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The Sources and Consequences of Inequality

T H E SOURCES AN D C O N S E Q U E N C E S O F
IN E Q UALITY

In this section, we summarize and briefly explain the important points that you need to remember from the module readings. It is not a substitute
for reading, but a complement to help you identify the important results.

Sources of Inequality
The following enumerates a few sources of inequality.

1. Inequality in skills: If some workers have a particular skill that is highly in demand, these workers will be well paid compared to the average
workers. For example, skilled hockey players will be drafted by teams from the national hockey league (NHL) and will be paid much more
than average workers. As another example, individuals with coding skills (software development, data science, etc.) are in high demand and
therefore well paid compared with unskilled workers. This is a natural source of inequality that can hardly be controlled.

2. Inequality in how skills are valued: Depending on how the society values products and services, some skills may result in higher income
than others. It also depends on the demand and supply of those skills: if a particular skill is in high demand and low supply, it will be more
valued.

3. Inequality in education: We assume here that higher education leads to higher income. The following compares the median wage by level of
education in 2016 (Statistics Canada, 2017).

Median annual earnings of women and men aged 25 to 64

who worked full time and full year as paid employees
Apprenticeship
High school diploma College diploma Bachelor's degree
certificate
Women $43,254 $38,230 $48,599 $68,342

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Median annual earnings of women and men aged 25 to 64

who worked full time and full year as paid employees
Men $55,774 $72,955 $67,965 $82,082

From the table, more educated workers earn more: a gap of about $25,000 between a high school diploma and a bachelor’s degree.
Therefore, inequality of education is likely to create income inequality. Notice that education inequality across countries is also a source of
income inequality in the world. Therefore, government policies that focus on reducing education inequality are likely to also reduce income
inequality.

4. Technological advances: This source is related to skills and education. For example, advances in information technology increase the value
of computer scientists without affecting the value the unskilled workers or other types of unrelated skilled workers. For example, we saw in
a previous section that the Gini coefficient in Canada increased substantially in the '90s, a period characterized by a boom in computer
technology.

5. Value of education: Everything that affects the value of being educated will increase the impact of education inequality on income
inequality. For example, technological advances affect the value of some types of education.

This is a shortlist of what may cause income inequality. We will cover other sources in more detail in the Growth and Development module.

The Effect of Inequality on Growth

Explaining the effect of inequality on growth requires a theoretical background that we don't have, and testing empirically whether this
relationship exists is something difficult even for well-trained economists. The following quote from the readings summarizes well the issue:

"Does inequality raise or lower growth? Unfortunately, available statistical data are unable to answer this question. Although some
economists claim to find evidence that inequality is on average bad for growth, others claim the data point in the opposite direction."

Just to mention the possible channels through which inequality may have an effect of growth, the inequality may affect:

investment, which affects growth through its impact on the accumulation of capital goods (goods used to produce),
education, which affects the productivity of workers,
taxation (for redistribution purposes), which effects incentives to work or produce,
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the political stability, which affects the incentive to invest, and

the level of criminality, which implies wasting resources to prevent it instead of producing goods.
Most economists think that those channels exist, but we don't know which one has the largest impact. For this course, you need to understand
the intuition behind the different channels and be aware of the difficulty of evaluating their relative impact.

Economic Mobility
Economic mobility is defined as the ability for individuals to move from one part of the income distribution to another (e.g. moving from the first
quintile to the second of third quintile). This is much harder to measure than inequality. In the last section of the module readings, we see a
transition matrix which is a way to measure mobility.

For example, we see that persons whose parents were in the bottom quintile of the income distribution have 42% chance of being in the bottom
decile, 23% chance of being in the second and 6% chance of being in the top decile. Also, persons whose parents are in the third quintile have an
almost equal chance to be in any quintile. This is a sign that there is some mobility in the economy. One main advantage of living in a highly
mobile economy is that everyone has an equal chance of being successful. In the absence of mobility, poor families would remain poor for
generations.

Two important factors that affect mobility are:

1. The accessibility of education: Children whose parents are poor have more chances to be in higher deciles if education is easily accessible.
2. The accessibility of health care: Health has an impact on school performance. Therefore, having an accessible health system helps poor
children to acquire a higher level of education and move to a higher income decile than their parents.
A study mentioned in the readings showed that mobility is higher in Canada than in the United States. The fact that health care and education is
more accessible in Canada can explain some of the difference. This part of the reading is required and it is a nice way to conclude the module.

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