Why has American income inequality increased?

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  • Income inequality has increased in many countries. This applies to most industrialized countries and in particular to the USA, even if, globally and across national borders, income inequality has declined in recent decades.
  • In Germany, the inequality of disposable income is relatively low in an international comparison and has been stable since 2005. The German tax and transfer system in particular has a balancing effect.
  • When it comes to wealth inequality, however, the international comparison for Germany reveals a different picture. Germany also continues to face challenges when it comes to equal opportunities in the education system.
  • France's initiative to make inequality an important issue for this year's G7 presidency is supported by the German government.

introduction

Social inequality plays a major role in economic and socio-political discussions. Social inequality and have also been an important topic in discussions among the G7 and G20 for years. The French government has made inequality a priority of its G7 presidency this year.

In order to approach the topic of social inequality, different dimensions of social inequality have to be considered. Income inequality plays an important role in the public discussion. Inequality in the distribution of wealth is another dimension of social inequality. Equal opportunities also belong in this context, because inequalities are more likely to be accepted as fair if they are the result of individual action and not external factors that determine success and failure.

Has been explicitly on the G20 agenda since 2015 and has been explicitly mentioned in the communiqués as a G20 goal since 2016 (“Strong, Sustainable, Balanced and Inclusive Growth”). The concept of “inclusive growth” expresses the will that as many people as possible should benefit from economic growth and that no one should be left behind. The World Bank relates its measure of “shared prosperity” to inclusive growth, since it measures how much economic growth actually reaches the low-income segments.

Income inequality

Comparatively reliable data are available for recording income inequality, at least for the industrialized countries. However, there are a variety of methods and metrics that can be used to measure income inequality. This is the most commonly used indicator.

The Gini coefficient

measures the deviation of actual incomes from a perfectly equal distribution. If the incomes are the same for all individuals, the Gini coefficient takes the value 0. If a single individual earns the entire income it is 1. The problem with the Gini coefficient is that it cannot capture the structure of inequality. For example, an increase in the Gini coefficient does not provide any information about whether the income of the middle class has decreased compared to the upper income, or whether the poorest part of the population has been left behind. Such a distinction would be important for a political evaluation.

While the Gini coefficient looks at inequality across the entire distribution, other measures of inequality look at the edges of the distribution. The intuitive measure of the 80:20 quintile ratio, which is also collected by the Organization for Economic Co-operation and Development (OECD) and Eurostat, relates the average income of the richest 20% to the average income of the poorest 20%. The World Inequality Report (WIR), in turn, which, inter alia, is published by Thomas Piketty, puts the income development at the upper end of the distribution in the foreground and considers in particular the income share of the richest percent or the richest ten percent of the population in total income. The World Bank, on the other hand, focuses on the lower end of the income distribution with its measure of “shared prosperity”. It looks at the income growth rates of the poorest 40% of the population.

Regardless of the inequality measure used, when analyzing income inequality, a distinction must be made between market income (before redistribution through the tax and transfer system) and disposable income (after redistribution). While market income is interesting for the analysis of market processes, the disposable income is important for welfare analysis. Unless explicitly mentioned, developments in disposable income are presented below.1

Inequality on a global scale

If one looks at the entire world population, most studies state that income inequality as measured by the Gini coefficient has decreased over the past two decades. This is mainly due to the successes in fighting poverty, especially in East Asia.

However, not all research publications support the statement of decreasing global inequality. The WIR 2018 paints a different picture. If one considers the benchmark predominantly used there (income of the richest percentages relative to the income of the poorest 50%), the statement of decreased income inequality on a global level cannot be understood. Even in countries that have had great successes in fighting poverty, such as B. China, the income shares of the richest percent have risen sharply. Therefore, the WIR overall does not come to the conclusion that income inequality has decreased worldwide.

