- Income inequality
- Inequality at the global level
- Income inequality in the G7 countries and in Germany
- Is global economic growth reaching all sections of the population?
- Causes of rising income inequality
- Wealth inequality
- Equality of opportunity
Social inequality is a central subject in debates over economic and social policy. Along with inclusive growth, it has been on the G7 and G20 agenda for a number of years. The French government has chosen to make tackling inequality a priority of its G7 presidency this year.
The issue of social inequality encompasses various aspects. One of these is income inequality, which plays a major role in the public debate. The uneven distribution of wealth is another dimension of social inequality. Equality of opportunity also needs to be considered. After all, inequality is more likely to be accepted as “fair” if success or failure is the result of individual actions, not extraneous factors.
Inclusive growth has been on the G20’s agenda since 2017 and has been explicitly cited as an objective in G20 communiqués since 2016 (“strong, sustainable, balanced and inclusive growth”). The aim is to ensure that all people benefit from economic growth, with nobody left behind.
The World Bank’s “shared prosperity” measure is related to inclusive growth. It measures the extent to which economic growth actually reaches low-income sections of the population.
At least for advanced economies, there is relatively reliable data available on income inequality. However, numerous different methods and indicators are used to measure it. The Gini coefficient is the most widely used metric.
The Gini coefficient
The Gini coefficient measures the extent to which actual incomes deviate from a completely equal distribution. A Gini coefficient of zero means that all individuals have exactly the same income. A Gini coefficient of one means that all the income goes to a single individual. One problem with the Gini coefficient is that it is unable to capture the exact structure of inequality. For example, a rise in the Gini coefficient could mean that the incomes of the middle classes have declined compared with those of high-income groups, or it could mean that the poorest population groups are being left even further behind.
However, such distinctions are important when making political assessments.
While the Gini coefficient measures inequality across the entire population, other measures of inequality focus on the upper and lower end of the distribution. The intuitive 80/20 quintile ratio, which is calculated by institutions such as the Organisation for Economic Co-operation and Development (OECD) and Eurostat, compares the average income of a population’s richest 20% against the average income of its poorest 20%. The World Inequality Report (WIR), which is published by Thomas Piketty (among others), focuses on income trends in the upper range of the distribution by measuring the share of total national income that accrues to a nation’s top 1% of earners or the top 10% of earners. In contrast, the World Bank’s “shared prosperity” measure focuses on the lower end, looking at the rate at which the incomes of the population’s poorest 40% have grown.
Regardless of the inequality measure used, it is important when analysing income inequality to distinguish between market income (before redistribution through the tax and transfer system) and disposable income (after redistribution). Market incomes are more meaningful in analysing market processes, while disposable incomes are the most significant metric when it comes to assessing welfare. Unless explicitly stated otherwise, this article refers to disposable income trends.1
Inequality at the global level
Looking at the world population as a whole, most studies show that income inequality (measured using the Gini coefficient) has decreased over the past two decades. This is mainly due to successful efforts to fight poverty, especially in East Asia.
However, not all published research confirms this decline in global inequality. The WIR 2018, for example, paints a different picture. The main measure used in this report (income of the richest 1% of a population relative to that of the poorest 50%) does not confirm the idea that income inequality is declining at the global level. Even in countries that have been very successful in fighting poverty, such as China, the share of income earned by the top 1% of the population has increased substantially. Overall, therefore, the WIR does not support the conclusion that global income inequality has declined.
Income inequality in the G7 countries and in Germany
As Figure 1 illustrates, income inequality has increased over the past two decades in most of the world’s advanced economies. Notable exceptions are Norway, Finland and Iceland, where inequality as measured by the Gini coefficient has decreased.
Figure 2 shows the same results using the 80/20 quintile ratio instead of the Gini coefficient. According to both measures, the highest rise in inequality among the G7 countries was recorded in the US. Compared with the US, both the level and the rate of increase of income inequality are moderate in European countries.
