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ECON305 – Economic Policy

Solution:

Essay

Introduction: Economic inequality refers to as income, wealth or interest that is distributed unevenly among individuals in a population. The income inequality is the indicator of the fair or unfair distribution in a society. To place the inequality trends in Australia to a broader context, it is objective to look at the economic landscape of Australia for the last three decades. The unparalleled economic growth of Australia for the past 25 years distinguishes it from other developed countries with a sustained period of disposable income growth in the years 1992-93 to 2007-08. This growth period had a number of cyclical as well as structural developments (Australia, 2018).

Microeconomic reforms implemented in the period of 1980s and 1990s such as privatization of public sector enterprises, reductions in tariffs, shift in wage determination from centralized power to bargaining at enterprise level, and reduced barrier to competition in markets for essential infrastructural facilities like gas, electricity etc. led to the sustained output and productivity growth (Australia, 2018).

Growth in housing prices in the early phase of 2000s is considered to be an important driver of wealth among the house owners. Residential property doubled in capital cities in the period of 2003-2017. Another trend that contributed to economic growth is mining investment boom in the years 2005 to 2013. As per Downes et al. (2014), mining boom led to the increase in real expendable income and real wages per capita, as well as decreased unemployment (Australia, 2018).      

The Global Financial Crisis (GFC) was a resilience to economic shocks for Australia. A brief reduction in per capita GDP was experienced by Australia immediately after GFC and a small increase in unemployment was witnessed in the recession period of 1990s. A substantial fiscal expansion and low interest were the measures taken to deal with the recession in the country. Moreover, employment and demographic trends such as rising labor force participation and an increasing ageing population also contribute to economic inequality in Australia (Australia, 2018).

Literature Review:

When examining economic inequality in Australia, Slesnick (1998) and Barrett et al. (2000) claimed that expenditure, rather than revenue or wages, is a more appropriate metric to analyze. Consumption is a reliable indication of an individual’s personal or household’s well-being. Income fluctuates, and if households can stabilize such swings via savings and bank debt, income becomes much more possible than expenditures, which may overestimate the degree of disparity in household wealth. Barrett et al. (2000) discovered that spending equals yearly revenue and that the increase of income and wealth during that period indicated cyclical responsiveness in inequity. These findings corroborate the research (Cutler and Katz, 1992; Pendakur, 2001) indicating that income gap in Australia has increased faster than consumption inequality.

Majority of the literature on income inequality in Australia in the last two decades is based on the ABS surveys of household income in Australia. Besides the ASB income survey publications, many researchers have studied the income inequality in Australia (Saunders et al., 1991; Barrett et al., 2000; Pappas 2001; OECD, 2011; Saunders, 1993 and Whiteford, 2013). All these studies have found that income inequality has risen in Australia over the last three decades.

Many scholars have paid attention to the mining impacts on income inequality Fleming and Measham (2015) discussed the impacts of mining activities such that it estimated Gini Coefficients for sub-regions of Australia and analyzed the changes in income during the mining boom period (2001-2011). The results revealed the variations in Gini coefficients across different mining and non- mining regions suggesting that the mining industry boom (socio-economic impact) is likely to affect the income distribution in multiple ways in all regions.  

A research paper by Australian government (2018) suggested that inequality has risen in Australia in the last three decades. Australia’s progressive tax system and highly targeted transfer system has been found to have reduced the income inequality in Australia. The measure of income inequality has typically been reduced due to income tax and government transfers neutralizing the effect that increased the income inequality in the 1980s. The paper suggested that this effect in income inequality of the 1980s has been fluctuated over the years but there has not been witnessed any material change in the past three decades in the income inequality in Australia. This redistributive tax policy system and government transfers although have a negative consequence on the economic efficiency such as inciting a reduction in the supply of labor.

McManus (2019) discussed that the real wage rate in Australia has mired and many of the workers have not got the benefits they must have enjoyed from the improvements in productivity. Although this wage crisis in not for everyone in the labor market, wage rate inequality exists. The workers enjoying high wage rate enjoy a large increase in the real wages when compared with lesser wage earners. Thus, wage inequality has increased significantly in the period of 1995 to 2012 more in Australia than any other OECD countries.  

