Date: Monday 4 March, 2013
Location: PG Hub 7, Senate House
Topic: Income Inequality in the UK and beyond
Speaker: Justus J.H.P. Timmers

Note on the author: Justus Timmers was at arms length from core of the 99% protest at St. Paul’s Cathedral during his internship over the summer of 2011 when the nationwide riots and looting sparkled among others the income inequality debate in the UK. Income inequality is traditionally often a secondary consideration at best in the hierarchy of considerations in economics. As a student Economics and Geography at UCL and currently of Behavioural and Economic Sciences at Warwick, this is core to Justus’ interests and found the national divide on the issue striking. At the Warwick Economics Research Lounge Justus sought to discuss further the causes of income inequality.

Presentation: Justus started his presentation with providing an overview and definitions of inequality, to continue with some traditional sociological and economic theories on the causes of inequality. His own empirical research is based on the 2002 and 2010 Labour Force Survey data for a course at UCL titled Scales of Inequality. Possibly a quirk of history, the protest witnessed nearby was marked by little structure, no identifiable leader and no demands: yet it might have been very successful in its goal, which is to stipulate debate in this unprecedented social and somewhat ignored academic territory.

The economic terrain is indeed unprecedented in terms of scope and depth, as both the universality and severity of the economic crisis and levels of inequality have not been seen since founding of the OECD in 1961. The level of income perceived as typical is often severely biased by surrounding, neither rich nor poor often realise the scale of the differences, and I refer you for the pre-tax hourly job wages and the coefficients of inequality to the presentation, please click here for the slides.

The graph below summarises the key facets of increase of income inequality over the last decade adequately: income inequality is a feature of the top earnings monopolising most economic gains. This requires some additional comments.

The bottom 90^th percentile of earners are more egalitarian. It is indeed neither at the 99^th percentile – i.e. those just making the 1% category – nor even the 99.9^th percentile that capture the situation to any justifiable extend. It is the top-of-the-top earners.

To translate this in the more protest’s banker bonus terminology: it is not all those greedy bankers, it is the one banker who earned a £40mm bonus opposite to me in his glass office responsible for corporate and financial engineering, as dicing and slicing ABN-Amro in a €72bn deal. The consequent bailouts might have nearly bankrupted governments, but enriched a few grossly over the crisis for those who manage to benefit from their connections.

Ascribed characteristics / SBTC.

It should therefore indeed not come to a surprise that these ascribed characteristics are not key in making these individuals so privileged in society. These super-earners are typically male (gender however is the fastest closing gap and accounts for about 4% of inequality in 2010), reside around London (again about 4% of inequality can be explained by region) and are white-European (0.3% of inequality is explained by ethnicity). Yet, these characteristics barely account for the discrepancies in earnings.

The inequality within any group you can imagine is far greater than that between different groups and increasingly so. It is indeed very hard to guess in advance exactly who the individuals are by characteristics they are endowed with.

Instead of ascribed characteristics, maybe these people are more skilled, more experienced, more future oriented, and educated? Skill-Biased Technological Change (SBTC) is a popular economic theory based on these premises and actually does a better job than the ascribed characteristics mentioned above.

To summarise the SBTC theory predicts that technological change caused some workers to become very productive (think designers, IT engineers, bankers) and other workers (think catalogue keepers, toy makers, etc.) to become replaceable. Dependent on skill level some groups gained and others lost out. The high skilled are the predicted winners. Slightly counter-intuitive those losing out most are not the lowest skilled, as non-routine work is hard to replace, but pretty a university education to adapt to take advantage of the newest advances in technology has become a prerequisite.

Yet the capacity of education and experience to explain income is diminishing. Differences in education and age accounted for about a fourth of inequality in 2002, but diminished in explanative power to a fifth in 2010.

Intuitively it makes sense that these explanations do not bring us very far. For Joe on the street to Warren Buffet there is a large realization that income is greatly affected by serendipity. For an economist this is very dissatisfying, as lucky few by definition are impossible to identify a priori, nor does this say much about the underlying causes of inequality.

Alternative explanations.

Therefore people have increasingly been looking to alternative explanations, often involving politics, institutions, globalisation and norms. Prominent thinkers include Stiglitz, Acemoglu, or Pogge and all believe that the political aspect is undeniable. It is the interaction between economic and political power that create this vicious spiral of increased inequality. Put very simply: (political, economic) connections matter and are becoming more profound. What empirical evidence can we present here?

Justus focuses in his presentation on parent-child earning elasticities. Previous research, by e.g. Björklund, shows that unequal countries often have very high father-son earning elasticities. This nears parity for the top 0.1% earners. Given the low accountability of income personal characteristics have, it can only be concluded connections – if not outright nepotism – play a main role in income inequality. Why is it right now that income inequality is increasing? For instance, in his presentation Justus Timmers presents evidence of his research that the institution of marriage is very recently becoming less universal and dependent on incomes. This effect is not significant yet in 2002. However, post anno 2010, if you have two parents from which connections you can benefit: they are most likely financially well off. We find hereby evidence for an increasing polarisation of those not connected and those connected in a bubble providing unlimited financial opportunities.

N.B. My current MSc. Research Project (eq. dissertation) is on the topic of assortitative matching in couples.

N.B. The analysis is based on hourly earnings from the main job before deductions. As Lukas Mergele noted in the discussion, the inclusion of capital gains would most likely exacerbate the effect of income inequality.

 

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