Gini coefficients1 of the G7 countries since 1994
The line chart shows the gender pay gap between 2000 and 2016 in different countries.
1 Gini coefficient of disposable income, after taxes and transfers.
Source: OECD
yearCanadaFranceGermanyItalyJapanUnited KingdomUnited States
19940,287zero0,268zerozero0,3370,366
19950,289zero0,2660,3270,323zero0,361
19960,2970,2770,26zerozerozero0,363
19970,3010,2780,259zerozerozero0,364
19980,3070,2760,259zerozerozero0,357
19990,3070,2840,259zerozero0,340,354
20000,3150,2870,2640,3230,3370,3520,357
20010,3170,2870,27zerozero0,340,36
20020,3180,2840,28zerozero0,3350,376
20030,3160,2820,282zero0,3210,3350,374
20040,3220,2830,2850,331zero0,3310,36
20050,3170,2880,297zerozero0,3350,38
20060,3170,2930,29zero0,3290,3390,384
20070,3180,2920,295zerozero0,3410,376
20080,3210,2930,2870,317zero0,3420,378
20090,320,2930,2880,3150,3360,3450,379
20100,3190,3030,2860,321zero0,3410,38
20110,3160,3090,2930,326zero0,3540,389
20120,3170,3050,2890,330,330,3510,389
20130,320,2910,2920,325zero0,3580,396
20140,3130,2930,2890,326zero0,3560,394
20150,3180,2950,2930,3330,3390,360,39
20160,3070,291zero0,328zero0,3510,391

Income inequality in the G7 countries and in Germany

In most developed countries, income inequality has increased over the past two decades, as Figure 1 shows. Notable exceptions are Norway, Finland and Iceland, where inequality as measured by the Gini coefficient has decreased.

This result also applies if the 80:20 quintile ratio is used instead of the Gini coefficient, as shown in Figure 2. According to both concepts, the USA recorded the greatest increase in inequality in the G7 countries. Compared to the USA, both the level and the increase in income inequality are moderate in the European countries.

80:20 quintile ratio1 of the G7 countries since 1994
The line diagram shows the proportions of the income quintiles in the G7 countries since 1994.
1 Ratio of the average income of the highest income 20% of the population to the average income of the lowest income 20% of the population. Here: disposable income, after taxes and transfers.
Source: OECD
yearCanadaFranceGermanyItalyJapanUnited KingdomUnited States
19944,5zerozerozerozero5,5zero
19954,5zero3,95,95,7zero6,9
19964,74,1zerozerozerozerozero
19974,8zerozerozerozerozerozero
19984,9zerozerozerozerozerozero
19995zerozerozerozero5,6zero
20005,14,23,95,66,35,96,9
20015,1zerozerozerozero5,7zero
20025,2zerozerozerozero5,5zero
20035,1zerozerozero5,85,5zero
20045,3zero4,25,6zero5,4zero
20055,24,2zerozerozero5,47,8
20065,1zerozerozero65,7zero
20075,2zerozerozerozero5,7zero
20085,34,34,35,3zero5,87,7
20095,34,34,35,36,25,77,7
20105,24,54,35,6zero5,67,9
20115,24,74,45,7zero5,98,2
20125,34,64,35,96,15,98,2
20135,54,34,45,8zero68,6
20145,24,44,45,9zero68,7
20155,54,44,56,36,26,18,3
20165,14,34,65,9zero68,5

If one compares the development of inequality in the USA and Western Europe, clear differences become apparent. This is particularly true if one looks at the development of the share of the highest income percentage of the population in total income and relates this share to the income shares of the poorest 50%. As Figure 3 shows, this ratio has almost reversed in the USA, while the development in Europe appears to be very moderate.

In Germany, too, income inequality is somewhat higher today than it was two decades ago. After a certain increase after reunification, the inequality of disposable income as measured by the Gini coefficient has been stable in Germany since 2005. However, a current study by the German Institute for Economic Research shows that the income gap has widened slightly but statistically significantly since 2010. Overall, income inequality in Germany with a Gini coefficient of around 0.29 is relatively low in an international comparison and is just below the OECD average of 0.32. In Germany, the difference between market income and disposable income is also very high in an international comparison - similar to France. The reason for this is the comparatively high degree of redistribution, especially via the tax and transfer system, so that despite the relatively uneven distribution of market income, the inequality of disposable income is relatively low in an international comparison, as Figure 4 shows.

Is global economic growth reaching all levels of the population?

In East Asia and the Pacific region, but also in Latin America and the Caribbean, there was a relatively high average growth in the income and consumption of the lowest-income 40% of the population in the period 2010-2015. In East Asia in particular, good educational successes and export-oriented growth in the manufacturing sector were growth drivers, especially for the incomes of the poorest 40%. Often the growth rates of the income of the poorest 40% exceed the growth rates of the income of the population as a whole.

