Download Lecture 6: Evaluating Government 1. A list of tools or measures used

Lecture 6: Evaluating Government
1.
2.
A list of tools or measures used to evaluate government performance in the popular media
would include at least the following:
a.
Gross National/Domestic Product (GNP/GDP) measures the total size of the
market economy, defined either geographically (GDP) or by people (GNP).
i.
GNP/GDP growth is often taken as a measure of economic performance.
b.
Consumer Price Index (CPI) measures the year-to-year change in the prices of
commodities, that is, the cost-of-living.
c.
Productivity and productivity growth measure the amount of economic output we
get per unit of inputs. For example, taking labour as the only input, GDP/worker
is a productivity measure.
d.
Unemployment Rate (UR) measures the population of people seeking work as a
fraction of all those either working or seeking work.
e.
Exchange rate (ER) measures the cost of foreign currency in terms of Canadian
dollars. Business pages often treat this as if it were a measure of economic and
government performance.
f.
Poverty measures assess the size of the population with ‘too little’ to get by.
g.
Medical service waiting lists quantify the waiting times for various specific
medical procedures.
h.
Interest rates are the price of borrowing money. Low interest rates are often seen
as ‘good’.
The size of the market economy
a.
Gross Domestic Product is the total marketed economic activity taking place
within a geographic region, such as Canada.
b.
Gross National Product is the total marketed economic activity done by a specific
group of people, such as nationals of Canada.
c.
Two equivalent definitions, suitable to different types of problems.
i.
Sum of gross income from all sources in a region (or of a bunch of
people).
ii.
Or, sum of private consumption + investment + government spending +
the change in inventories + (exports - imports).
(1)
The two definitions are equivalent because: all private
consumption, firm investment and government spending eventually
shows up as someone’s income; increased inventories imply
increased final sales later; exports involve foreigners paying locals
and imports involve locals paying out to foreigners.
d.
These definitions add up payments for stuff. Thus, stuff which is transacted
without payment is not counted at all.
i.
Most household work is not counted; leisure is not counted; much child
care is not counted. Anything which is valued but not paid for is left out
of GDP, even though it is produced by people in the economy.
e.
These definitions add up payments for stuff, and assume that those payments
reflect their social value. (If the conditions for the first fundamental theorem hold,
then they do in fact reflect their social value).
i.
3.
4.
However, some things are transacted at prices less than their social
value—these are things that have positive externalities, so that the price
does not reflect their total social worth.
(1)
examples may include cultural activities such as writing and music.
ii.
Some things are transacted at prices greater than their social value—these
are things that have negative externalities, so that the price overstates their
total social worth.
(1)
examples may include polluting activity, such as mining, which
pollutes neighbouring rivers.
f.
These definitions are defined nominally, that is, they are evaluated without
adjusting for changing prices over time.
i.
Eg, if everyone’s income rises, then GNP rises. However, if prices rise
just as much, nobody is really any better off, so the nominal GNP measure
is not very informative.
Employment and Unemployment
a.
The population according to Statistics Canada is divided into 3 types:
i.
Employed (worked more than 1 hour this week);
ii.
Unemployed (wants to work, but did not work 1 hour this week).
(1)
Sometimes, Employed+Unemployed is called the Labour Force.
iii.
Non-Employed (does not want to work);
iv.
Unemployment rate:=(Unemployed/(Employed+Unemployed)).
v.
Information on the fractions of the population in each of these groups is
collected every month by the Labour Force Survey.
vi.
Employed includes people who are working, but may be working more or
less than they desire. Starving part-timers are “employed”.
vii.
Unemployed includes only those who ‘want’ to work by the following
criterion—they have looked for work during the past month.
(1)
looking for work includes: making a phone call; applying for a job;
waiting for your union job to re-appear; reading the classifieds;
going to an employment center.
(2)
looking for work by these definitions is what you have to do to
qualify for Employment Insurance benefits (with the exception of
parental/maternal benefits).
(3)
Unemployed thus excludes those who have given up on looking.
viii. When the economy starts growing after a recovery, sometimes the
unemployment rate rises, because the unemployed grow in number as
people start actively looking for work again. After all, only an idiot looks
for work when there is no work out there.
Prices, Price Indices and Inflation
a.
To the extent that we care about consumption, we care not about how much we
spend on goods and services, but rather about the quantity of goods and services
that we get as a result of that expenditures.
b.
If the prices of things change over time, then we want to adjust any measure based
on spending or income for that price change.
c.
