Inequality

The Ringingof the DivisionBell:InequalityanditsTrends,Causesand Effects____________________
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The Ringing of the Division Bell:
Inequality and its Trends, Causes and
Effects
Nathan Conlon

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Abstract
This paper aims to provide a comprehensive analysis of the concept of inequality. Much of
the literature on this issue has focused on a single aspect of this phenomenon with a level of
scrutiny which, at times, has bordered on excessive. My goal here is to provide a much
broader understanding of inequality, with all relevant facets given their due attention. In
this respect, my work can be seen as an enterprise which ties together the existing literature
on this topic. I might add, however, that some of my findings are in addition to what has
already been said, particularly my analysis of tax rates and their effect on inequality, which
may well warrant further investigation due its findings.
I begin by discussing is meant by inequality, and the various measurements and definitions
associated with it. The proceeding section will elucidate the historical trends with regard to
inequality, and the current situation we find ourselves in. The next two section focus on its
causes and effects. Finally, the last section will explore some of the options available to
policy-makers in the quest for a more equitable society.

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Introduction
The Occupy Wall Street movement that sprang up in the aftermath of the 2008 financial
crisis was made up of individuals from a plethora of political backgrounds, from free-market
fundamentalists to hard-line socialists, and everything in-between. Representatives from
every point on the political spectrum had been united under a single umbrella. Regardless of
how diverse their normative principles may have been with regard to how the system
should function, they were all united by a common belief that inequality was simply too
high, and that something needed to be done about it.
Unbeknown to some in the Occupy movement, it has been 14 years since the UN pledged to
reduce global inequality as part of its Millennium Development Goals, an unprecedented
commitment at the time, but one which had been urgently required, given the rising gulf
between the haves and have-nots in recent decades. "We have a collective responsibility to
uphold the principles of human dignity, equality and equity at the global level. As leaders we
have a duty therefore to all the world's people, especially the most vulnerable and, in
particular, the children of the world, to whom the future belongs." (U.N. Millennium
Declaration, 2000: Paragraph 2).
It could be argued that inequality by itself is not such a bad thing. Indeed, from a
philosophical perspective, it is difficult - if not impossible - to formulate a rational argument
which condemns inequality as an immoral feature of our society. Some philosophers have
attempted it, but their arguments have tended towards a logical fallacy or a hidden
assumption. John Rawls (1971), on the other hand, insists that our only concern should lie
with those in the bottom echelon of society: the very poorest. This argument, if correct,
would render inequality as an irrelevant factor in determining the level of social welfare
within a society. However, inequality, whilst perhaps consistent with the demands of
morality when observed in isolation, can nonetheless be instrumental in yielding immoral or
undesirable outcomes, particularly in the political, social and economic realms, and this is
why it has been the subject of such public outrage in recent times.

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In my research, I found the literature on inequality to be quite like a puzzle: all (or most) the
right pieces were there, but no-one had attempted to put them together. For example,
Bartels (2005) talks about political representation and how this is mediated by income
inequality, but says nothing on social services. Ortiz and Cummins (2011), on the other
hand, talk about social provisions and how they relate to inequality, but shy away from any
discussion on how to define inequality itself. What I want to do in this paper is put the
puzzle together in order to provide a more comprehensive understanding of inequality.
A discussion on how to define and measure this notion is exactly where I start; this is the
focus of my paper, and so the term should be well elucidated before proceeding. In the next
section, I analyse the historical trends with regard to inequality before presenting the
current scenario we find ourselves in in the 21st century. Over the following sections, which
form the crux of this paper, I look at the causes and effects of an unequal society. Finally, I
present the normative principles which are relevant to those policy-makers in the business
of reducing inequality, and the progress which has been made so far. Due to the finite
nature of time and space, my focus is limited for the most part to the U.S., but I seen no
reason why the causes, effects, and normative implications of my study should be limited
solely to one nation.
Defining Inequality
The notion of inequality can be applied over a broad range of concepts, from material goods
such as food and housing to non-material such as love and happiness. Key to this paper is an
understanding of economic inequality, which can be further divided into market inequality
and inequality of opportunity. Market inequality is said to be high when a sizeable disparity
exists between those at the top-end of the income bracket and those at the bottom.
Inequality of opportunity can be said to exist when certain segments of the population
(generally the rich) have better access to jobs, education, and other resources with which to
further oneself.

