Inequality in income and wealth affects social cohesion, economic efficiency, and development. This topic explores how to define, measure, explain, and respond to inequality.
Definitions of inequality
Income inequality
Income inequality refers to the uneven distribution of earnings among individuals or households in an economy over a specific time period, usually one year. Income includes wages and salaries, pensions, dividends, rent, interest, and government transfers such as unemployment benefits or tax credits.
It can occur when a small portion of the population receives a disproportionately large share of total income.
For example, if the top 10% of earners in a country receive 40% of the national income, while the bottom 50% share only 20%, income inequality is said to be high.
In many economies, the growing share of income earned by high-skilled workers and capital owners has contributed to widening income inequality.
Wealth inequality
Wealth inequality is the unequal distribution of assets owned by individuals or households. Unlike income, wealth is a stock variable, meaning it reflects accumulated value at a point in time.
Wealth can include:
Property and land ownership
Financial assets such as stocks, bonds, savings, and pensions
Business ownership and capital equipment
Personal valuables like jewellery and art
Wealth inequality is usually more pronounced than income inequality because:
Wealth accumulates over time and can be inherited.
Wealth generates passive income (e.g., rent, interest), which reinforces inequality.
Those with wealth can invest in education, health, and opportunities, increasing their ability to earn more.
Measures of income inequality
Lorenz curve
The Lorenz curve is a graphical tool used to illustrate the distribution of income or wealth within a population.
The x-axis represents the cumulative percentage of the population, starting from the poorest to the richest.
The y-axis shows the cumulative percentage of total income received.
If everyone had exactly the same income, the Lorenz curve would follow the line of perfect equality, a 45-degree diagonal from the origin to the top-right corner.
The more the Lorenz curve sags below the line of equality, the greater the level of inequality.
A perfectly unequal distribution (where one individual receives all income) would produce a Lorenz curve that runs along the x-axis and then rises vertically at the far right.
Lorenz curves can be used to compare inequality over time or between countries.
Gini coefficient
The Gini coefficient is a numerical representation of inequality derived from the Lorenz curve.
It measures the area between the line of equality and the Lorenz curve (Area A), divided by the total area under the line of equality (Area A + Area B).
Gini coefficient = Area A / (Area A + Area B)
The Gini coefficient ranges from 0 to 1:
0 represents perfect equality (everyone earns the same income).
1 represents perfect inequality (one person earns all the income, everyone else earns nothing).
A Gini coefficient can also be expressed as a percentage, from 0 to 100.
Countries with a Gini coefficient below 0.30 are considered relatively equal (e.g., Sweden, Norway).
Coefficients above 0.50 indicate high inequality (e.g., South Africa, Brazil).
The Gini coefficient is widely used due to its simplicity but has limitations:
It does not identify where in the distribution inequality occurs.
It can mask differences between countries with the same coefficient but different income structures.
Causes of income and wealth inequality
Within countries
Education and skills
Access to quality education significantly impacts lifetime earnings.
Individuals with higher educational qualifications tend to earn more and have lower unemployment rates.
Differences in education quality and attainment between social groups contribute to income gaps.
A failure to invest in education can leave entire segments of the population locked into low-skilled, low-paid jobs.
Taxation and welfare systems
Tax systems influence the post-tax income distribution.
Progressive taxes (where higher earners pay a larger percentage of their income) reduce inequality.
Regressive taxes (e.g., sales taxes) disproportionately affect lower-income households.
Welfare benefits such as unemployment payments, child support, and housing allowances can reduce poverty and inequality.
Inequality tends to be higher in countries with weak welfare systems and flat or regressive tax structures.
Inheritance and intergenerational transfer
Wealth passed down through generations enables the accumulation of assets and opportunities by certain families.
Inherited wealth leads to unequal starting points in life, reinforcing long-term disparities in income and wealth.
Access to inheritance can enable business investment, home ownership, and higher education.
Market structure
In markets dominated by a few firms (monopolies or oligopolies), profits can be highly concentrated.
Workers in these sectors may receive high salaries, while others earn considerably less.
Globalisation and deregulation have increased the earnings of highly skilled professionals and capital owners, while reducing wages in some traditional sectors.
Discrimination
Income gaps may arise due to gender, racial, ethnic, or age-based discrimination.
Discriminatory hiring practices and wage structures contribute to unequal outcomes, particularly for minority groups.
Wage disparities
Executives and professionals in finance, law, and technology can command much higher salaries than those in service or manual labour sectors.
Automation and technological change have increased the wage premium for high-skilled jobs while reducing demand for low-skilled labour.
Between countries
Access to resources
Countries with abundant natural resources (oil, minerals, arable land) may enjoy higher incomes.