Inflation is the change in the price of goods and services. If inflation is 2%
d.
e.
f.
between last year and this year, then it takes 2% more money this year to buy as
much goods and services as we bought last year.
Consumer Price Index (CPI) is a measure of price inflation produced by
Statistics Canada, and reported in the popular press.
i.
Basic measurement strategy is this: measure the total quantities of goods
that people buy (eg, food, clothing, shelter...), call these quantities .
Measure the proportionate change in price of each good (eg, in Vancouver,
perhaps 0% for food, clothing, but 5% for shelter), call this set of price
changes as dp=[dp1 dp2 dp3 ... dpN], and call last year’ set of prices as
1=[1 1 ... 1] for each good. Thus, this year’s set of prices is [1+dp1 1+dp2
1+dp3 ... 1+dpN]
(1)
last year, we bought a set of quantities of goods, q=[q1 q2 ... qN],
at the set of prices 1. The cost of this was the sum of [q1 q2 ...
qN], which may be denoted q*1. This year, to get the same
quantities, we have to spend q*(1+dp)=[q1+q1dp1 q2+q2dp2 +...+
qN+qNdpN]. The ratioq*(1+dp)/q*1=
Sum of [q1+q1dp1 q2+q2dp2 +...+ qN+qNdpN]/sum of [q1 q2 ... qN]
is the proportionate change in prices.
(2)
CPI is expressed as a percent increase, so it is this proportion
minus 1.
(3)
example: about a third of spending is on shelter, so in Canada, that
is about $350 billion. The other 2/3 is about $650 billion. If
shelter prices rise 5%, and other prices don’t change, then the CPI
is equal to [650 350]’*[1 1.05] divided by [650 350]’*[1 1]. This
is 1017.5/1000=1.0175.
(4)
So, CPI in this case is 1.75% (1.0175-1 expressed as a percent).
Price indices such as the CPI can be used for lots of important things.
i.
Can use them to adjust nominal GDP/GNP measures. Thus, if prices go
up 2%, then we adjust nominal GDP 2% downwards to compare it with
last year.
ii.
Bank of Canada targets CPI (actually, CPI computed only on ‘less volatile
commodities’, also known as ‘core inflation’) in setting its monetary
policy (see interest rates below). The current monetary regime targets
inflation between 1 and 3 percent per year.
As a measure of the ‘cost-of-living’, CPI has many features that leave it wanting.
i.
It is one measure for a whole population of people. If the price of luxury
cars goes up, so goes the CPI. However, lots of people are not affected at
all by the price of luxury cars, and so the CPI does not reflect their reality.
ii.
It takes last years’ quantities as fixed. But, if the price of, say, fuel really
went up drastically, people would consume less of it (their chosen quantity
would go down) as they found substitutes. Thus, in this case, CPI would
overstate the change in the cost of living.
iii.
Since it takes last years’ quantity as fixed, it cannot accomodate new
goods. If phones that take pictures enter the market, people are maybe
better off because they can buy this new thing, but alas, it does not enter
5.
the CPI in any way, because phones that take pictures were not purchased
last year.
Government fiscal policy—spending and borrowing
a.
Sometimes governments use expenditure and revenue tools to affect the economy.
b.
For example, if the economy is in a recession, the government may want to help
speed the recovery.
i.
recession is defined as negative GDP growth for 2 consecutive quarters.
c.
It may choose to spend more money while holding revenues constant. This
implies increasing the deficit in the short term, and increasing the debt in the long
term.
d.
The increased expenditure will affect GDP:
i.
GDP=C+I+G+X+dI where C is personal consumption, I is firm
investment, G is government spending, X is exports
less imports, and dI is the change in inventories.
(1)
increased government spending pushes up G, which pushes up
GDP.
(2)
it may also push down I. If firms are thinking about investing in
capital, but government spending is used on capital, firms may be
dissuaded.
(3)
it may also push down C. If people realise that they have greater
government debt obligations, they may try to save up for them.
(4)
typically, these counteracting effects will not completely undo the
increase in G, so the net effect is still to push up GDP.
e.
You can also think of this via the other definition of GDP, as the sum of
everyone’s income from all sources.
i.
Increase government spending takes the form of: increased government
employment (increases employment income in the government sector);
increased government transfers to people (increases transfer income);
increased government spending on goods and services (increased capital
income and employment income in the nongovernment sector.
ii.
Here again, things are partially undone—increased government
employment might result in decreased private employment (if government
poaches private sector workers); increased transfers might result in
decreased non-transfer income (if transfer recipients decide to reduce their
work hours because the government gave them more money).
f.