There are clear differences in inequality trends between the US and Western Europe. These are especially stark when it comes to changes in the share of total income accruing to the richest 1% of the population relative to the share earned by the poorest 50%. As Figure 3 shows, this ratio has nearly reversed in the US, while the trend appears to be very moderate in Europe.
In Germany, too, income inequality is somewhat higher today than it was two decades ago. Following a certain increase after German reunification, disposable income inequality as measured by the Gini coefficient has remained steady in Germany since 2005. However, a recent study by the German Institute for Economic Research shows a slight but statistically significant narrowing in the income gap since 2010. With a Gini coefficient of around 0.29, Germany’s overall income inequality is relatively low by international standards, and just below the OECD average of 0.32. In Germany, the difference between market income and disposable income is very high compared with other countries, similar to that recorded for France. This indicates a comparatively high degree of redistribution, primarily via the tax and transfer system. In other words, despite a relatively unequal distribution of market incomes, disposable income inequality is comparatively low by international standards, as Figure 4 shows.
Is global economic growth reaching all sections of the population?
In East Asia and the Pacific region, but also in Latin America and the Caribbean, average income and consumption figures for the bottom 40% of earners increased at a relatively high rate between 2010 and 2015.
Especially in East Asia, improvements in educational outcomes and export-oriented growth in manufacturing have been drivers of growth, reflected in the incomes of the poorest 40% in particular. Often, income growth for the poorest 40% in this region exceeds the rate of growth for the population as a whole.
In most of the world’s advanced economies, however, lower incomes grew only slightly, stagnated or even declined between 2010 and 2015. It is significant that the incomes of the poorest 40% of the population declined at above-average rates in countries that experienced economic downturns. Examples include Spain, Greece, Cyprus, Portugal and Italy. For Germany, the World Bank recorded slight growth in average real incomes between 2010 and 2015, but the poorest 40% of the population suffered an average decline of 0.18% per year.
Causes of rising income inequality
One explanation for the rise in income inequality in some advanced economies over the past two decades is the falling labour share – in other words, the fact that factor income is shifting from labour to capital. This can be attributed in part to automation, but also to the migration of manufacturing industries to low-wage countries.
The labour share is the part of an economy’s national income that is generated by labour, as opposed to the share allocated to capital, which includes interest, dividends and rental income.
It is often argued that the transfer of jobs from the manufacturing sector to the services sector leads to declines in productivity and income. However, the International Monetary Fund (IMF) has found that the shift of jobs to the services sector is not necessarily associated with productivity losses. Rather, inequality has increased within individual sectors of the economy.
In a globalised economy, capital is far more mobile than labour. This is also reflected in factor income. The capital share has risen worldwide in recent decades, while the labour share has fallen.
This is relevant for the distribution of disposable income, as the distribution of capital income is less equal than that of labour income. Since 1970, the labour share has fallen significantly in almost all advanced economies. However, Figure 5 shows that this trend has varied greatly from country to country since 1970. The OECD does not have any data on the labour share prior to 1970.
Federal Statistical Office data shows that Germany’s labour share reached its peak at the beginning of the 1980s. With 1950 as the baseline, however, Germany’s labour share has not, in fact, declined at all: Figure 6 shows that the labour share is actually higher today than it was in 1950.
Another possible explanation for rising income inequality focuses on changes in market structures. If the market structure changes, this also affects the ability of market participants to take advantage of “economic rents”.
In welfare economics, the term “rent” refers to proceeds in excess of those that could be achieved in a competitive market process. Examples include monopoly rents – profits generated by a monopolistic company solely on the basis of its market position.