However, resource wealth can also lead to corruption and unequal distribution, known as the “resource curse.”
Colonial history
Former colonial countries often inherited institutions that favoured elites and excluded the majority from education and land ownership.
Unequal land distribution and limited access to capital have constrained growth and reinforced inequality.
Technological advancement
Countries leading in technology reap substantial economic benefits.
Others may struggle to adapt due to lack of infrastructure, skills, and investment, widening the global income divide.
Trade patterns
Nations exporting high-value manufactured goods or services benefit more from global trade than those reliant on low-value primary goods.
Unequal terms of trade contribute to persistent international inequality.
Economic change and development impacts
Structural change
As economies develop, they often shift from agriculture to industry and services.
This can increase inequality if new job opportunities are concentrated in urban areas while rural populations remain poor.
Formal sector jobs with regular wages tend to pay more than informal sector or subsistence agriculture.
For example:
In China, rapid industrialisation lifted hundreds of millions out of poverty but also widened the urban–rural income gap.
Growth patterns
The nature of economic growth matters. Inclusive growth shares benefits broadly across society.
Exclusive growth, where gains accrue to a narrow elite, can worsen inequality despite rising GDP.
Fast-growing developing countries may see inequality rise in early stages of growth, known as the Kuznets curve hypothesis.
Foreign direct investment (FDI)
FDI can stimulate job creation, technology transfer, and economic expansion.
However, FDI may be concentrated in specific sectors or regions, increasing regional inequality.
Profits may be repatriated abroad, limiting local benefit.
Industrialisation
Large-scale industrialisation brings higher productivity and income.
However, it can lead to the displacement of traditional sectors, unemployment, and widening income gaps without supportive social policies.
Capitalism and inequality
Market-based incentives
Capitalism rewards efficiency, innovation, and entrepreneurship, often leading to unequal outcomes.
Those who innovate or take risks are rewarded with higher returns.
Unequal returns to capital and labour
Capital earns income through profits, interest, and rent. Labour earns wages and salaries.
Returns to capital often outpace wages, especially when labour bargaining power is weak.
This can lead to a growing share of national income accruing to wealth owners rather than workers.
Thomas Piketty famously argued that r > g (where the rate of return on capital r is greater than the rate of economic growth g) results in widening inequality unless offset by redistributive taxation.
Innovation, competition, and accumulation
Technological innovations often generate large rewards for a small number of individuals or firms.
Accumulated wealth leads to further investment and capital income, compounding inequality.
Competitive markets can drive efficiency, but in winner-take-all industries (e.g., digital platforms), dominant firms can entrench inequality.
Limited redistribution
In the absence of effective taxation and welfare systems, market outcomes alone lead to significant disparities.
Some capitalist economies have stronger social safety nets (e.g., Nordic countries), while others (e.g., the US) rely more on market outcomes.
Policy responses to inequality
Progressive taxation
In a progressive system, tax rates increase with income.
For example, higher earners may pay 40% or more in income tax, while lower earners pay 10–20%.
Benefits:
Reduces disposable income inequality.
Funds public services and welfare programmes.
Drawbacks:
Risk of reduced incentives to work or invest if rates are too high.
Wealthy individuals may engage in tax avoidance.
Education and training
Improving access to high-quality education boosts skills and productivity.
This enhances employability and reduces inequality over time.
Examples:
Expanding early childhood education.
Investing in tertiary and vocational education.
Healthcare
Healthier individuals are more productive and can work longer.
Universal healthcare access reduces inequality caused by illness and healthcare costs.
Wealth taxes
Taxes on property, capital gains, and inheritance help reduce wealth concentration.
Benefits:
Provides government revenue.
Addresses long-term inequality.
Challenges:
Difficult to assess true wealth value.
Risk of capital flight and reduced investment.
Universal Basic Income (UBI)
A guaranteed payment to all citizens, regardless of income or employment status.
Advantages:
Simplifies welfare administration.
Provides income security and reduces poverty.
Disadvantages:
Very costly to fund at a meaningful level.
May reduce labour force participation.
Equity and efficiency trade-offs
Governments must balance fairness and economic efficiency.
Policies like higher taxes may reduce incentives to work or invest, but promote social cohesion.
Efficient redistributive systems seek to minimise distortions while enhancing equality of opportunity.
FAQ
Wealth inequality is usually more extreme than income inequality because wealth accumulates over time and often generates additional income through returns on investment, such as interest, rent, and dividends. Unlike income, which is typically earned through labour, wealth can be inherited, gifted, or passively acquired. This creates a cycle where those who already possess significant wealth can continue to grow their assets without actively working, while those with little or no wealth have fewer opportunities to accumulate it. Additionally, wealth provides access to better education, healthcare, legal advice, and financial services, reinforcing advantages across generations. Furthermore, asset prices, particularly for property and stocks, tend to rise faster than wages, making it easier for asset-holders to outpace income earners. Tax systems also often favour capital over labour, with lower rates on capital gains and inheritance in many countries, further entrenching wealth inequality. These structural advantages mean that wealth is far more unequally distributed than income.