Greenville et al. (2013) discussed how despite income inequality; Australia has seen a continuous era of rate of economic growth. According to Greenville et al. (2013), labor earnings account for the largest chunk of Australians’ revenue and are consequently the major motivation of income disparity. The study examined market family income disparity using investment and other income sources and discovered that increased availability to low-wage labor has over offset wage inequality on the opposite side of the scale.

Theoretical Framework: Public sector economics theories can be helpful in explaining the income inequality as a market failure in Australia. The two major theories discussed in the literature are Pareto efficiency and Social Choice theory explained below:

Pareto Efficiency and Income Inequality: The offsetting of inequality through tax structures and government transfers is called the Distribution Neutral Fiscal Policy (DNFP). Marjit and Sarkar (2017) refer this situation as Strong Pareto Superior (SPS) allocation in which the inequality degree is kept intact rather than the absolute level of income.  Pareto efficiency is a situation where one person can be made better off without making the other worse off.

Pareto efficiency conditions can be achieved in a scenario where no further trade can be mutually beneficial and is a situation of production efficiency such that factors of production cannot be reallocated further to make the goods improved. This comparison is made in terms of welfare or utility the two individuals achieve. Marjit and Sarkar (2017) argued that income distribution remains unchanged despite the shocks (positive or negative) to the economy due to government transfers or tax structures. Generally, people are reluctant in making the other person worse off assuming that many people are constraint by humanity. Taking an example of an oligopolist who has abundance of wealth, Pareto efficiency can be explained. For example, the government implements a wealth tax and redistributes the tax collected among the people in need of it. With this policy, many people are benefitted and only one person is negatively harmed that too, negligibly. However, as per the Pareto efficiency, this is not an idle efficiency situation as one person is harmed despite the improvement for many. Thus, Pareto efficiency principle largely ignores equal distribution and thus, can explain income inequality in countries (Marjit and Sarkar, 2017).

Social Choice Theory and Income Inequality: Social choice theory is another theory that can explain income inequality as a market failure. It is concerned with individual relationships with their preferences and social choices. A lot of problems can fit in this description and can be differentiated from one another. This theory is the study of collective processes and procedures. The theory is a cluster of models that is concerned with the amalgamation of individual inputs (e.g. welfare, preferences, judgments, votes) into collective outputs (e.g, preferences, welfare, judgments, votes). The theory defines the social alternatives to achieve social welfare and the process of individuals choosing the winning outcome among the available options. These interpersonal aggregations can take three forms:

  1. Committee decision: A committee decides on a winning action from among the alternative proposals by comparing the relative merits of which the members have different views.
  2. Social Welfare judgment: An individual making a judgment whether an action will benefit the society wherein some members will gain while others will lose.
  3. Normative indication: This involves measuring national income, inequality, poverty and other indicators with normative motivation involving interpersonal weighting in an easy way.

The competing grounds of preferences and justice has major implications on the discipline of inequality evaluation and income distribution (Sen, 2000).

Data on Measures/Indicators of Inequality:

There are numerous measurements for quantifying inequality, which enable assessments over time frames or even between distinct populations, such as geographical areas. Economic inequality is often quantified in three distinct ways; income, consumption, or wealth are all notions. Metrics of inequalities can be beneficial for a variety of purposes; examining the causes and consequences of inequality. For instance, financial inequality is a problem and wealth inequality are considered to be a cause and also an effect of (Piketty and Saez, 2014).

The Gini index or Gini coefficient is a statistical tool for measuring income distribution. It was created in 1912 by Corrado Gini, a statistician based out in Italy. It is being used as proxy for income disparity, indicating the distribution of wealth within a society. The coefficient is between 0 (or 0%) and 1 (or 100%), with 0 signifying absolute equality and 1 suggesting perfect disparity. Values higher than are often not practicable since we do not consider for negative revenues. (Income can sometimes be low but just not zero at its lowest level).  Thus, a country with equal income distribution would have a Gini index of 0. A country wherein one citizen earns all of the money and the rest earns nothing will have a Gini coefficient of one.  As we already know, the Gini coefficient is a critical tool for examining the income disparity or wealth inside a specific country. However, it should not be confused with an objective measure of income and wealth.  A country with a high income and the other with a low income might have the same Gini index if their earnings are distributed identically inside every region. The Gini index is extremely susceptible to differences in the description of income and fluctuations in the average income level, because this is where the bulk of citizens in the distribution live. It does not, unfortunately, provide information on changes in the amount of inequity among income categories, like the top and bottom. The Gini coefficient can be determined with the use of the Lorenz curve. The cumulative percentage of the total income is plotted against the incremental percentage of the population through lowest to the highest income. The curve begins at zero and increases to a max of one. A horizontal line indicates everyone should have the same income; a curved curve depicts inequality. The Gini coefficient is obtained by multiplying the area of the straight line of complete equality by the area of the real Lorenz curve (AU, 2013).