Government spending (holding revenue constant) will also tend two rather
negative effects
i.
In the long-term, the increased deficits increase debt.
ii.
In the short-term, increased spending may push prices up. The mechanism
is this: governments are writing cheques to people, so people have more
money to spend. But, if there are no more goods and services to buy, that
larger amount of money will be spent on the same amount of stuff,
pushing the price of the stuff upwards.
(1)
thus, government spending which creates more stuff will tend to be
less inflationary (or not inflationary), but government spending
6.
7.
which does not create more stuff tends to be inflationary.
g.
Thus, increased government expenditure (holding revenue constant) will typically
result in the following in the short-term:
i.
Increased size of economy (increased GDP);
ii.
Increased employment (lower unemployment rate);
iii.
Possibly increased price inflation;
iv.
And in the long-term, increased debt.
Interest Rates
a.
The ‘interest rate’ is the proportionate amount that must be paid per unit of time
(eg, per year) in order to borrow/save money.
i.
Typically, the rate paid to savers is less than the rate paid by borrowers.
This is because financial intermediation (read ‘banking’) uses real
resources.
b.
There are lots of different interest rates, beyond the distinction between borrowing
and saving.
i.
Long-term fixed interest rates are promises to pay the same rate of interest
for some specified period of time.
ii.
In Canada, mortgages typically fix the interest rate for 5 years.
iii.
Short-term rates can be very short, as short as overnight.
c.
The Bank of Canada sets a particular rate: the overnight government bond rate.
i.
This is the rate of interest (almost always presented in an annualised
equivalent) to borrow one dollar overnight.
ii.
This is the Bank of Canada’s main policy instrument, and almost the only
monetary policy instrument reported on in the business pages.
d.
This rate is correlated with all other rates because a longer term rate is ‘like’ a
sequence of promises on overnight rates.
e.
However, it is not perfectly correlated with other rates because sometimes people
and firms can act in ways to ‘undo’ the driving force of the Bank of Canada’s
overnight rate.
i.
This is called monetary or macro-economics, and it is tricky stuff.
Interest Rates, GDP/GNP growth rates, Unemployment rates and Inflation are connected.
a.
The Bank of Canada uses its control of the overnight government bond rate to
influence longer term rates.
b.
This influence over longer term rates derives that, very loosely, a long-rate is like
a sequence of short rates. A one month loan is like 30 overnight loans. Thus, if
the Bank of Canada embarks on a campaign of raising overnight rates for a
sequence of 30 days, privately controlled one-month rates will go up, too.
c.
Long rates are crucial for various kinds of investment.
i.
People buy homes more readily when long rates are low.
ii.
Firms engage in investment when long rates are low.
iii.
These activities, and other investment-related activities, fuel economy
activity in both the short term and the long term.
(1)
in the short term, the input markets for these investments are
spurred—eg, homebuilders.
(2)
in the long term, firm investments yield outputs.
d.
8.
So, low interest rates are seen by many to ‘cause’ increased GDP.
i.
Macro-economists don’t interpret this relationship so blithely, because
forward-looking consumers and producers won’t get ‘fooled’ by such
Central Bank activity.
e.
Low interest rates by the same mechanism raise the demand for labour, and thus
push up employment, and push down unemployment. It seems like low interest
rates are ‘just good’.
f.
The economy and employment can grow too fast. If people are all in a rush to buy
goods and services, but the quantity of goods and services to buy has not really
changed, then the price of those things rises—you get inflation.
Poverty
a.
The preceding discussion has treated the economy as if it were summarisable in a
few numbers: GDP growth, inflation, unemployment, interest rates.
b.
But really, these numbers have different meaning to different people.
i.
Growth only matters to you if your income is growing;
ii.
Inflation only matters to you if the prices of the commodities you buy are
rising;
iii.
Unemployment only matters to you if you lose your job;
iv.
High interest rates are bad if you are a borrower; they are good otherwise.
c.
So, there is always a nontrivial issue of distribution—whose outcomes are getting
better over time; who has a job; who has enough to eat, etc.
d.
Poverty may be defined as a lack of material resources, the state of not having
enough. This is hard to operationalise, but if you want to think seriously about the
distribution of economic outcomes, it is the very first thing you have to figure out.
e.
The Low-Income Cutoffs are a set of income thresholds defined by Statistics
Canada to capture the idea of ‘not enough money’.
i.
If your household has less money than the LICO for your household type
in your city size, then you are called a ‘low-income household’.
ii.