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The notion of “inequality” can be applied over a range of concepts, so it is important that
we know which one we are referring to when we talk of inequality, as different segments of
the population are affected by different driving forces. Whilst the following definitions could
be both supplemented and expanded upon (see OECD 2011), they are sufficient for the
purposes of this paper:
 Market income inequality (including incomes from capital, savings and private
transfers): includes all income minus social transfers, such as welfare benefits and
taxes
 Disposable income inequality: includes all available income after social transfers
have been taken into consideration
 Inequality of opportunity
 Political inequality
 Social inequality
The first three concepts come under the banner of “economic inequality”. A free market will
typically lead to vast disparities in income, hence the term “market income inequality”. This
is why the government performs redistributive functions, in order to level the economic
playing field. These functions take the form of cash transfers, i.e. taxes and benefits. The
residual inequality which remains after these cash transfers have occurred is known as
disposable income inequality.
Inequality of opportunity can be said to exist when certain segments of the population
(generally the rich) have better access to jobs, education, and other resources with which
utilize their potential.
Another concept we will come across is political inequality, which is mediated by economic
inequality and arises when some segments of the population are better represented than
others. Robinson and Acemoğlu (2012) coined the term "extractive political institutions" to
describe those supposedly "democratic" institutions which, through the influence of
political inequality, become highly biased towards particular agents.

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Finally, there is social inequality, which like political inequality, is again mediated to a large
extent by wealth. A socially unequal society is typified by differential access to social
provisions across various groups within that society. An uneven distribution of social goods
and instituions such as health, education or property rights is an indicator of social
inequality.
Measuring Inequality
Corrado Gini (1912) is credited with providing the empirical standard for measuring the
statistical dispersion of income distribution on both the state and global level. The
paramaters associated with the Gini coefficient range from 0 (representing the Communist
utopia of perfect equality where everyone receives the same amount with regard to
income) and 1 (representing a situation of maximal inequality in which all wealth is
concentrated in the hands of one individual).
Calculations of a nation's Gini index
show slight variations across various
studies, but not by a great deal.
Figure 1 draws on figures published
by a 2011 study by the OECD,
entitled An Overview of Growing
Income Inequalites in OECD
Countries: Main Findings. As the
graph shows, inequality in the U.S.
has been on the rise since the late
1960s.
Strikingly, the countries which score lowest on the Gini index (and are therefore more
equal) tend to have higher levels of overall happiness within their borders. To illustrate this
point, consider Norway, Denmark and Switzerland. The respective Gini ratios for these
countries was 0.250, 0.248 and 0.303 in the aforementioned study by the OECD, well below

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the global average of 0.553 (Berry and Serieux, 2006). This essentially means that these
countries are characterised by a much greater level of equality relative to other nations.
Interesting for the purposes of this paper is the fact that these three countries were found
to be the happiest in the world according to the World Happiness Report by the United
Nations Sustainable Development Solutions Network in 2013. This phenomenon is given a
visual representation in figure 2 below; as you can see, there is a negative correlation
between the Gini coefficient and overall happiness within each nation. Of course , happiness
can be relatedtofacorsotherthan inequality,andthisiswhythe correlationisfarfromclear-cut.
There is,however,anundeniable statisticalrelationshipbetweenthe twovariables.
One of the key aims of this paper is to explain both the reasons for disparities in the
distribution of income and the effects it can have upon society as a whole, effects which are
likely to be causal mechanisms through which the relationship between inequality and
overall happiness manifests itself. As we shall observe, the causal mechanisms associated
with this phenomenon are both direct and indirect, and are largely cloaked in subtlety.
Before any such enterprise can begin, however, a historical review of income inequality is in
order. This will better enable us to observe those causal mechanisms by allowing a
20
25
30
35
40
45
50
55
60
4 4.5 5 5.5 6 6.5 7 7.5 8
Ginicoeffient
Happiness index
Fig. 2: Gini coefficient vs Happness index for OECD 34
Sources: UN Happiness Report 2013; World Bank figures