Figure 2: Lorenz curve

According to the available statistical data as presented in the Figure 3, Australia has the 11th greatest Gini coefficient (0.33), out of the 33 OECD nations.  Chile seemed to have the least equitable distribution of wealth (Gini score of 0.46), whereas the Slovak Republic will have the most equal distribution (Gini coefficient of 0.24) (OECD, 2021).

Figure 3: Gini Coefficient (Source, OECD, 2021)

Over the course of 2017-18, personal wealth totaled $903.9 billion, with the median household earning $49,805, a 3.0 percent increase compared to the previous year. Also, employee income was the highest revenue source, accounting for 87.1 percent of total personal income.  The majority of people (77.7 percent) relied on employment salary as their primary source of income (up from approximately 76.9 percent in the preceding year). Wages and salaries were also the stream of income with the greatest median salary. Employees took home a median income of $50,861, representing a 3.6 percent rise over the past year. Superannuation money was the second greatest source of median income. The median pension earnings were $21,738, a rise of 5.2 percent compared to the previous year. Only 1.6 percent of the population (falling from 1.7 percent over the previous year) relied totally on pension savings (ABS, 2021).

Figure 4: Income source (Source, ABS, 2021)

The following local govt divisions in Australia had the smallest income disparity (minimum Gini coefficients) during the 2017-18 fiscal year:

  • South Australia’s Roxby Downs
  • In Tasmania, Brighton
  • In South Australia, Palmerston in the Northern Territory, and Katherine in the Northern Territory, Playford in South Australia

Additionally, the following local authority districts in Australia had seen the worst income levels disparity (highest Gini coefficients):

  • Western Australia’s Peppermint Grove
  • Western Australia’s Cottesloe
  • Walgett in the state of New South Wales

Additionally, the Figure below 5 and 6 showcases the local areas of Australia with lowest and highest Gini coefficients, 2017-2018 (ABS,2021).

Figure 5 Local areas of Australia with lowest Gini score, 2017-18 (Source, ABS, 2021)

Figure 6 Local areas of Australia with lowest Gini score, 2017-18 (Source, ABS, 2021)

Figure 7 Income inequality (Gini coefficient 2001-2017) (Source: Wu et al., 2021)

Additionally, the upper and lower panels illustrate the trends in earned income and family equivalent income disparity, respectively (Figure 7). The solid line indicates Gini coefficients estimated using personal income, the dashed line with circle marks suggests Gini coefficients estimated using gross income, and the longitudinal stripe with cross lines indicates Gini values derived using disposable cash. Between 2001 and 2008, individual income gaps and family comparable income inequality decreased, but increased from 2009 and 2017. However, these developments are minor in view of the total level of inequality. The Gini coefficient for household disposable income is approximately 0.3-0.33, while it is approximately 0.43-0.46 for individual disposable income. As a result of the inconsistencies between these two sets of data, it appears that intra-household payments eliminate poverty by around 0.13 Gini points, or approximately one-third of individual income inequality. In one study, it was discovered that individual income redistribution through public transfers reduced income disparity by approximately 0.06 Gini points, or nearly 11 percent. Income inequality is further reduced by 0.04 Gini points, or 8%, by the tax policy. Inequalities in comparable household income have been further minimized as a result of governmental transfers and taxation. These findings imply that while both governmental transfers and taxes are effective at lowering income disparity, government subsidies do so twice as effectively as taxation (Wu et al., 2021).