Such rents can form part of the incomes of both capital owners and workers. Scientific studies show that only 20% of the increase in inequality in the US since 1970 can be attributed to shifts from labour to capital income. The remainder is a result of unequal distribution within each factor of production and the emergence and exploitation of economic rents. Rents are influenced by the level of competition, the bargaining power of workers and network effects, among other things. The digital economy in particular is characterised by a “winner-takes-most” trend. Rapidly growing digital companies are able to amass huge competitive advantages, for example through access to large amounts of data or through reputational and network effects. Monopoly rents and the profits generated by market leaders are correspondingly high. It is true that these digital companies pay very high salaries, partly due to the high qualification bonuses common in this sector. However, even in “superstar” companies, the factor of production that benefits most from high profits is capital. The market power of individual companies and related macroeconomic effects are especially apparent in the US. In its 2018 country report on the United States, the IMF found that the increasing market power of individual companies can have important macroeconomic effects, including declines in investment and R&D spending as well as further downward pressure on the labour share of income.
Declining unionisation rates offer another explanation for rising inequality in advanced economies. Trade unions strengthen the bargaining power of low-income earners and, in the context described above, increase their ability to benefit from rents that would otherwise be reaped by higher-income groups. There are a number of empirical studies underscoring the key role of employee representation. For example, analyses by IMF economists suggest that, on average, it is the top 10% of earners who benefit most from a decline in union density. Similarly, the World Bank argues that social inequality in a society decreases whenever union density and union membership rise, and increases when they fall. There has been a decline in the number of unionised workers in many advanced economies. Collective bargaining coverage is also decreasing. Figure 7 charts this decline for Germany, the US, the UK and the OECD average.
Based on the available data, wealth is far more difficult to assess than incomes. At the global level, there is hardly any reliable data on either high wealth or low wealth.
Credit Suisse’s Global Wealth Report is one of the most comprehensive sources of data on global wealth distribution, but its figures too need to be interpreted with caution. High wealth is typically much more dependent on the economic cycle than low wealth – wealth inequality tends to decline during recessions and rise during economic upswings. Alongside the stock market and capital market, exchange rate movements can also strongly distort results. Credit Suisse’s latest report describes a sharp rise in the number of millionaires and ultra-high net worth individuals with assets in excess of $50m since the global financial crisis, particularly in the US and Europe, and a steady rise in median wealth in most regions (with the exception of Africa). Measured in terms of the share of total wealth held by the richest 1% of the population, wealth inequality has risen since the global financial crisis, having fallen in the years prior to the crisis. According to Credit Suisse, this figure declined from 47% in 2000 to 42% in 2008, started rising again in 2008, and has slightly exceeded the 2000 level since 2016.
In Germany, wealth is distributed much less evenly than disposable income. This was confirmed by the Deutsche Bundesbank in its April 2019 monthly report. The report presents the results of a panel survey conducted every three years based on a sample of 5,000 households. The Bundesbank concludes that the distribution of wealth in Germany is comparatively unequal. However, in terms of changes in wealth inequality over time, there have been no clear trends in recent years. The report puts Germany’s Gini coefficient for net wealth at 0.74. This figure also corresponds to the Gini coefficient calculated using the Federal Statistical Office’s income and consumption sample for 2013. According to the report, wealth inequality in Germany is also reflected in the share of total wealth held by the 10% of the population with the highest net wealth, a figure that the Bundesbank puts at about 55%. However, this estimate is probably understated, as such surveys typically do not include very large assets. The OECD’s figures are similar. They also indicate that wealth in Germany is concentrated in the hands of fewer people than in many other countries. According to OECD data for 2017, 10% of Germans hold about 60% of total net household wealth. The average for all OECD countries is 52%. However, claims on state pension insurance systems are not taken into account in any of the country comparisons cited above, which understates assets in Germany.
Equality of opportunity
Not all inequality is automatically perceived as unfair. In fact, an economy based on competition could not exist without a certain degree of inequality. Educational attainment, hard work and a willingness to take risks need to carry financial rewards. If they do not, there is something wrong with the economy’s incentive system. However, fairness demands that all people should start off with the same chances and compete on a level playing field. Accordingly, the subject of equal opportunities plays a key role in the normative debate surrounding distribution. Differences in income or wealth that are the result of individual achievements are much easier to reconcile with society’s sense of fairness than differences determined by external factors that are beyond each individual’s control. Examples of such external circumstances include family socio-economic class, gender and place of birth. Analyses of social mobility, the openness of the education system and the gender pay gap look at the concept of equal opportunities empirically.