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juxtaposition of historical inequality with historical events. Of course, each state tells a
different tale when it comes to the notion of inequality, and an inclusive narration of each
and every such tale would simply be unfeasible, given the spatial limitations one must
consider in the world of academia. My focus will therefore lie primarily with the U.S. due to
its prominence in global affairs, although references to other nations will appear, where
appropriate.
Inequality in the U.S: A History
The United States Census Bureau collects data on the distribution of income and uses it to
formulate the Gini coefficient for a given year. Figure 1 draws upon this data, and shows the
U.S. Gini coefficient from 1947 to 2011. Two things about the graph are particularly
interesting. Firstly, we can clearly see a consistent decrease in the level of inequality
throughout the post-war period, or the “Golden Age of Capitalism” as it is sometimes
referred to. Indeed, this paper argues that the presence of low inequality during the Golden
Age was no mere coincidence, a point which will be expanded upon in the proceeding
sections. Secondly (and relatedly), we can also see that inequality began to soar in the late-
1960s, rising from a low of 0.368 in 1968 to a high of 0.469 in 2010.
This sudden trend reversal and its causal mechanisms are highly relevant to any discussion
on inequality, but the literature has surprisingly failed to acknowledge this point, despite its
utility for any would-be egalitarian. The reasons for this phenomenon will be discussed over
the proceeding sections.
The Causes of Inequality
Technological processes are cited as a driver of market income inequality in much of the
literature. “[A]dvances in information and communication technology (ICT) are often
considered to be skill-biased and, therefore, an inequality-increasing factor.” (OECD, 2011:
26). This is known as skills-biased technological change (SBTC). The laws of supply and
demand are often invoked to support this argument: increased demand for skilled labour

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inevitably leads to higher wages for such. Furthermore, technology has been replacing
unskilled workers with machines for some time, exacerbating the distributional effects on
income even further. This process of job destruction has hit some sectors of the economy
more than others; manufacturing, the very sector that helped to create a burgeoning middle
class in post-war America, has been hit particularly hard. According to the Bureau of Labor
Statistics, employment in this sector has fallen from 18 million on 1988 to 12 million in the
present day.
These structural changes in the economy are compounded by shifting comparative
advantages. The emerging markets, especially China, “gained competencies and invested
heavily in education, technology and infrastructure. The U.S. share of global manufacturing
shrank [even further] in response.” (Stiglitz, 2012: 67). This was due to cheap labour from
abroad. As a result of both technological change and shifting comparative advantages, many
American workers have subsequently found themselves in jobs which did not pay as well as
their previous ones; they essentially went from being skilled employees in the one sector to
being unskilled employees in some other sector of the economy.
Here we have an example of how globalization – the integration of markets from across the
world – can lead to greater inequality, with the U.S. at least. However, this is not the only
causal mechanismby which the influence of globalization can affect the distribution of
income. As trade barriers are knocked down and markets become more open, capital
becomes more mobile, making it easier for businesses to relocate to countries in which their
interests are best represented. This has created what is known as the “race to the bottom” -
a situation in which governments around are continually favouring capital over labour, the
latter being less mobile than the former. From the workers’ perspective, this manifests itself
in lower wages (through de-unionization and the diminished bargaining power that
accompanies it) and weaker job protection, with the lowest rungs of society generally being
hit the hardest, all in order to attract business investment. Again, this phenomenon is
instrumental in fuelling inequality.
There is another driver of inequality which I believe is worth mentioning, particularly due to
the scant attention it has received by the academic community: I am talking about taxes. It

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should come as no surprise that the tax regime within a state, whether uniform,
proportional, progressive or regressive, has a significant impact on inequality – or to be
more specific, disposable income inequality. To illustrate this point, I have juxtaposed the
U.S. Gini coefficient data above with data provided by the National Taxpayers Union on the
top rate of income tax. In order to do this, it was necessary to scale the latter data so that it
could be compared on the same axis as the Gini coefficient data. I did this using the
equation (logX)/4, with X representing the top rate of tax for a given year. Since some years
were missing from the Census Bureau’s data on yearly Gini coefficient values, it was
necessary to extrapolate these values with the equation
(A+C)/2 = B, with B representing the (statistically unavailable) midway point between two
other values. This is admittedly a crude way of filling in the data, but in any case it does little
to distort the general picture and so I would consider this methodology to be sound for our
purposes at least.
As you can see from the results of this analysis, there has been a general trend towards
lower top rates since 1947 (the bottom rate was not nearly as erratic, hovering between 10
and 15 per cent). This fall in the top rate was accompanied by a simultaneous rise in the Gini
coefficient within the U.S. It is not hard to see why: a lower tax rate for the wealthiest
echelons of society concentrates wealth at the top since they are paying less in taxes,
resulting in a heightened disparity between those at either end of the distributional
spectrum.

