Income and Wage InequalityA. Introduction1. We have considered (and will consider) why there mightbe variation in labor supply and wage outcomesa. variation in hours: from our previous models,differences in labor supply result from differences inpreferences, wages, non-labor incomes, familystructure, non-market production opportunities, etc.b. variation in wages:1) we have also talked about differences in skills(more specifically, human capital) contributing todifferences in wages2) in future lectures, we will discuss other reasons fordifferences in wages such as compensatingdifferentials and discriminationc. variation in hours and wages leads to variation inearnings and incomes2. Given that we have already examined these issues, whatmotivates any additional inquiry into inequality?a. concern for fairness – people (including economists)may prefer relatively equal distributionsb. concern for people at the bottom of the wage andincome distributions (the poor)c. want to explain trends – why does inequality in asociety increase or decrease over time; specifically, forthe U.S. want to examine why1) inequality has increased since the 1970s00.20.40.60.81Cumulative Share of Income0 0.2 0.4 0.6 0.8 1Share of Households 0.0360.1250.2750.507 Lorenz Curve -- Household Income 19972) absolute outcomes for people at the bottom of thedistribution have gotten worseB. How do we measure income inequality?1. The Lorenz Curvea. orders households (or individuals) in order of incomeb. then captures the cumulative share of income receivedby each share of the populationc. if incomes are all equal, the curve is a 45° lined. if incomes are not equal, the curve is convexe. the farther the curve is from the 45° line, the greaterthe degree of income inequalityf. Lorenz curve for 1997 household incomes in U.S. isshown on right (Census Bureau, 1998)g. picture isgood butwould like asummarystatisticGini Coefficientarea under Lorenz Curve=−..552. Gini Coefficienta. calculated as the ratio of1) the difference between the area under the LorenzCurve under perfect income equality (.5) and theactual Lorenz curve, and2) the area under the Lorenz Curve under perfectincome equalityb. the formula is3. Variance of the natural log of incomea. variance is a standard measure of dispersionb. measure is sensitive to the units used (e.g., might notbe comparable over time or across countries)c. not necessarily a good measure for skeweddistributions4. Coefficient of variation of incomea. defined as the ratio of1) the standard deviation of the distribution2) and the mean of the distributionb. provides a way of scaling the standard deviation(variance)5. Ratios of incomes at different points of the distributiona. for example, could compare incomes of thehouseholds in the 90th and 10th percentiles of thedistribution or 75th and 25th percentiles0.35 0.4 0.45 0.5 1967 1972 1977 1982 1987 1992 1997 Gini Coefficient -- HH Incomes 1967-b. useful when working with top-coded data or data withsome unreasonably low values (extreme outliers)6. All of these are sensible distributional measures, but...a. they capture different points or different features ofthe distributionb. because of this, conclusions regarding trends andpatterns in income inequality may be sensitive toalternative measuresC. Trends in income inequality over time1. Trends in the Gini Coefficient for household moneyincome from 1967-97 are shown below (U.S. CensusBureau 1998)2. Note: the survey methodology of the CPS changed in31000320003300034000350003600037000380001967 1972 1977 1982 1987 1992 1997Median Household Income 1967-971993 (spike in 1993-4 is an artifact of that change)3. By most measures income inequality has risen since thelate 1970s4. rise in inequality has been accompanied by slow growthin incomes (see graph below)5. households at the lower end of the income scale havebeen growing poorer in both relative and absolute terms6. Levy and Murnane (1992) divide recent income andinequality trends into three distinct periodsa. 1970-19821) some increase in overall inequality; however, littleconcern because of rising income levels and fallingpoverty rates2) some concern about the decrease in the returns toschooling and increase in the returns to experienceb. 1983-19871) large increase in inequality2) slow real wage growth3) tax cuts and reductions in redistribution furtherfocused attention on inequality4) concerns about de-industrialization (switch frommanufacturing to service jobs), loss of “middleclass jobs”c. after 19871) continued increases in inequality2) increasing returns to education and experience3) more sophisticated studies that begin to look atwhy the demand for skills may have changed andwhy within group inequality increased7. Katz and Autor (1999) examine wage inequality; findsimilar patterns (see their Figure 3)a. 1963-19711) strong wage growth for men and women2) little change in inequalityb. 1971-19791) little wage growth2) small increase in inequality for menc. 1979-19871) men–little wage growth; women–some growth2) large increase in inequality for men and womend. 1987-19951) slight wage growth for women, slight declines formen2) modest increase in inequality for both sexesD. Other changes in earnings inequality1. Black/white – between groupa. men:1) narrowing of gap during the late 1960s2) relatively little change over the 1970s and 1980s3) continued narrowing during the 1990sb. women:1) gap was much smaller to begin with2) narrowed during the late 1960s3) no change during the 1970s4) widened during the 1980s5) and has begun to narrow again2. Age (experience) – between groupa. premium associated with age has increased over timeb. much of the increase in the earnings differential isassociated with the absolute declines in the earnings ofyoung menc. there has also been an absolute, albeit smaller, declinefor young women3. Education – between groupa. rate of return to schooling declined during the 1970sb. rate of return has subsequently increased4. Within group changes in inequalitya. changes in inequality between groups has also beenaccompanied by changes within groupsb. specifically, inequality has increased within groupsdefined by age, education, and gender since the 1970s5. Differences across countriesa. many other countries experienced increases ininequality over the last few decadesb. increases in inequality have been especiallypronounced, however, in the U.S. and U.K.E. Explanations1. Supply shiftsa. increase in supply of young