paying very little income tax anyway. Governments that cut spending on public services such as education and healthcare will have more effect on the poor who rely on these services than richer households. Low-income households will also be adversely affected when governments use market-based supply-side policies such as reducing the lower of trade unions and removing regulations that protect employees.

Globalisation

Globalisation often involves greater competition in domestic markets from foreign competition as trade barriers are removed between countries. This increase in competition often favours producers in low-wage economies that outcompete producers in higher-wage countries. This often means producers who cannot compete either shut down or reduce wages in an attempt to compete. This process has the effect of driving down incomes in many countries, widening income inequalities and leading to poverty.

Impact of income and wealth inequality

Social stability

Countries with very uneven income distributions often suffer from high crime rates. It can be argued that wide income inequality creates a sense of unfairness in society and this can lead to an increase in crime and social unrest. Poor people may also be more likely to be pushed towards crime because it may be the only way to make a sustainable living. For example, poor people might sell recreational drugs in communities where there are few job opportunities.

Economic growth

A high level of income and wealth inequality can restrict economic growth in two ways:

Demand-side

Domestic aggregate demand does not grow as quickly when there is wide inequality and a significant proportion of the population is on relatively low incomes.  Low-income households tend to spend a high proportion of their income so if their income growth remains relatively low then this prevents aggregate demand from growing.

Supply-side

Where income and wealth inequality results in a high proportion of low-income households then this might slow the growth in aggregate supply. Low-income households may not be able to access the education, training and healthcare needed to support them as productive workers. If people in the labour force do not have the income needed for effective education and training, then they will not be as skilled and as productive as workers. People on low incomes may also lack the financial incentive to be as productive as if they were able to earn higher wages.

Standards of living

An uneven income distribution with a high proportion of low-income households can reduce the quality of life in a country. High levels of poverty amongst poorer households have a negative effect on their welfare in terms of their access to food, housing, health and education. There is also evidence that income inequality in society has a negative effect on mental health and personal happiness amongst poorer households.