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The Conservative wing of American politics argues that the wealthiest citizens of America
are the ones that create jobs and drive the economy forward. Imposing a higher rate of tax
of them is therefore economically inefficient, since their entrepreneurial spirit will be
crushed as a result, thus inhibiting growth. This claimmay bear some truth, but its effects
are often over-exaggerated. In any case, this would be a small price to pay for the potential
benefits of an increased rate at the top. This leads me on the next section of my paper.
The Effects of Inequality
It is a well-known fact that the Great Depression of 1929 was preceded by soaring levels of
inequality (Jayadev, 2003: 1-39). Since the rich save a greater proportion of their wealth
than those further on down the economic ladder, a concentration of wealth at the top leads
to a fall in aggregate demand throughout the economy. This spurs unemployment, which in
turn leads to further inequality – a vicious cycle. It is not surprising, then, to see from the
above graph that the Gini coefficient in the U.S. had been rising for some time prior to the
Great Recession of 2008, just like it had been in the years before the Great Depression.
0.35
0.37
0.39
0.41
0.43
0.45
0.47
0.49
1947 1967 1970 1980 1987 1992 2000 2006 2008 2010
Fig. 3: U.S. top tax rate vs. Gini coefficient 1947-2011
Gini coefficient
Income tax rate (top
bracket)
Source: U.S. Census Bureau; National Taxpayers Union

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It has also been argued that measures taken to combat the fall in aggregate demand
actually led to the housing bubble which gave rise to the Great Recession. Enlightened by
the thinking of the great British economist John Maynard Keynes, governments around the
world have acknowledged a need for increased spending – whether it be public or private –
in order to combat such weak demand. The Bush administration tried to encourage private
consumption with three large tax cuts over eight years. This did not work. The burden of
countering weak demand was then placed upon the U.S. Federal Reserve, which lowered
interest rates in the hope that more money would be provided to households and firms,
thereby boosting demand. The problem with this policy instrument, however, is that it can
often lead to bubbles. This is exactly what happened in the run-up to the financial crisis: a
housing bubble was created because of excess liquidity, inflating property prices well
beyond their intrinsic value. Their continual rise was simply unsustainable, and an iron law
of economics is that any unsustainable activity will eventually come to an end, which it did.
The collapse of the housing bubble in the U.S. has had far-reaching consequences which
were felt throughout the global economy, and the policy decisions of the Federal Reserve
were largely to blame. “While it is not inevitable that policy makers will respond to the
deficiency in demand brought about by the growth in inequality in ways that lead to
instability and a waste of resources, it happens often.” (Stiglitz, 2012: 108).
Speaking of “wasted resources”, a highly unequal society will generally fail to unleash the
potential of its greatest asset: its people. A country in which most of the resources are
concentrated at the top generally under-invests in its citizens, at both state and private
levels. In many cases, private education is too expensive for the lower classes, so the onus is
on the state to educate its citizens so that they may reach their potential in terms of
economic productivity. But a highly unequal society tends to feature a great deal of
regulatory capture (see Baker, 2010), and since those doing the “capturing” (i.e. the rich) do
not want to pay the higher taxes associated with a stronger public sector, services such as
health, education and child care tend to be underprovided, giving rise to both social
inequality and inequality of opportunity. A further consequence of this poor state provision
is the social unrest that tends to accompany it. A U.N. report in 2012 found that crime,
disease and environmental problems tended to be higher in unequal societies, where many
citizens feel neglected by the state. “When inequality and disparities reach extreme levels,