In most industrialized countries, on the other hand, only slight growth, stagnation or even a decline in lower incomes can be observed between 2010 and 2015. It is significant that in countries affected by an economic downturn, the incomes of the poorest 40% have declined at an above-average rate. This applies, for example, to Spain, Greece, Cyprus, Portugal and Italy. For Germany, the World Bank recorded slight growth in real incomes on average in the period 2010-2015, but the poorest 40% would have suffered an average annual income loss of 0.18%.

Causes of increasing income inequality

One explanation for the increased income inequality in some industrialized countries in the last two decades is the declining one, i.e. the shift of factor income away from work towards capital, which is due, among other things, to automation, but also to the migration of manufacturing industries to low-wage countries.

The wage share

is the share in the economic output of a national economy that is generated by the factor labor. Capital income such as interest, dividends or rental income are not included.

It is often argued that the relocation of jobs from the manufacturing sector to the service sector results in losses in productivity and income. The IMF shows, however, that the relocation of labor to the service sector is not necessarily associated with lost productivity and that inequality has increased within individual economic sectors.

The fact that in a globalized economy the capital factor is far more mobile than the labor factor is also reflected in factor wages. The share of investment income has risen worldwide over the past few decades, while the wage share has fallen. This is relevant for the distribution of disposable income, since capital income is more unequally distributed than labor income. Since 1970 the wage share has fallen significantly in almost all industrialized countries. However, Figure 5 also shows that this development has varied greatly from country to country since 1970. The OECD does not hold any data for the wage share prior to 1970.

If we use data from the Federal Statistical Office, it can be seen for Germany that the wage share had reached its peak in the early 1980s. If one chooses 1950 as the base year, the finding of a falling wage share for Germany changes over time, because the wage share is still higher today than in 1950, as Figure 6 shows.

International comparison of the wage share from 1970 onwards
The line diagram shows the wage share from 1970 in an international comparison between 1970 and 2012.
yearCanadaFranceGermanyItalyUnited States
197067,9041477,9849273,1484780,372769,47986
197168,1474277,9558573,9354783,363368,5668
197268,0579177,157974,5255682,5609468,33058
197366,0177875,8293275,3626481,6401468,16059
197465,8722277,019176,2735680,3099769,34931
197566,7044980,3704676,0106482,721268,37968
197666,9691480,524375,2554281,3983368,28029
197766,7469380,0249975,2725981,829868,1604
197865,2250479,9094275,3037781,086268,25721
197963,7857279,7573474,8251479,8733168,87105
198063,1708580,0992775,8474479,4914569,59779
198164,5357880,3283375,8369281,0250768,1596
198265,6346980,4433374,9621880,5984668,95372
198363,3591679,4397273,4320281,50168,59631
198462,4728978,3190572,664179,6595867,46698
198562,6487477,0867371,979278,607867,53373
198663,5595774,6812271,6572476,8559868,20468
198763,4973,8485172,8637976,7470568,1914
198863,7288471,9109671,7134176,1956967,76199
198964,3283570,3778470,3494475,5859967,65607
199065,1991170,4374369,88376,4356568,1846
199166,8176770,5801871,5343176,9507868,62012
199267,1062569,9098372,5996777,364468,67377
199366,2053569,7877272,7969275,38568,67938
199464,1008668,9622771,743272,6920167,98676
199562,7978468,7438671,7334170,4347767,46593
199662,6174668,9248371,5017370,3015466,72389
199762,9718368,3535370,5551470,7893766,32828
199863,9612967,4993970,465167,9808666,95809
199962,6124767,852671,2110867,6968766,77181
200061,2867267,6054472,0300966,1382967,70476
200161,6569267,5398271,3229165,7756367,4786
200261,7545367,9341170,616565,9012366,76959
200361,1939767,9045570,5729666,4534366,73893
200460,7591467,5672869,3247766,0149265,86397
200560,121467,5772568,3758866,6597165,19952
200660,6204367,5703266,5746567,0798965,15788
200760,6932466,7066965,2467666,5837565,1094
200859,752866,9124266,2276367,1550365,51527
2009zero68,5784569,8652868,5518164,84048
2010zero68,6393167,8107368,587863,80531
2011zero68,6447667,6450468,2508263,73501
2012zero69,036368,5118368,67993zero

Another explanation looks at the change in market structures. If the market structure changes, the possibility for market participants to “skim” also changes.