The low-income, or poverty, rate is equal to P/N where P is the number of
people living in low-income households and N is the size of the
population. Statistics Canada always says ‘these numbers are not poverty
counts; they are low-income counts’, but the press always reports them as
poverty counts. After all, what is the difference?
iii.
The low-income cutoffs are computed via the following algorithm:
(1)
define necessities as food, clothing, and shelter.
(2)
From the Family Expenditure Surveys, or the Surveys of
Household Spending, estimate the average share of all expenditure
commanded by necessities.
(a)
In 1992, this share was 43.6%.
(b)
Declare that spending 20 percentage points more than this
on necessities is ‘a lot more’.
(c)
Figure the income at which the necessities share exceeds
63.6%. This is the low-income cutoff.
(3)
Go through this algorithm for each household size and city size.
f.
Pendakur 2001 on my website has lots of ways to think about poverty.
Definitions from The Economist
Too technical, but maybe helpful to you.
GDP
Gross domestic product, a measure of economic activity in a country. It is calculated by adding
the total value of a country's annual OUTPUT of goods and services. GDP = private consumption
+ INVESTMENT + PUBLIC SPENDING + the change in inventories + (EXPORTS IMPORTS). It is usually valued at market prices; by subtracting indirect tax and adding any
government SUBSIDY, however, GDP can be calculated at FACTOR COST. This measure more
accurately reveals the income paid to FACTORS OF PRODUCTION. Adding income earned by
domestic residents from their investments abroad, and subtracting income paid from the country
to investors abroad, gives the country's gross national product (GNP).
The effect of INFLATION can be eliminated by measuring GDP GROWTH in constant real
prices. However, some economists argue that hitting a nominal gdp target should be the main
goal of MACROECONOMIC POLICY. This is because it would remind policymakers to take
into account the effect of their decisions on inflation, as well as on growth. GDP can be
calculated in three ways. The income method adds the income of residents (individuals and
firms) derived from the production of goods and SERVICES. The OUTPUT method adds the
value of output from the different sectors of the economy. The expenditure method totals
spending on goods and services produced by residents, before allowing for DEPRECIATION and
CAPITAL consumption. As one person's output is another person's income, which in turn
becomes expenditure, these three measures ought to be identical. They rarely are because of
statistical imperfections. Furthermore, the output and income measures exclude unreported
economic activity that takes place in the BLACK ECONOMY but that may be captured by the
expenditure measure.
GDP is disliked as an objective of economic policy by some because it is not a perfect measure
of WELFARE. It does not include aspects of the good life such as some leisure activities. Nor
does it include economically valuable activities that are not paid for, such as parents teaching
their children to read. But it does include some things that lower the quality of life, such as
activities that damage the environment.
GNP
Short for gross national product, another measure of a country's economic performance. It is
calculated by adding to GDP the INCOME earned by residents from investments abroad, less the
corresponding income sent home by foreigners who are living in the country.
PRODUCTIVITY
Relationship between inputs and OUTPUT, which can be applied to individual FACTORS OF
PRODUCTION or collectively. LABOUR productivity is the most widely used measure and is
usually calculated by dividing total output by the number of workers or the number of hours
worked. Total factor productivity attempts to measure the overall productivity of the inputs used
by a firm or a country.
Alas, the usefulness of productivity statistics is questionable. The quality of different inputs can
change significantly over time. There can also be significant differences in the mix of inputs.
Furthermore, firms and countries may use different definitions of their inputs, especially
CAPITAL.
That said, much of the difference in countries’ living standards reflects differences in their
productivity. Usually, the higher productivity is the better, but this is not always so. In the UK
during the 1980s, labour productivity rose sharply, leading some economists to talk of a
“productivity miracle”. Others disagreed, saying that productivity had risen because
unemployment had risen – in other words, the least productive workers had been removed from
the figures on which the AVERAGE was calculated.
There was a similar debate in the United States starting in the late 1990s. Initially, economists
doubted that a productivity miracle was taking place. But by 2003, they conceded that during the
previous five years the United States enjoyed the fastest productivity growth in any such period
since the second world war. Over the whole period from 1995, labour productivity growth
averaged almost 3% a year, twice the average rate over the previous two decades. That did not
stop economists debating why the miracle had occurred.
