The Economy: 10. Inequality

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Welcome to Understand the Economy, the podcast that takes you back to basics to explain how economics affects our everyday lives.

In this episode, Inequality. Why are the rich rich and the poor poor and was it always this way? We'll be talking about the difference between individual people.

There are many ways of measuring that difference. If you look at one measure, the picture might look good.
If you look at another, it might paint a very different picture entirely.

One person might earn lots more money than you, and you might have a bigger pile of savings in the bank.

And to talk me through all this is Xiawei Shu, Senior Research Economist at the Institute for Fiscal Studies. So let's start by just exploring this question of why does it matter?

What impact does inequality have on a society?

Well, I think it matters because people care about inequality. So consistently in surveys, people express concern with the level of inequality in society, and many express a wish to reduce inequality.

There are lots of reasons people care about inequality. So people might think inequality is unfair in and of itself.

They might think the inequality we see today is the result of some sort of unfair process, or they might worry about the consequences of inequality.

So we know in unequal societies they tend to have lower social mobility, political power tends to be more concentrated, which in turn could threaten the democratic process.

When economists talk about inequality, what is the central concept that they have in mind?

When economists talk about inequality, they mostly refer to inequalities in income or in wealth.

So income is the flow of money you get from your salary, from benefits, whereas wealth refers to the money you have in a savings account or the value of your home.

So let's just paint a picture together of what's been happening to inequality in the UK since the middle of the 20th century.

And I know that After the war, you had this creation of sort of solid middle-class jobs like accounting clerks, and that helped to bring down income inequality.

And then in 1979 the Iron Lady herself is elected. What happens to income inequality in the 1980s? In the 1980s inequality rose sharply.
Now that's due to a number of factors.

So we saw de-industrialization which increased unemployment and dramatically reduced incomes in some parts of the country.

There was a process of deregulation which then increased incomes, in particular the financial sector. So we saw this big rise in earnings inequality.

So coal mines and steel mills are being closed and the City of London is booming. I'm exaggerating but that's broadly it.
Broadly. But on top of that there's some other things as well.

So cuts to top taxes meant that high earners got to keep more of what they earned which further increased inequality in disposable incomes.

And we also saw a rise in two earner couples and with high earning men increasingly partnering with high-earning women, which again increased inequality in household incomes.

So that's the story through to what the mid-1990s, then what? So the period from the 1990s is quite interesting in that you see earnings inequality continuing to rise.

That probably reflects a lot of structural factors.

So for example, advances in computing and the internet, making skilled workers more productive and therefore pushing up wages at the top, whilst lots of middle-income jobs, so manufacturing or admin jobs for example, disappearing because they're being replaced by machines or being replaced by software.

However, the tax and benefit policies during this period, and in particular, the expansion of tax credits by the Labour government kept this rise in earnings inequalities from translating into a rise in disposable household income inequalities.

Right. So people are getting paid more and more at the top end, but because new labour introduces countervailing policies, you don't actually see an increase in inequality.
Exactly.

So to recap the story, after the Second World War, the 1950s, you've got falling income inequality because you've got lots of good middle-income jobs.

In the 1960s and the 1970s, everyone is getting rich together. In the 1980s, the coal mines are closing, the steel mills are closing, the city of London is booming.

And so you've got rising inequality and the Conservative tax policies at the time are exaggerating that. Then in the late 1990s, you've got new labour.

And although some of those forces are still at work increasing earnings inequality, they're using the tax system to fight back against that and to try to compress that difference in incomes.

And overall, income inequality doesn't really change very much. So that takes us through to the financial crisis.
Finish it off.

What has happened to income inequality in the UK over the last 10, 15 years? So the short answer is not much has happened to income inequality since the financial crisis.

Over this period, we've seen very little income growth anywhere in the distribution, so inequality has been broadly stable. Because

basically, we're all suffering together. No one is getting richer.
Exactly.

When economists are thinking about inequality, what's their favourite way of measuring it?

Well, perhaps the most common measure of inequality is the Gini coefficient. It's a number that ranges from zero to one, where zero denotes an economy that's perfectly equal.

So it's an economy where everyone has exactly the same amount of income.

Whereas one would be an economy that's totally unequal, in which one person has all the income and no one else has any income at all.

So since the 1990s, the Gini coefficient has remained essentially flat, but we do see things going on across the income distribution.

It could be more intuitive to just ask how much more money do the rich have than the poor. Another common measure is the 90 to 10 ratio.

So that compares incomes of someone who's just in the top 10% of incomes with the incomes of someone who's just in the bottom 10% of incomes.

Right, so comparing the income of someone who's well off but not crazy rich with someone who's struggling. What has that been doing in the UK in recent years?

So like all other measures of inequality, that measure rose in the 1980s. But actually since the 1990s, that measure has been coming down.

Right, so the fairly poor have been catching up with the fairly rich. I think that'll surprise a lot of people because the narrative is that inequality is increasing.
It's almost relentless.

