What’s it: Income distribution is about how the income or wealth of the economy is shared among its citizens. It is fair when income is evenly distributed to all people who really need it and are on target. Thus, there is no sharp disparity between the rich and the poor. The poor get access to increase their income and improve their social status, just like the rich. When the poor do not have the same facilities as others, the government intervenes, for example, by providing assistance such as allowances, access to education and training, job opportunities, and other programs.
Why is income distribution important?
Income and its distribution are the main concerns of policymakers. When income is unequally distributed, economic inequality arises. And inequality has become a focus in almost every country in the world. Many health and social problems arise because of it, including:
- Poor educational attainment
- Low social mobility
- Increased level of violence
- Decreased life expectancy
- Higher infant mortality
- Increased mental illness
Many countries pursue high economic growth for the welfare of their citizens. But, that’s not the ultimate solution. Many countries achieve that, but inequality is increasing. Income is not distributed effectively because the factors of production are concentrated in the owners of capital or those who are rich. Finally, when the economy grows high, the rich get richer. In contrast, the poor find it difficult to move out of the poverty line and move up the social ladder.
On the other hand, income inequality affects economic growth. Countries with decreasing inequality are growing faster than countries with increasing inequality. When income distribution is relatively even, everyone has access to higher education, which is important for building reliable human capital. As in the theory of long-term economic growth, human capital is a key to growth in the long term besides capital investment.
What is the relationship between income distribution and the economic system?
In economics, income in the economy is divided among the suppliers of factors of production. Factor suppliers will receive compensation. For example, landowners will receive rent as compensation. Labor suppliers earn wages. Meanwhile, the capital owners receive interest, and entrepreneurs receive profits.
Since the economic system determines the ownership of the factors of production, it also affects how income is distributed in the economy. Under a free market system, private companies and individuals control the factors of production. And the distribution of income is determined by the law of supply and demand. The government does not interfere.
On the other hand, under a socialist economic system, everyone in society owns the factors of production. And, usually, it’s all regulated by the government. Thus, the government regulates the distribution of income among its citizens.
Meanwhile, the private sector and the government both participate under a mixed system. The government controls strategic and vital sectors. The rest is left to the private sector. And under this system, market mechanisms and government policies determine the distribution of income in the economy.
What are the factors affecting the income distribution?
Several factors affect the distribution of income. The macroeconomic variables usually associated with an increase in the income distribution are:
- Higher growth rate
- Higher income level
- Higher investment rate
- Real depreciation
- Improvements in terms of trade
Other factors are inflation, unemployment, and labor participation rates, especially in Asian countries. In addition, official development assistance, education levels, and political stability also contribute.
Population growth is another factor. High population growth is associated with an uneven distribution. Conversely, a decrease in population growth tends to increase distribution. And this argument is usually associated with theories of urbanization and growth in metropolitan areas.
What are the indicators to measure inequality in income distribution?
Two indicators to measure how income is distributed in an economy, namely:
- Gini coefficient
- Lorenz curve
The Gini coefficient is a statistic to measure the distribution of income or wealth among citizens of a country. It is the most frequently used metric to measure inequality. The coefficient value ranges from zero to one. A coefficient of zero means perfect equality. Conversely, a coefficient of one means perfect inequality, where one person controls all income or wealth in the economy.
The Lorenz curve graphically represents the distribution of income or wealth in a country. The X-axis illustrates the cumulative percentage of the population by income, from lowest to highest. Meanwhile, the Y axis shows the cumulative percentage of earned income. A straight 45-degree diagonal line represents perfect equality so that, for example, the poorest 25% of the population would represent 25% of total income.
How to reduce inequality in income distribution?
Income inequality is a complex issue. And dealing with it can involve several ways, including:
Implement progressive income tax. Taxes are determined based on the ability of the taxpayer to pay. Thus, those with higher incomes bear higher tax rates than those with lower incomes.
Housing subsidies. Rent or house maintenance can be significant for a poor family’s expenses. Thus, housing subsidies are designed to assist them in obtaining adequate housing.
Unemployment benefits. Aid allows the unemployed to sustain their lives before getting a new job. This is important to prevent them from falling economically during unemployment.
Transfer in kind. An example is food stamps. This is an alternative to cash assistance.
Create jobs. Many people are stuck on the poverty line because they have been unemployed for a long time. Thus, growing the economy is a way to create more jobs and income for many people.
Invest in quality education. Education opens up new opportunities for children from poor families to improve their social status. With higher education, they can earn higher incomes.
Unlock more job skills training. Providing more skills training will improve the quality of workers, leading to higher wages. Or at least they are not trapped in unemployment because their skills do not match the market demand.
Increase the minimum wage. Higher wages increase household income. Thus, they can access more goods and services than they need to survive. For example, higher wages allow them to access higher education, attend skills training, or save for their future.
What to read next
- Inflation Rate: How to Calculate, Types, Effects of Economic Policy
- Unemployment Rate: Formula, Types, Causes, and Effects
- Balance of Payment: Meaning, Formula, Component, Importance
- Economic Growth: Factors, Importance, Impacts, How to Measure It
- Income Distribution: How to Measure and Overcome Inequality
- What are the 5 macroeconomic objectives
- Possible Conflicts Between Macroeconomic Objectives