More on Income Inequality

Earlier this year, I discussed the origins of the terminology of the “1%” and the “Occupy” movement described by Joseph Stiglitz.  Stiglitz has once again reaffirmed when speaking at Ramapo College, reported by North Jersey, about the income inequality in America.

Stiglitz talks about what makes income inequality such a mess for the United States.  Because of the separation, the amount of economic growth is hindered, and ultimately has led to recessions in American history.

“When we have a lot of inequality, demand goes down. … All this inequality was offset by creating a bubble. The bubble allowed people to consume more. Now we have the inequality but we don't have a bubble, and that means that we will have persistent, weak demand, and therefore unless we create another bubble it's going to be very difficult for us to get back to full employment.” -Economist Joseph Stiglitz

So this leaves us at our current standing.  The market looks to be growing, but as long as we continue to stand at a level of inequality in wealth, how far will we be able to hold growth?

Further points are made by Stiglitz that the problem with income inequality doesn’t revolve simply around the need to literally redistributing money to the poor, but more so the ability to create economic growth in the United States.  This includes building on education, infrastructure, and technology that will ultimately benefit growth in human capital.      

In my behavioral economics course, we have discussed the valuation of risk, and what the overall utility effect will have on society.  When looking at the situation theoretically, we can determine that there are two kinds of people: those who thrive off the benefits of wage gain, and those who further fear the loss of wages.  For each scenario, there are benefits that can be gained by society when determining what people would prefer. 

 Figure A

Figure A shows the benefits that a person who values higher wages gains over the risk of lower wages (a typical 1% mindset).  We can see that the overall benefit, or utility, of receiving an equal pay raise compared to pay reduction.  The raise in wage offers higher utility and outweighs the risk of receiving an equal pay cut.  In this scenario, If we were to assume society taxed the people to average the initial wage, the person with this preference curve would consider themselves worse off.    

 Figure B

On the other hand, figure B shows the other spectrum.  As one can see, the person typified for this curve is more risk adverse, and realizes a larger drop in utility from the initial price, showing the value placed on the initial price.  This preference would benefit from the averaging of the wages of the initial price, as the growth of more wages, as a whole, would not benefit enough to see a large change in preference.

Now how does this relate with Stiglitz’s arguments?  Well, we can likely assume that majority of the people in America take harder hits from wage cuts of the same value of a raise (based off assumptions that the 99% stand for).  With the ability to balance out the income distribution, we can potentially see higher utility for a higher quantity of Americans. 

While this may be a bit of a stretch, trying to connect the problems with income inequality can further benefit the potential that the United States economy can hold.  Perhaps extending the term wages, to amount spend towards human capital per capita, would be more sufficient.  This variable may then hold Stiglitz’s points on redistributing in order to stimulate the economy, and avoid the dreaded bubble that we have fallen victim to in the past.

References:

1. Tangel, Andrew. “Famed Economist: Income Inequality Bad for Economy”. North Jersey. http://www.northjersey.com/news/141149483_Economist_says_wealth_gap_is_bad_for_growth.html