So are people just wrong about that or are they looking at some other way of measuring inequality or some other concept that's related to inequality that is still getting worse?

So over this period we've seen a rise in wealth inequalities. So if we're looking at the savings, the assets that people have, wealth inequality has been increasing.
Right.

So what's happening is the salary that you've got used to be able to get you a down payment on a house and now it can't. So it's quite simple really.

If you already have a house then you're doing very well from this boom in house prices.

If you don't have a house then because of stagnating incomes it's harder to get on the housing ladder and it's harder to accumulate wealth.

And that actually has implications on social mobility as well because it's harder for young people to accumulate wealth which means that they're more reliant on inheriting wealth from their parents.

What that means is that people's personal wealth or their living standards are now more strongly tied to their parents' wealth. Right.

So, in the old days, if you wanted to make it, you hustled, you got a good job. Nowadays, if you want to make it, you just need a large inheritance from mum and dad.
Exactly.

And really, my generation, the generation born in the 80s and 90s, are the first in recent cohorts not to do better than their parents at our age. So, tell us about the 1%.

The 1% has become almost, a political rallying cry, it's a bit of a meme.

So, that's because the incomes of the very top has carried on increasing, so they've carried on pulling away from the rest of the population. So, in the UK, how much money do you need to be in the 1%?

Do you need to be a multi-millionaire? If you think about the top 1% in terms of earnings, for example, the amount of money you receive through labour income,

you need to have around £120,000 a year to make the top 1%.

Right. Hold that thought because it's time for a history lesson with resident expert Dr.
Victoria Bateman from Cambridge University.

And she is going to tell us a story of levelling up in a most unpleasant fashion.

In the middle of the 14th century, the Black Death killed between a third and a half of the British population and it had a major effect on inequality.

It created to begin with a real shortage of workers and that meant that wages literally doubled overnight. So if you survived the Black Death you were literally in the money.

There was such a shortage of male workers now that landowners turned to women to fill the jobs of those that had sadly passed away during the Black Death.

And so there were new opportunities for women now in this economy. And with it, gender inequality also starts to fall.

Wages were increasing so fast that the king, taking the side of employers, including the landowners, who were desperately trying to find workers to take the crops out of their fields at harvest time, the king brought in a ruling that workers were not allowed to ask for wages any higher than their pre-Black Death level.

Disgruntlement followed. Workers were literally up in arms.
They took to their pitchforks, and by the 1380s, there was a literal peasants' revolt breaking out right across the country.

So, despite various attempts by the king to halt the direction of travel, there was little that the elite could do to prevent what was a rebalancing of power between the workers and landowners.

Wages ended up permanently higher for centuries to come. In fact, they didn't reach even higher levels until the 19th century.

Dr. Victoria Bateman.

Shaw Weishu, if we step away from the UK for a moment and look globally, there's 8 billion people on this planet, do we get a different picture of what is happening to income inequality over time?

If you look across the world as a whole, actually inequality has been decreasing and that's driven by countries like India and China catching up with richer countries.

That's interesting. I think for a lot of people they think of inequality globally as something that relentlessly increases.

But then when you look within the whole distribution of income, China's a big country, India's a big country, Indonesia, Brazil, and a lot of people there and they used to be very, very poor.

And now that the incomes in those countries are growing much faster than the incomes in Germany or in Japan.

Well, that's a slightly more cheerful picture then, falling inequality across the world. Let's zoom back in then.
Let's talk about the individuals.

What determines whether a child born in a particular country is likely to do well or do badly or to experience a lot of inequality? Well, there's lots of things that determine the level of inequality.

And if you just think about how much people get paid, for example, raw talent is going to be a factor, but the education you acquire, the skills you acquire, the types of jobs you have access to will all determine the wages you can command.

So what can governments do about that if they want to push back against that? I think the most immediate lever lever that governments have at their disposal is the tax and benefit system.

And beyond that, governments can also try to address the factors that give rise to inequality in earnings in the first place.

So for example, lots of governments are using the minimum wage to push up wages at the bottom.

There's also policies to reduce inequalities in education or inequality in access to opportunities that can try to equalise the wages that people can command in the labour market.

So better schools, better apprenticeships, better funding for people from poorer households to go to universities, all of this sort of thing. Shall we shoot? Thank you very much.

And next time you hear somebody complaining that inequality is getting worse, you'll know to ask them which measure they're using and you'll be able to call them out.

That was the last episode of the present series. And I hope you do now understand the economy.

Remember, we will always be here online. You can listen again and again to the podcast whenever something confusing or terrible happens in financial or economic news.

Download all the episodes and you can take us with you wherever you go. Understand the Economy was presented by me, Tim Harford, and produced by Phoebe Keene.

The researchers were Kirsten Knight and Drew Hindman, and the series editor was Claire Fordham.

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