Poverty, Income Distribution, and Wage Inequality
Economists often ask the question "How do we increase total output?" In our pie analogy, this is the same as asking "How do we increase the size of the pize?" In this topic, we pay particular attention to "who gets which slice" of the pie. While U.S. GDP per capita may be over $25,000, not everyone earns this much.Income distribution has direct consequences on the poverty rate in a country. Even in a wealthy country, poverty is a problem if a significant fraction of the poorest people have little or no income. We will examine poverty in the United States and then turn to the issue of income distribution.
THE ECONOMICS OF POVERTY
The official poverty line (click for official 1996 poverty threshholds from the Census Bureau) is the annual cost of a nutritionally adequate diet multiplied by three. If money income falls below the poverty line, people are counted as poor.Click here to view a Census Bureau table showing poverty rates for families.
Click here to view a chart of the poverty rate.
Money income includes earnings before taxes plus private and government cash transfers, such as alimony and child support payments, Social Security, unemployment checks, and AFDC payments. In-kind transfers (payments-in-kind) are not counted in official poverty estimates. These exclude spending on medical care, food stamps, and housing assistance. Inclusion of these reduces the poverty rate by 2.7 percent, or 6.8 million people. The chart below shows the poverty trend in the United States from 1959 to 1995. As you can see, the poverty rate decreased substantially with the introduction of many anti-poverty programs in the 1960s. But the rates bottomed out in 1974 and have been slowly rising since with little trend in recent years.
The pretransfer poverty rate measures the estimated poverty in the absence of all government cash transfers. In other words, this statistic gives us an indication as to the "core" level of poverty that would exist without any government intervention. This rate increased 3 percentage points between 1975 and 1992, implying that the poverty in the Unites States has increased over the last 17 years.
Check out these poverty statistics published by the Census Bureau.
The Feminization of Poverty
The highest incidence of poverty occurs among female-headed households, blacks, and hispanics. In 1959, 25 percent of the poor were black and 26 percent lived in families headed by a woman. In 1992 the respective figures were 29 percent and 37 percent. Thus the largest increase in poverty has come from female headed households. This has led to what is called the feminization of poverty. The percentage of families headed by women with children who had never married increased from 25 percent in 1979 to 41 percent in 1992.The Main Government Transfer Programs
Government entitlements are the fastest growing portions of the federal budget. The largest of these programs are Social Security (which is not a "pure" transfer program), Medicare (health care for the elderly), Medicaid (health care for the poor), Food Stamps, SSI (a branch of Social Security for the poor elderly and disabled), TANF (Temporary Assistance to Needy Families, formerly AFDC), and Housing Assistance. TANF is often what we mean when we refer to "welfare. As you can see from the chart below, entitlements account for more than half of the federal government's outlays. Social Security and health care alone account for over 40 percent of the federal budget. When traditional welfare programs are included, the number rises to above 50 percent. Entitlements have become huge factors in our economy.
Impact of Transfers on Work Effort and Family Composition
Many people criticized recent welfare policy because it reduced work effort and encouraged the break-up of families. An income-tested transfer reduces work effort in three ways:- The transfer gives the individual more income which is used to take more leisure time.
- The individual finds that higher earnings from work cause the transfer to fall due to the effect of the transfer reduction rate. Therefore, work hours are scaled back or eliminated.
- If the amount of the no-work transfer is large enough, the individual may decide not to work at all.
- In many states AFDC payments are denied to households where both parents are present.
- Public assistance provides unhappy couples the means to establish separate households.
- Public assistance increases out-of-wedlock childbearing.
In 1996, Congress passed the Personal Responsibility and Work Opportunity Reconciliation Act. The purpose was to provide incentives for welfare recipients to find employment. The bill requires adults to find employment after 2 years and limits lifetime assistance to five years. Importantly, the federal government now gives states incredible freedom in setting eligibility and support amounts. As a result, states are experimenting with new ideas on how to encourage people back to work. While many welfare recipients have been encouraged back to work, the big question is whether the new welfare programs or the favorable economic conditions in the late 1990s (low unemployment rates and high GDP growth) is responsible.
Income Inequality
How do we measure income inequality? One way would be to list the incomes of every household in the economy. While this picture would certainly present us with any information we would want, it would also be overwhelming. Instead, we search for a few key statistics that give us a pretty clear picture.We could, for example, ask "What percent of income is earned by the bottom 20 percent of households?" For the U.S. in 1995, the answer is 3.7 percent. What percent of income is earned by the bottom 40 percent of people? Our answer is 12.8 percent. The Lorenz curve graphs this information. This is a chart that plots percentage of the households ranked by income on the horizontal axis (ranked from lowest income earner to highest income earner) and the percentage of total income earned on the vertical axis. Two points are always certain. They are the origin and all income. If there are zero people, they earn zero income, and all the people earn all the income. Therefore, the Southwest and Northeast points on the box do not change. The measure of income distribution is represented by the shape of the line that connects these two endpoints. Notice that if the poorest 20 percent of the population earn 20 percent of the nation's income, 50 percent of the population earn 50 percent of the income, and so on, then the Lorenz Curve is a 45 degree line. So the 45 degree line in the chart respresents the line of perfect income equality. But if 20 percent of the population earns only 5 percent of the nation's income, and 50 percent of the population earns only 25 percent of the income, then the Lorenz Curve bows downward. The curve plotted for the United States is for the year 1995.
Explanations for the Rising Income Inequality
There is wide disagreement over what has caused the trend towards rising income inequality. Three possiblilities are presented below.- Increase in wage inequality. When wages fail to keep up, so do incomes. We have more working poor today and the wages of those at the bottom of the income scale have fallen considerably in the 1980s.
- Tax and Spending Policies. It is possible that our tax policies are not as progressive as they once were. We are not distributing as much purchasing power to the poor in our society.
- Increase in single parent households. Single parent households do not earn as much income as two parent households. This may play a large part in explaining the rise in low income households.
Wage Inequality
The table below presents data on wage changes between 1950 and 1990. The data come from the US Bureau of the Census, and from Juhn and Murphy, Economic Policy Review, Jan. 1995.REAL WAGE GROWTH Percentile 1940-50 1950-60 1960-70 1970-80 1980-90 11-20 .315 .278 .192 -0.15 -.169 21-40 .277 .292 .207 .015 -.116 41-60 .197 .301 .232 .073 -.072 61-80 .127 .302 .252 .096 -.024 81-90 .091 .300 .284 .089 .011
From this chart we can see clear trends. First, both wage inequality has increased substantially from the 1980s to the present. The main reason for the rise in wage inequality has been the fall in wages for the lowest 20% of workers, not the rise in wages for other groups. The trend has also occured in Western Europe though the lower tier is becoming unemployed due to laws that prohibit wages from falling as far as they have in the US.
Possible Explanations for Rising Wage Inequality
- Decline in Unionization: many employees without a college education benefited from union membership into the 1970s. The decline in union influence means that many workers receive less compensation.
- Increase in International Trade: An increase in international trade most likely results in the US exporting technology-based goods and services while importing simple technology products. This means that workers in low-technology sectors face severe competition from abroad. Two implications from this are: 1. US workers who compete with imports see wages fall while wages in other countries rise, and 2. The prices of import-competing products fall in the US. Evidence on the falling prices of products is weak.
- Shift of Employment to Technology-Base: This results in a reduction in demand for less educated workers and an increase in demand for college graduates. Skills needed in the workplace are changing to require more analytical tools and more "brain-power."
- Increase in immigration: This impact mainly occurs because the number of relatively less-skilled immigrants to the US has increased, skewing the wage distribution downward.
*Page Designed by Tim Yeager