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the foment discontent that can lead to political instability and in some cases violence and
conflict.” (U.N., 2012: 7).
Inequality can also have an adverse effect on our political institutions. Key to the functioning
of a democratic system is the notion of equal political representation: the views of some
must not take precedence over the views of others, regardless of race, class, gender, and so
forth. Our leaders must not show different responsiveness to different segments of society,
because this would subvert our democracy. Sadly, this is shown to be precisely the case in
Larry M. Bartels' 2005 paper Economic Inequality and Political Representation. Bartels
makes use of data from the Senate Election Studies of 1988, 1990 and 1992 in order to
gauge the responsiveness of political leaders to the preferences of wealthy, middle-class,
and poor constituents. His analysis suggests "that senators are vastly more responsive to the
views of affluent constituents than to constituents of modest means... (T)he consistency of
the difference across a variety of political contexts, issues, opinion measures, and model
specifications is impressive, and the magnitude of the disparities in responsiveness to rich
and poor constituents implied by [the] results is even more impressive." (Bartels, 2005: 29).
Bartels does not elaborate on the causal mechanisms through which this relationship
occurs, but they are well documented in the literature on regulatory capture, going back to
George Stigler's Economic Theory of Regulation (1971). The basic argument advanced by
Stigler was that "concentrated industry lobbies had incentive, information and
organizational cost advantages that allow them to overcome collective action and engage in
lobbying for regulation designed for the industry's benefit." (Baker, 2010: 651). The financial
sector has been ruthlessly efficient in converting its wealth concentrations into political
weight, with deregulatory reforms such as the repeal of the Depression-era Glass-Steagall
Act becoming the norm, at least up until the financial crisis of 2008. This situation has given
rise to what Johnson and Kwak (2010) refer to as the emergence of an "American financial
oligarchy" which, through its wealth and lobbies, has been able to influence policy-makers
to a great extent.
What the government can do to reduce inequality
First and foremost, the government can adopt a more progressive tax regime. At present,
the top rate of income tax in the U.S. stands at 35 cents on the dollar. If inequality is to be

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reduced, the top rate must rise. The Republican consensus is that such a move would hurt
the economy and ultimately end up doing more harm than good, but this is simply not the
case. Throughout the Golden Age of Capitalismin America, the average top rate was around
80 cents on the dollar. It may sound counter-intuitive to those economists of a free-market
persuasion, but a higher tax on the wealthiest echelons of society will benefit the economy
as a whole, since the extra public revenue can be used to strengthen public institutions such
as health and education, allowing citizens to realise their potential in terms of economic
productivity. It could also be used to mitigate the effects of structural changes within the
economy; technological change and shifting comparative advantages mean that the U.S.
must equip its workers with new skills. A knock-on effect of doing so would be a reduction in
social ills such as crime and disease. Regulations that protect workers from unfair practices
such as discrimination or unfair dismissal would also be conducive to this end.
There have also been arguments for a greater level of cooperation amongst governments as
regards corporate governance. This would help put an end to the “race to the bottom” I
mentioned previously, whereby capital is favoured to labour at the latter’s expense
Admittedly, the diversity of conditions within each nation and the competitive nature of our
globalized economy limits the scope for such an enterprise, but I do believe that some
progress can be made in this direction. For example, whilst a generic rate of corporate tax
for all nations would be politically unfeasible, as this would take away a valuable policy
instrument from every government’s arsenal, I would suggest the implementation of a
minimum levy on corporation profits, on a global scale. There would still be a race to the
bottom, but the bottom would not be as deep, and there would be more money in the
public purse for social spending.
Another measure the government should take which would reduce inequality, albeit
indirectly, is the stamping out of regulatory capture. When money is allowed to dictate the
policy decisions in a so-called democracy, the results tend to favour those at the top, usually
at the expense of those below them. This should come as no surprise. The influence of
wealth on policy outcomes needs to be curtailed. If this were to happen, the U.S. would
become a more equal society, in terms of both economic outcomes and political
representation.

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Conclusion
Inequality in the U.S. has been on the rise since the early 1970s. It is no mere coincidence
that the top rate of income tax began to fall at around the same time; indeed, I believe that
the relationship between these two variables should be a focal point in any discussion of
inequality. I find it peculiar that is often not the case. Of course, this is not the only causal
mechanism by which an exacerbation of inequality is brought about. Technological progress,
shifting comparative advantages (particularly with Chinese industrialization), and the race to
the bottom have all played their part in this process.
Whilst it may be argued that inequality is not a bad thing in itself, it can certainly lead to
undesirable outcomes. Economies in which wealth is highly concentrated at the top tend to
perform worse than more equal ones since there is less aggregate demand. Moreover, the
policy decisions taken to alleviate this shortfall in demand can lead to instability. Inequality
can even subvert the democratic process itself, with vast concentrations of wealth
translating into political power.
In order to avoid these outcomes and reduce inequality, the government needs to revert to
a more progressive tax regime, as was the case in the decades proceeding WWII. The
addition revenue generated by a higher top rate would allow the government to spend
more money on social services such as health and education, and help to dispel the social
unrest that has gripped the country. Indeed, the Occupy Wall St. movement was a sign that
such reforms are urgently needed.

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U.N: World HappinessReport (2013)
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