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29 November 2012

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Income inequality – should we mind the gap?
Jasson urbach

If government continues to view income inequality as an undesirable, it should stop focussing on reducing the incomes of top earners. It should rather concentrate on removing the artificial barriers it imposes on the functioning of the market and open up the economy to give the poor greater opportunities. Increase the wage earning power of all South Africans significantly by boosting employment and increasing productivity. And encourage people by showing them that they can reap the reward of their effort and expertise.

Most people believe that income inequality is bad. This crude assumption shifts the focus away from the millions who are mired in poverty and puts an inordinate amount of emphasis on money.

Seldom acknowledged is the fact that, to achieve a more equal distribution of income, people have to be treated unequally. The unequal distribution of income is not the problem. It is more one of envy; an evil preoccupation that prevents people from caring about the well-being of others because they are so concerned about how much certain people earn. For everyone in this country to have the chance to earn a living and possess a slice of the wealth, requires a fundamental shift in policy.

South African policy is currently geared towards equality of income. Rather, the emphasis should be on the equality of opportunity. Policies designed to reduce income inequality involve the redistribution of income through social welfare policies, a progressive tax rate regime, and outright discrimination; policies that discourage savings and investment, retard economic growth and opportunity, and discourage the hiring of labour. If government were to adopt policies based on equality before the law and designed to enhance equality of opportunity, it would quickly foster economic growth and increase the size of the available pie and make it possible for everyone to take a bite.

Although the income gap has widened in many developing and developed countries over the last thirty years, the disparity in world income inequality has lessened. This is mainly due to the rapid economic growth that has been occurring in developing countries with big populations such as Brazil, India and China. As gross domestic product (GDP) in these countries increased, so has the per capita income of their people which has greatly reduced the number of people living in extreme poverty. Due to the advances in medical technologies people in low and middle income countries are also living much longer than previously. Indeed, life expectancy in low and middle income countries has increased from an average of 47 years in 1960 to an average of 68 years in 2010.

According to Professor Julian Simon, “Data on the absolute gap between yearly incomes of the rich and poor countries are beside the point; widening is inevitable if all get rich at the same proportional rate, and the absolute gap can increase even if the poor improve their incomes at a faster proportional rate than the rich. Here one should notice that increased life expectancy among the poor relative to the rich reduces the gap in lifetime income, which is a more meaningful measure than yearly income”.

In South Africa, the income gap has widened. Our most common measure of inequality is the Gini coefficient, named after its inventor, Corrodo Gini, who introduced the calculation in 1912. Its range is from zero to one. Zero indicates a perfectly equal distribution of income (the poorest individuals in a population earn the same as the richest individuals in a population), or one, the extreme opposite (one individual or household earns all the income in the economy).

In 1991, South Africa’s Gini coefficient was 0.68. By 1996, it was 0.69. Although, by 2001, the gap in incomes between South Africa’s rich and poor had widened even further with the Gini registering 0.77, no-one can dispute a substantial rise in the overall well-being of South Africa’s citizens had occurred. South Africa’s GDP per capita (measured in real terms) in 1960, was R21,589. By 2011, it was R37,474 – an increase of 74 per cent; a dramatic improvement. In 1960, the average South African could expect to live only until the age of 49 years. By 1993, the average life expectancy had increased to 61 years. Unfortunately, from 1994 onwards, average life expectancies have begun to regress; and in 2010 the average South African could only expect to live until the age of 52 years – the same as a South African living in 1968.

Does it matter if person A is 10 times, or even 100 times wealthier than person B? Surely, what matters most is person B’s standard of living. Consider, for example, what happened with the US basketball team, the Chicago Bulls.

In 1986, the team’s median player salary was $300,000 (R2.4 million) per annum. The team’s lowest paid player was paid $135,000 (R1.1 million), and the highest paid player made $806,000 (R6.4 million). The Gini coefficient for the team was 0.36. When Michael “Air” Jordan joined the team, its popularity reached an all time high. By 1998, even with Jordan’s two year break when he first ‘retired’, the median player’s income rocketed to $2.3 million (R18.4 million). The lowest paid player was paid $500,000 (R4 million) and the highest paid player (Jordan) received $33 million (R264 million) per annum. The gap in incomes between the highest paid player and the rest of the team had widened substantially and the Gini coefficient almost doubled to 0.67.

By the time Jordan retired from the Bulls (for the second time) in 1998, the median player was receiving more than seven times that paid in 1986. The lowest paid player, in 1998, had an income that was four times that of his 1986 counterpart. Was this “unfair”? Should some of Jordan’s income have been redistributed to his fellow team mates? No doubt the lower earners would have benefited, but only in the short-run. In the long-run, Jordan and other valuable players would start to feel unrecognised and cheated and, simply, would choose not to play any longer, to the detriment of the whole team. If such redistribution policies are entrenched here in South Africa, everyone here would suffer from the loss of highly-motivated, successful people like the USA’s Michael Jordan.

AUTHOR Jasson Urbach is an economist with the Free Market Foundation. This article may be republished without prior consent but with acknowledgement to the author. The views expressed in the article are the author’s and are not necessarily shared by the members of the Foundation.

FMF Feature Article / 16 October 2012