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What Is Income Inequality?
Income inequality (or income disparity) is the degree to which total income is distributed unevenly throughout a population.
In many cases of economic inequality, the greatest amount of wealth flows disproportionately towards a small number of already financially well-off individuals. People with the top income are often called the “one percent” in reference to the fact that they make up a minor fraction of the population but harbor a large percentage of the country’s wealth. Learn more about income inequality in our complete guide here.
What Is the Difference Between Income Inequality and Wealth Inequality?
- Income represents how much you earn in a given year both from work and from the yearly return on your investments.
- Wealth is your total net worth.
The income inequality that existed prior to World War II was largely caused by wealth inequality. Some families had large fortunes which produced large returns every year.
A Brief History of Inequality in America
In his analysis of income inequality in the United States, Paul Krugman focuses on three eras: the period between World War I and the end of World War II; the post-WWII period up through the late 1970s; and the late 1970s through the present.
Before World War II, income inequality in the United States was roughly equivalent to where it is today. During and after World War II, income inequality fell rapidly and drastically. It stayed at this low level until about the 1970s, when inequality began rising again.
The income inequality that we have today mostly comes from wide differences in salaries.
- At the very extreme are C-suite executives who have seen their average compensation grow nearly tenfold between 1960 and 2010.
- College-educated workers, in general, have fared far better than average, seeing their wages nearly double over that same period.
- By comparison, workers with less than a high school diploma have seen no growth in real wages over that same period.
That income inequality from salary differences is beginning to lead to income inequality from wealth differences. Few high-income people spend all of what they make in a year. Over time, that built up savings produces vast wealth that will eventually pass onto their children.
Most economic crises tend to drive down income inequality. This happens because stock market collapses not only bring down the wealth of the richest Americans but because CEOs of public corporations and financial executives are often paid based on the performance of the market. The last crisis, however, was concentrated in the housing market. The most valuable asset that most middle-class people own is their home. Therefore, the crisis hit the middle class much harder than previous crises. It has also meant that many middle-class families have not yet recovered from their loss of wealth.
Why Is Inequality Rising in America?
Economists are still working to figure out exactly why inequality rose over the last half century. Ascertaining what percentage of inequality was caused by each particular mechanism is an ongoing challenge.
Changes in technology and trade are almost certainly part of the story. Recent technological advances have tended to favor educated workers over less educated workers, driving the wages of the former up while holding stagnant or even driving down the wages of the latter.
International trade undoubtedly also plays a role. Like technology, international trade has tended to favor highly educated workers at the expense of workers with lower educations. When economists measure the effect of these two causes, however, the size is not large enough to explain all of the inequality that has occurred. The timing is also not perfect.
Some economists, including Paul Krugman, point to factors like culture and politics to help explain the rise in inequality. The decline in inequality happened during the presidency of Franklin Roosevelt. The equality of mid-century America was created by government policies of that era. The roll back in some of those policies and the failure to enact new ones has led to the rise in inequality we see today.
The Impact of Rising Inequality
There are several reasons why the rise in inequality is particularly troubling to Paul. First, in purely mathematical terms, if more national income goes to those at the top, that implies that less may be going to those at the bottom. Second, there has been an enormous rise in political polarization. This trend occurred over roughly the same time period as the rise in inequality and followed the same pattern.
Rising inequality tends to have a disproportionately strong impact on people who are not white. One theory for why America tends to have less economic redistribution to reduce inequality than Europe is that many white voters do not see these policies as helping people who are like them. Instead, they see them as taking away from their community and giving to another community.
Paul Krugman’s Advice for Lowering Inequality
Paul is an advocate for lower inequality. If you share his point of view, he offers several insights about advocating for equality. First, understand that the market itself can’t create more equitable outcomes. That will require government intervention. Second, policies like universal health care and nutrition assistance can do an enormous amount to reduce inequality by improving the long term prospects of poor children. Third, it is also important to focus on policies that prevent wages from getting so unequal in the first place.
Learn more about economics and society in Paul Krugman’s MasterClass.