What do we really know about income inequality - and how does it affect you?

If you watch the news or read the papers, chances are you have heard about income inequality. The issue is complex and polarizing. But what does income inequality really mean? And what are the consequences? In this post, Uma Rani Amara, Senior Economist, and Marianne Furrer, Research Officer in the ILO’s Research Department unpack income inequality, how it affects people’s lives, and what can be done to reduce it. This article was originally a two-part series on the ILO's 'Work in Progress' blog.

For anyone who’s still in the dark about income inequality, it’s essentially the uneven way in which income is distributed within a population. A recent report shows that inequality seems to be reaching new extremes, with the richest one per cent having more wealth than the rest of the world combined.

At the ILO, we’ve been studying income inequality for a long time with an eye towards answering three major questions:

  1. What drives income inequality?
  2. How does income inequality affect people?
  3. What can we do to reduce income inequality?

To begin answering those questions, we can look at some of our latest research, particularly the data from countries in the G20, a group of the world’s 20 largest economies. As you might expect, income inequality across the G20 varies significantly, a fact owing to differing policies on labour, taxes and welfare among other factors.

These differences allow us to identify some common denominators which can help us to better understand income inequality and its impact on our societies.

The most commonly used measure of inequality is the Gini coefficient. It ranges from 0 to 1, with 0 indicating perfect equality and 1 perfect inequality (i.e. one person has all the income while all others have none). The higher it is, the more inequality you have.

The most commonly used measure of inequality is the Gini coefficient. It ranges from 0 to 1, with 0 indicating perfect equality and 1 perfect inequality (i.e. one person has all the income while all others have none). The higher it is, the more inequality you have.

Here are a few of the things that we’ve learned over the course of our research:

  1. Income inequality traps people in poverty. Skewed income distribution is a sign that the economy had a chance to improve living conditions for the poor, but didn’t take it. As a result, lower-income families find themselves at an increasing disadvantage compared to wealthier households in terms of access to things like education, credit and even food—the very things they need to pull themselves out of poverty.
  2. Income inequality concentrates political power in the hands of the few. Political contests have long been marked by significant spending of money and resources. Elected officials often depend on private contributions to fund their campaigns. Wealthier households who are better able to make those contributions engender a system where government becomes more responsive to their needs than to those of lower-income households. As such, income inequality can diminish the ability of lower-income families to make their voices heard in government and society.
  3. Wealth often determines a person’s earning potential. Labour income (mostly through wages) is the biggest source of income for all G20 countries and accounts for 75 per cent of income in emerging economies. It’s normal for people to be paid differently according to their skills, experience and type of work. Unfortunately, factors like gender and ethnicity can play a role as well. But perhaps the biggest factor determining a person’s income potential is whether or not they’re already wealthy.
  4. High levels of income inequality go hand in hand with high rates informal or non-standard work. ILO research shows that globally, workers who have permanent, formal contracts earn a higher average annual income that workers who don’t. As such, countries with higher rates of irregular work tend also to have higher levels of income inequality.
  5. Income inequality makes it harder for poor families to benefit from economic growth. Globalization and new technologies have together shifted the demand for labour from low-skilled workers to high-skilled workers. As a result, workers from lower income families, with less access to training and education, are at once at greater risk of losing their current jobs and less able to get new or better ones. This makes income inequality a major hurdle to inclusive economic growth.
  6. Strong social protection systems can reduce income inequality. ILO research shows that countries with stronger social protection systems generally have lower levels of income inequality. The more restrictive the system, the more likely it is that vulnerable groups like non-standard and informal workers, the unemployed or the elderly—are negatively affected by income inequality.
  7. What other factors affect income inequality? As we said before, income inequality differs across countries. In China, it has a strong regional component while in the USA and Turkey, age is a significant factor. Ethnicity continues to be a powerful driver in South Africa.

Here are a few ways that income inequality can affect our daily lives, whether we realize it or not:

  • It can cause social and political unrest. A growing body of research, including ILO’s World of Work Report for 2014, shows that high-levels of income inequality can undermine social cohesion in the long run, giving rise to events like the Arab Spring. This is not to say that income inequality was the only or the biggest factor leading to the upheaval – but it was certainly one of them. It’s not hard to understand why this happens. Income inequality concentrates more and more of a country’s wealth in the hands of the few. When times are good, people in lower income brackets may be willing to overlook the unequal distribution. But in times of hardship, it becomes an obvious source of resentment.
  • It can change the quality of jobs and affect wages. One of the many drivers of income inequality are the increasingly common forms of what we call “non-standard employment” or “informal employment”. This refers to people who either work outside of the formal economy, have temporary job contracts or are self-employed. ILO research shows that the more common non-standard employment becomes, the more inequality tends to rise. These kinds of jobs usually pay less and aren’t as protected, which makes it difficult for the people who do them to plan for the future. These workers are especially vulnerable in economies without strong social protection systems. When hard times hit, they may have no other option but to look to their families for help. With more and more people in non-standard employment, these support networks are placed under added strain.
  • Poverty and Social Assistance programmes. In economies where income inequality is high, poverty levels tend to be high too. This is further exacerbated in economies where institutional mechanisms are weak or non-existent. In response, governments often step in to introduce social assistance programmes that can assist those who need protection. However, these programmes can sometimes be ineffective if they are not well targeted.

ILO Director-General Guy Ryder has repeatedly emphasized that tackling income inequality requires a systematic plan of action. The good news is that more and more world leaders are beginning to agree.

At a recent summit of the G20 in China, world leaders committed to “work[ing] to ensure that our economic growth serves the needs of everyone and benefits all countries and all people including in particular women, youth and disadvantaged groups, generating more quality jobs, addressing inequalities and eradicating poverty so that no one is left behind.”

What will that mean in practice?

First, it’s important to understand that the best place to begin addressing income inequality is the labour market. Tackling issues such as working poverty and workplace discrimination are critical to solving income inequality. Similarly, measures need to be taken to address rising informality and non-standard employment. In addition, unemployment and underemployment are both issues that need remedy–by providing economic opportunities to the poor and disadvantaged, it will be possible to reconfigure the distribution of market incomes.

Second, governments should put in place fair minimum-wage schemes and promote social dialogue as a means of translating global agreements—like the one formalized at the G20 summit in China—into sustainable solutions. In advanced economies, policies are needed to respond to increasing levels of precarious employment and to incentivize better terms for all employees. This would entail, for example, the extension of benefits to temporary and part-time workers.

Finally, social protection is a powerful tool to remedy income inequality and should be extended to all members of society. Progressive taxation can help to pay for these programmes in ways that ensure no one gets left behind. This would also include creating a gender-sensitive policy plan to prevent discrimination against women, both inside and outside the labour market.

This article was originally a two-part series on the ILO's 'Work in Progress' blog, and is based on data and the findings of the ILO Research Paper No. 15 and World Economic and Social Outlook 2016.