In a comprehensive study on social mobility, the World Bank paints a sobering picture of the global situation. According to this study, social mobility has stalled in the last 30 years, and advancement opportunities for the most vulnerable population groups in developing economies have declined.
In terms of educational mobility, the OECD still presents a relatively unfavourable picture for Germany compared with other countries. As illustrated in Figure 8, the OECD data indicates that educational attainment in Germany is more strongly linked to parental education than it is elsewhere. Nearly 60% of the population experience intergenerational stagnation in education, and only slightly more than 20% of all people achieve a higher level of education than their parents.
The 2015 PISA study examined the extent to which students’ socio-economic backgrounds determine their academic performance in science subjects. As shown in Figure 9, France and Germany are the G7 countries in which the academic performance of 15-year-olds is most strongly linked to their socio-economic background.
These figures too suggest that there is still considerable untapped potential in Germany’s education system, and that there is a relatively high level of inequality of opportunity among students.
Inequality of opportunity and unequal treatment can also manifest themselves in unequal pay between men and women, with women typically earning less than men for the same work. Significant differences in income between men and women persist in G7 countries. However, as Figure 10 illustrates, the gap is narrowing in all G7 countries.
Figure 10 shows the unadjusted gender wage gap. In other words, the figure does not take account of the structural differences in employment between men and women. The Federal Statistical Office calculates an adjusted gender pay gap for Germany every three years, taking into account the effects of career choice, educational level and professional experience, and also the lower proportion of women in management positions, among other things. Even after correcting for these factors, an unexplained pay gap of 6% remained for 2014. Many countries have tackled the issue of gender-based wage discrimination through measures such as anti-discrimination legislation and transparency initiatives. However, the persistence of significant pay gaps underlines the importance of continuing and redoubling efforts to achieve gender equality.
Following a certain increase after German reunification, disposable income inequality has remained steady in Germany since 2005. Thanks to the powerful redistributive effects of the German tax and transfer system, the level of income inequality in Germany is low by international standards. However, Germany performs less well when it comes to equality of wealth, with assets concentrated in the hands of fewer people than in most other advanced economies. Nor does Germany do well in terms of equal opportunities. The OECD’s data on equality of opportunity shows how important well-functioning education systems are – from early childhood education to school and university education to further training opportunities for (older) employees.
Research on the role of competition and economic rents suggests that effective competition is what helps to reduce inequality – not protectionist measures. It is true that monopoly rents can have a useful place in an economy, for example by creating incentives for innovation and research. However, the very high returns generated by some (digital) companies over many years show that more effective steps are needed to safeguard fair competition, adequate market access and the innovative power of industry. In addition, many of these large global players do not pay enough taxes. This underlines the need for a comprehensive, internationally coordinated approach to ensure adequate taxation of global companies. This is something to which Germany is strongly committed internationally.
Increasing flexibility in the labour market and the weakening of worker representation can exacerbate income inequality. For this reason, efforts should be made to improve compliance with labour standards, strengthen worker representation and provide more secure employment, especially in lower wage segments.
Given the rising disposable income inequality in most G7 countries, particularly the US, Germany welcomes the great importance attached to this issue by France’s G7 presidency. In particular, Germany welcomes the French presidency’s aim of achieving improved compliance with the International Labour Organisation’s core labour standards.
- Household circumstances also play a key role and are frequently taken into account using what is known as “equivalised income”. Unfortunately, exploring this in more detail would go beyond the scope of this article. Information about equivalised income is available (in German only) at the website of The Federal Ministry of Labour and Social Affairs.