Economic pensions

In welfare economics, “rents” are those revenues that exceed revenues that could be achieved in a highly competitive market process. Examples of pensions are, for example, monopoly rents that a monopoly company earns solely on the basis of its market position.

The line diagram shows the wage share in Germany.
yearWage share in% (unadjusted)
195058,3
195158,08
195257,09
195358,74
195460,14
195559,71
195660,35
195760,37
195860,91
195960,16
196060,11
196162,41
196263,85
196364,89
196464,55
196565,31
196666,38
196766,16
196864,65
196965,69
197065,61
197167,4
197268,49
197369,58
197471,14
197571,09
197670,7
197771,4
197871,3
197971,57
198073,18
198173,61
198273,2
198371,57
198470,58
198569,98
198669,71
198771,16
198869,67
198968,17
199067,79
199169,85
199271,08
199371,64
199470,92
199570,72
199670,38
199769,58
199869,67
199970,78
200071,86
200171,04
200271,07
200370,91
200467,72
200566,63
200664,29
200763,6
200865,46
200968,44
201066,75
201166,06
201267,71
201367,96

These pensions can flow into the income of both capital owners and employees. Scientific studies show that since 1970 only 20% of the increased inequality in the USA can be attributed to income shifts from labor to capital. The rest has its origin in the unequal distribution within the respective factors and the occurrence and skimming of economic rents. These are e.g. B. influenced by the intensity of competition, the bargaining power of employees or network effects. The digital economy in particular is characterized by a “winner-takes-most” dynamic. Strong competitive advantages arise for rapidly growing digital companies e.g. B. through access to larger amounts of data or through reputation and network effects. The monopoly rents and profits of the market leaders are correspondingly high. It is true that these companies pay extremely high salaries due to the very high “qualification bonuses” in this sector. However, the high profits also in these “superstar companies” mainly benefit the capital factor. The market power of individual companies and the corresponding macroeconomic effects can be observed particularly in the USA. In its country report on the United States for 2018, the IMF states that the increasing market power of individual companies can have important macroeconomic effects, such as declining investment activity and less spending on research and development, as well as a further decline in the wage share.

The declining degree of organization of workers in trade unions can also help explain increasing inequality in industrialized countries. Unions strengthen the bargaining power of low-income earners and, in the context described above, increase their ability to skim off pensions that would otherwise be collected by higher-income groups. A number of empirical analyzes underscore the role of employee representatives in this context. Analyzes by IMF economists indicate that the top ten percent of income earners in particular benefit from a decline in union density on average. Similarly, the World Bank argues that social inequality in a society decreases when union density and membership increase, and increases when it decreases. A decline in the number of workers organized in trade unions can be observed in many industrialized countries. Collective bargaining coverage is also declining in many countries, as shown in Figure 7 for Germany, the USA, the United Kingdom and the OECD average.

% of workers with the right to collective bargaining

The line graph shows the collective bargaining coverage% of employees with the right to collective bargaining.
yearGermanyUnited KingdomUnited StatesOECD - total
1985856420,545,1
1986zerozero19,944,4
1987zerozero19,243,8
1988zerozero1943,5
1989zerozero18,643,2
1990854718,243
1991zerozero18,143,5
1992zerozero17,742,4
1993zerozero17,642,1
1994zero4017,541,2
199580,83616,740,2
199675,73716,239,3
199774,93615,638,5
199873,635,415,438,3
199970,636,115,337,9
200067,836,414,937,4
200168,835,514,737,3
200267,835,214,537,2
200367,635,514,336,8
200465,7534,713,836,2
200564,934,913,736
200663,3533,313,135,1
200761,6534,613,335,3
200861,3533,613,735,5
200961,7432,713,635,6
201059,7630,913,134,6
201158,931,21334,4
201258,329,312,533,5
201357,629,512,433,3
201457,827,512,333
201556,827,912,332,6
20165626,31232,2

Wealth inequality