UNEMPLOYMENT
The number of people of working age without a job is usually expressed as an unemployment
rate, a percentage of the workforce. This rate generally rises and falls in step with the BUSINESS
CYCLE--cyclical unemployment. But some joblessness is not caused by the cycle, being
STRUCTURAL UNEMPLOYMENT. There are also VOLUNTARY UNEMPLOYMENT and
involuntary unemployment. Some people who are not in work have no interest in getting a job
and probably should not be regarded as part of the workforce. Others choose to be out of work
briefly while they look for, or are waiting to start, a new job. This is known as FRICTIONAL
UNEMPLOYMENT. In the 1950s, the PHILLIPS CURVE seemed to show that policymakers
could reduce unemployment by having higher INFLATION. Economists now say there is a
NAIRU (non-accelerating inflation rate of unemployment). In most markets, PRICES change to
keep SUPPLY and DEMAND in EQUILIBRIUM; in the LABOUR market, wages are often
sticky, being slow to fall when demand declines or supply increases. In these situations,
unemployment often increases. One way to tackle this may be to boost demand. Another is to
increase LABOUR MARKET FLEXIBILITY.
NATURAL RATE OF UNEMPLOYMENT
A controversial phrase, which actually means little more than the lowest rate of
UNEMPLOYMENT at which the jobs market can be in stable EQUILIBRIUM. Keynesians,
encouraged by the PHILLIPS CURVE, assumed that a GOVERNMENT could lower the rate of
unemployment if it was willing to accept a little more INFLATION. However, economists such
as MILTON FRIEDMAN argued that this supposed inflation-for-jobs trade-off was in fact a trap.
Governments that tolerated higher inflation in the hope of lowering unemployment would find
that joblessness dipped only briefly before returning to its previous level, while inflation would
rise and stay high. Instead, they argued, unemployment has an equilibrium or natural rate,
determined not by the amount of DEMAND in an economy but by the structure of the LABOUR
market. This is the lowest level of unemployment at which inflation will remain stable. When
unemployment is above the natural rate demand can potentially be increased to bring it to the
natural rate, but attempting to lower it even further will only cause inflation to accelerate. Hence
the natural rate is also known as the non-accelerating-inflation rate of unemployment, or NAIRU.
At first, the NAIRU became synonymous with the view that MACROECONOMIC POLICY
could not conquer unemployment. It was often used to justify policy inaction even when
unemployment rose to more than 10% of workers in industrialised countries during the 1980s
and 1990s, even though economists’ estimates of the NAIRU differed hugely. More recently,
economists looking for ways to reduce unemployment have started to ask whether, and under
what circumstances, the natural rate might change. Most solutions have stressed the need to make
more people employable at the prevailing level of WAGES, in particular by increasing LABOUR
MARKET FLEXIBILITY. Econ-omists still disagree over what jobless rate at any particular
point in time is the NAIRU, but nobody any longer thinks that the natural rate is fixed. Indeed,
some think the concept has no meaning at all.
INFLATION
Rising PRICES, across the board. Inflation means less bang for your buck, as it erodes the
purchasing power of a unit of currency. Inflation usually refers to CONSUMER PRICES, but it
can also be applied to other prices (wholesale goods, WAGES, ASSETS, and so on). It is usually
expressed as an annual percentage rate of change on an INDEX NUMBER. For much of human
history inflation has not been an important part of economic life. Before 1930, prices were as
likely to fall as rise during any given year, and in the long run these ups and downs usually
cancelled each other out. By contrast, by the end of the 20th century, 60-year-old Americans had
seen prices rise by over 1,000% during their lifetime. The most spectacular period of inflation in
industrialised countries took place during the 1970s, partly as a result of sharp increases in oil
prices implemented by the OPEC CARTEL. Although these countries have mostly regained
control over inflation since the 1980s, it continued to be a source of serious problems in many
DEVELOPING COUNTRIES.
Inflation would not do much damage if it were predictable, as everybody could build into their
decision making the prospect of higher prices in future. In practice, it is unpredictable, which
means that people are often surprised by price increases. This reduces economic efficiency, not
least because people take fewer risks to minimise the chances of suffering too severely from a
PRICE SHOCK. The faster the rate of inflation, the harder it is to predict future inflation. Indeed,
this uncertainty can cause people to lose confidence in a currency as a store of value. This is why
HYPER-INFLATION is so damaging.
Most economists agree that an economy is most likely to function efficiently if inflation is low.
Ideally, MACROECONOMIC POLICY should aim for stable prices. Some economists argue
that a low level of inflation can be a good thing, however, if it is a result of INNOVATION. New
products are launched at high prices, which quickly come down through COMPETITION. Most
economists reckon that DEFLATION (falling AVERAGE prices) is best avoided.