The Gini coefficient, while a useful indicator of income inequality, has several limitations that reduce its ability to give a complete picture. Firstly, it does not reveal the actual distribution of income among different segments of the population. Two countries with identical Gini coefficients may have very different income patterns; for instance, one might have a large middle class while the other has a wide gap between the rich and the poor. Secondly, it is sensitive to changes in the middle of the distribution but less responsive to extreme poverty or extreme wealth. This means it might not fully reflect changes that most affect the poorest or richest groups. Thirdly, the Gini coefficient does not distinguish between income inequality within and between different demographic groups, such as regions, genders, or ethnicities. Lastly, it only measures relative inequality and does not indicate whether living standards are improving overall. Therefore, it should be used alongside other measures for a fuller analysis.
Intergenerational mobility refers to the extent to which individuals can move up or down the economic ladder relative to their parents. It is closely linked to income and wealth inequality, as higher inequality tends to reduce mobility. When wealth and income are heavily concentrated among certain families, those born into lower-income households may find it harder to access quality education, healthcare, and social networks that are critical for upward mobility. Wealthy families can afford private schooling, university fees, and unpaid internships, giving their children significant advantages. Moreover, property ownership and savings passed down through inheritance enable some to start life with financial security, while others begin with debt or no assets. This entrenches inequality and limits equal opportunities. Societies with low intergenerational mobility, such as the US and UK, tend to have high income inequality, whereas countries like Denmark and Finland, with more equal societies, also exhibit higher levels of mobility across generations.
Horizontal inequality refers to disparities between groups of people who share a common identity or characteristic, such as ethnicity, religion, gender, or region. These inequalities persist even when individuals have similar income or education levels, and they often arise from discrimination, cultural norms, or unequal political representation. For example, women may be paid less than men for the same job, or ethnic minorities might face barriers to employment despite having equal qualifications. Vertical inequality, on the other hand, refers to differences between individuals or households ranked by economic status—such as differences in income or wealth levels. This form of inequality is typically captured by measures like the Gini coefficient or income deciles and is concerned with the overall distribution across the population. Understanding both is important because addressing vertical inequality alone may not resolve deeper structural injustices linked to identity and group-based disadvantage. Effective policy must target both individual outcomes and systemic group disparities.
Income inequality becomes politically and socially contentious because it influences perceptions of fairness, opportunity, and the legitimacy of economic systems. In highly unequal societies, people may feel that success is determined more by birth than by effort or talent, eroding trust in institutions and the social contract. When large segments of the population feel excluded from economic progress, social tensions can rise, leading to unrest, protests, or even populist political movements that challenge existing governance structures. Politically, inequality can affect voter behaviour and policymaking. Wealthier groups may exert disproportionate influence over political decisions through campaign financing or lobbying, potentially leading to policies that favour elite interests. At the same time, widespread inequality can pressure governments to adopt redistributive policies, such as higher taxes or increased social spending, which may be opposed by wealthier voters. The debate becomes highly polarised between arguments for economic freedom and efficiency versus calls for social justice and equity. Thus, inequality is not just an economic issue but a deeply political and moral one.
Practice Questions
Explain how the Gini coefficient and the Lorenz curve can be used to measure income inequality.
The Gini coefficient is a numerical representation of income inequality, ranging from 0 (perfect equality) to 1 (perfect inequality). It is derived from the Lorenz curve, which plots the cumulative percentage of income earned against the cumulative percentage of the population. The further the Lorenz curve lies below the line of perfect equality, the greater the inequality. The Gini coefficient calculates the area between this line and the Lorenz curve, relative to the total area under the line. A higher Gini coefficient indicates more income inequality. Together, they allow visual and numerical analysis of income distribution.
Evaluate the effectiveness of government policies in reducing income and wealth inequality.
Government policies such as progressive taxation, welfare spending, education investment, and healthcare provision aim to reduce inequality by redistributing income and improving equality of opportunity. Progressive taxes reduce disposable income gaps, while welfare benefits support low-income households. Education and healthcare improve long-term outcomes, reducing structural inequality. However, high taxes can reduce incentives to work or invest, and some benefits may not reach intended recipients. Wealth taxes are difficult to implement and may trigger avoidance. Overall, policies can be effective if well-targeted and efficiently administered, but trade-offs between equity and efficiency must be carefully managed to avoid unintended consequences.
