Did you know that equity and equality aren’t the same? Equality is about everyone being equal, while equity is all about fairness. In this explanation, we will look at how we can distribute income in the economy in a more fair way. Interested? Then dive in!
Understanding income and inequality
Before we consider what the equitable distribution of income is and what it looks like, let's briefly recap inequality and income in economics.
Inequality in economics can be measured in two different ways: income inequality and wealth inequality.
Income is a flow of earnings received at a certain rate in a given period, such as a salary or rental earnings.
In this article, we will stick to briefly covering income and income inequality. If you want to learn more about wealth, income and wealth inequality in more detail, check out our Distribution of Income and Distribution of Wealth articles.
Income inequality is the degree to which income is distributed unequally throughout a population.
Economists measure the distribution of income and income inequality in a country and globally through a variety of methods and ratios. The most common measures of income inequality are the Lorenz Curve and the Gini Coefficient.
Equitable distribution of income in economics
Income is distributed differently across countries. In some countries, like Norway, income is distributed quite equally. In others, income is very unequally distributed and that causes many economic and social problems like social unrest, poverty, etc.
Equitable distribution of income: Example
Figure 1 below shows how gross disposable household income (GDHI) per head is distributed in the UK, constituent countries and regions in 2019.
Figure 1. GDHI per head of the UK, constituent countries and regions, StudySmarter Originals. Source: ONS
As you can see, income in the UK and its constituent countries is distributed quite unequally. London has the highest GDHI per head at £30,256. The North of the UK, on the other side, has the lowest GDHI per head at £17,096, nearly half London's GDHI. 1
Why is income distributed unequally?
As you saw in Figure 1, income tends to congregate in a particular part of a country or within a particular group of people. Why is that?
There are many reasons why income is distributed unequally across a nation and around the world. Some of these reasons are:
- Unemployment. Unemployment benefits are very low in the UK. The most common unemployment benefit, the Jobseekers allowance (JSA) is around £60 a week.2 This is significantly lower than the average wage of £576 a week.3 Individuals who receive JSA and other forms of benefits, will have lower incomes compared to the average UK population.
- Age. Age is another reason that explains income inequality. Pensioners, especially those who rely on state pensions, tend to have lower incomes that are well below the average wage.
- Underemployment. Workers on zero-hour contracts have no guarantee of the number of hours they have to work in the week. This makes it difficult to know what their weekly wage is, so they might find themselves receiving a wage well below the average weekly wage.
- Skill. Workers in a higher-skilled labour market tend to earn a higher wage, one that is well above the equilibrium wage. This is because firms are willing to pay higher wages for their skills. Workers in lower-skilled jobs will earn a lower wage because of the competitiveness in the labour market. This income gap adds to income inequality.
How can income be distributed equitably?
Income in many countries, including the UK, tends to be distributed unequally. More equitable distribution of income would mean that income is distributed in a fair way. There are many micro and macroeconomic policies a government can implement to tackle income inequality and distribute it more equitably.
Some of these policies include:
- Progressive taxation. Progressive taxes reduce the tax burden on those with lower incomes and allows individuals to have more disposable income. Taxing the rich more allows the government to redistribute income in a more equitable manner, thus reducing income inequality.
- Investment in the welfare system. Neglecting the welfare systems often results in higher income inequality and poverty rates. When governments invest well in their country's welfare systems, they significantly help the poorest in society.
- Investment in education and healthcare. Investing in these two services allows for a more skilled and healthier workforce that earns higher wages. This reduces the gap between rich and poor.
We have considered only two policies. If you want to learn more about this topic, check out our Government policies on poverty and wealth explanation.
Countries with a more equitable distribution of income
The countries with the lowest rates of income inequality in the world are Denmark, Sweden, Iceland, Norway, and Finland - the Nordic countries.
These Nordic countries have a mixed economy: they use a combination of both capitalism and socialism.
Figure 2 compares their Gini Coefficients. We can see that income is distributed quite equally in these Nordic countries compared to other Western countries, like the US and UK.
Figure 2. Gini coefficient in six countries, StudySmarter Originals. Source: OCED, data.oced.org
A Gini coefficient of 1 represents complete inequality, while 0 represents complete equality.
As we can see, all Nordic countries have a coefficient below 0.3, which indicates low levels of income inequality.
Benefits of an equitable distribution of income
There are many benefits to an equitable distribution of income. We can see some of these benefits in the Nordic countries too. Some benefits are:
- Reduced social problems. When incomes are distributed in an equitable way, there is less social friction. Thus governments can enjoy a level of social peace and stability.
- Standard of living. The equitable distribution of income allows for all citizens to enjoy high standards of living.
- Economic growth. Poorer individuals have a higher marginal propensity to consume (MPC) because they have more essential goods and services that they need to buy compared to the rich. A more equal distribution of income allows these individuals to consume more and thus this spurs economic growth.
Drawbacks to an equitable distribution of income
Equitable distribution of income is a good thing. But it can have some economic drawbacks. Some of these are:
- Fewer incentives. Inequality provides an incentive for individuals to take risks and start a business. It also incentivises people to work and earn a higher income. If income is distributed in an equal way, it could lower some of these incentives.
- Loss of the trickle-down effect. This theory in economics is used to describe the belief that higher-income earners benefit everyone in society. If income was distributed equally, then the wider society wouldn’t experience the benefits that have been ‘trickled down’.
A millionaire sets up a business that further increases their income and wealth. But this business creates jobs and incomes for many other people. This does widen the gap between rich and poor, but one could argue that the poor are better off than without the millionaire.
The trickle-down theory
We can explain how some economists believe the trickle-down effect works in three stages:
- The effect starts off with a wealthy individual gaining more income. This could come in the form of higher incomes or a high return on investment.
- This individual then is assumed to have two options: invest, which creates more jobs and opportunities for others in the economy, or spend, which increases the level of consumption and demand in the economy.
- If the individual chooses to invest, this allows for the poorer in society to benefit from job creation and opportunities which allow them to receive higher incomes. When the wealthy individual and their workers pay taxes, the tax revenue the government receives can be further redistributed in the economy to help the poorest and allow for a more fair society. If the individual chooses to spend, the increase in spending can result in a positive multiplier effect which will benefit businesses and the national economy.
The trickle-down effect does have its fair share of criticism because despite the theory it doesn't seem to work in real life. Some argue that the rich have a high marginal propensity to save (MPS). Their savings are a withdrawal from the circular flow of income and thus don’t benefit the economy.
The rich are also more likely to avoid taxes, so the government will receive less in tax revenue to redistribute to poor individuals. Essentially, the rich get richer and the poor get poorer.
Equitable distributions of income - Key takeaways
- Equitable distribution of income means that income is distributed in a way that ensures fairness and allows everyone to have the same opportunities.
- Income tends to congregate in a particular part of a country or within certain groups of people.
- Some reasons why income is distributed unequally are unemployment, age, underemployment, and lack of skills.
- Governments can distribute income more equally by making taxes more progressive, investing in welfare systems, investing in education and healthcare.
- In the Nordic countries, income is distributed more equitably than in other Western countries.
- The benefits of the equitable distribution of income are: reduced social problems, higher standards of living, and economic growth.
- The drawbacks to the equitable distribution of income are: fewer incentives and the loss of the trickle-down effect.
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