To keep inflation low you need to know what causes it. Economists have plenty of theories but
no absolutely cast-iron conclusions. Inflation, Milton FRIEDMAN once said, “is always and
everywhere a monetary phenomenon”. Monetarists reckon that to stabilise prices the rate of
GROWTH of the MONEY SUPPLY needs to be carefully controlled. However, implementing
this has proven difficult, as the relationship between measures of the money supply identified by
monetarists and the rate of inflation has typically broken down as soon as policymakers have
tried to target it. -KEYNESIAN economists believe that inflation can occur independently of
monetary conditions. Other economists focus on the importance of institutional factors, such as
whether the INTEREST RATE is set by politicians or (preferably) by an independent CENTRAL
BANK, and whether that central bank is set an INFLATION TARGET.
Is there a relationship between inflation and the level of UNEMPLOYMENT? In the 1950s, the
PHILLIPS CURVE seemed to indicate that policymakers could trade off higher inflation for
lower unemployment. Later experience suggested that although inflating the economy could
lower unemployment in the short run, in the long run you ended up with unemployment at least
as high as before and rising inflation as well. Economists then came up with the idea of the
NAIRU (non-accelerating inflation rate of unemployment), the rate of unemployment below
which inflation would start to accelerate. However, in the late 1990s, in both the United States
and the UK, the unemployment rate fell well below what most economists thought was the
NAIRU yet inflation did not pick up. This caused some economists to argue that technological
and other changes wrought by the NEW ECONOMY meant that inflation was dead.
Traditionalists said it was merely resting.
PHILLIPS CURVE
In 1958, an economist from New Zealand, A.W.H. Phillips (1914–75), proposed that there was a
trade-off between INFLATION and UNEMPLOYMENT: the lower the unemployment rate, the
higher was the rate of inflation. Governments simply had to choose the right balance between the
two evils. He drew this conclusion by studying nominal wage rates and jobless rates in the UK
between 1861 and 1957, which seemed to show the relationship of unemployment and inflation
as a smooth curve.
Economies did seem to work like this in the 1950s and 1960s, but then the relationship broke
down. Now economists prefer to talk about the NAIRU, the lowest rate of unemployment at
which inflation does not accelerate.
POVERTY
The state of being poor, which depends on how you define it. One approach is to use some
absolute measure. For instance, the poverty rate refers to the number of households whose
INCOME is less than three times what is needed to provide an adequate diet. (Though what
constitutes adequate may change over time.) Another is to measure relative poverty. For instance,
the number of people in poverty can be defined as all households with an income of less than,
say, half the AVERAGE household income. Or the (relative) poverty line may be defined as the
level of income below which are, say, the poorest 10% of households. In each case, the dividing
line between poverty and not-quite poverty is somewhat arbitrary.
As countries get richer, the number of people in absolute poverty usually gets smaller. This is not
necessarily true of the numbers in relative poverty. The way that relative poverty is defined
means that it is always likely to identify a large number of impoverished households. However
rich a country becomes, there will always be 10% of households poorer than the rest, even
though they may live in mansions and eat caviar (albeit smaller mansions and less caviar than the
other 90% of households).
INEQUALITY
Does economic GROWTH create more or less equality? Do unequal societies grow more or less
slowly than equal ones? Economists have debated these questions for as long as anyone can
remember. One problem is to agree which sort of inequality matters: equality of outcome (that is,
INCOME) or of opportunity? Another is how then to measure it. Equality of opportunity, which,
in theory, should make a difference to growth, because it is about giving people the chance to
make the most of their HUMAN CAPITAL, is probably beyond the ability of statisticians to
analyse rigorously. The most often used measure of income inequality is the GINI
COEFFICIENT.
The evidence suggests that extreme poverty is more likely to slow growth than income inequality
itself. This is because very poor people cannot buy the education they need to enable them to
become richer and their children may be forced to forgo schooling in order to work for money.
Economic growth has generally reduced inequality within a country. This has been partly as a
result of redistributive tax and benefits systems, which have become so significant that they may
now be causing slower growth in some countries. The availability of WELFARE benefits may
have discouraged unemployed people from seeking out a better job; and the high taxes needed to
pay for the benefits may have discouraged some wealthy people from working as hard as they
would have done under a friendlier tax regime. However, the NEW ECONOMY may see
inequality in rich countries widen again, thanks to its alleged WINNER-TAKES-ALL
distribution of financial rewards.
Adapted from
"Essential Economist"
published by Profile Books.