While individual circumstances differ, Australia demonstrates pre-pandemic inequalities in a definitive manner. Australia had performed well in comparison to the rest of the countries in learning how to cope with the epidemic and rebounding from recession, according to the OECD’s economic outlook (Wright, 2020). Not only has the healthcare rebuttal been effective, largely attributable to geographical location and secure borders, scientific policy responses, and a community-oriented compliance culture (Wright, 2020), but the Government’s approach has shifted away from debt reduction and more towards stimulus, implying that Australia’s direct financial response, at 11.6 percent of GDP, is one of the highest in the developed world.

Prior to the COVID-19 epidemic, Australia’s wealth and income disparity had been increasing. In 2015–2016, a person in the top 1% of income people earned more in a week than someone in the bottom 5% of income workers earned per year. Since the 1980s, economic disparity in Australia has already been steadily increasing. The richest 10% of earnings raised their share of total income in the country from 23% to 33% (Gilfillan, 2021). According to a study released in mid-2019 by the National Bureau of Statistics, the wealthiest 200 persons improved their combined wealth by a projected 20% in 2018 (Long and Janda, 2019). But at the other hand, shifts in the labor market, debt levels, and the total mortgage size have culminated in 10% of working families in Australia having or less $90 in savings (Power, 2020). The World Disparity Report states the primary cause succinctly: “wealth distribution is driven primarily by unequal ownership of capital” (Alvaredo et al., 2018). Capital differences persist in Australia as a result of the significant disparities in ownership and annuities (individual retirement savings) (Coates and Chivers, 2019).

Conclusion(s) and Policy Recommendation(s):

Everyone has the right to demand that their real earnings and compensation are commensurate with their productivity and working hours. Pay scales should convey positive messages to people about the importance of investing in education, technical knowledge, and professional devotion. When wage inequality become extreme, they lose their beneficial effect on the market. Owing to the rising inequality in Australia, policymakers can consider the following measures for combating inequality:

  • Governments can act through tax and benefit regimes to promote equity and reduce income and wealth inequality. This entails a proportional tax and benefit system that levies a considerably greater tax on higher income earners and disburses social payments to lower earners.
  • Suitable economic reforms must be implemented to boost the economy’s productivity.
  • Cash benefits, including both contributory and non-contributory benefits, can be provided to help persons with low or no initial income. Contributory benefits, like pensions and job seekers’ allowance, are those who are paid by individuals or businesses into the National Insurance Funds and Non-contributory benefits, such as housing benefit, income assistance, carer’s allowance, and child benefit, do not require advance contribution.
  • A minimum wage policy needs to be implemented to address the issue of poverty pay, which occurs when earnings from paid work fall short of a decent salary and do not lift people out of extreme poverty.
  • Closing gaps in learning and educational outcomes—by increasing disadvantaged students’ enrollment and effectiveness of school—is important for reducing inequality. To begin, it decreases income inequality’s durability across decades. Greater businesses that generate mobility is correlated with improving educational results for children from poor families. Addressing educational gaps will improve economic efficiency by distributing educational resources primarily based on children’s potential than on their family’s economical position.


References:

ABS, 2021. Personal Income in Australia. Available from < https://www.abs.gov.au/statistics/labour/earnings-and-work-hours/personal-income-australia/latest-release >. [Accessed on 4 October 2021].

Alvaredo, F., Chancel, L., Piketty, T., Saez, E. and Zucman, G., 2018, May. The elephant curve of global inequality and growth. In AEA Papers and Proceedings (Vol. 108, pp. 103-08).

AU, 2013. Income inequality in Australia. Available from < https://treasury.gov.au/publication/economic-roundup-issue-2-2013-2/economic-roundup-issue-2-2013/income-inequality-in-australia>. [Accessed on 4 October 2021].

Australia, P., 2018. Infrastructure contributions: review of impact of infrastructure taxes and charges on the NSW economy.

Barrett, G.F., Crossley, T.F. and Worswick, C., 2000. Consumption and income inequality in Australia. Economic Record76(233), pp.116-138.

Coates, B. and Chivers, C. (2019), “Rising inequality in Australia isn’t about incomes: it’s almost all about housing”, The Conversation, Vol. 19 September, available at: http://theconversation.com/ rising-inequality-in-australia-isnt-about-incomes-its-almost-all-about-housing-119872.

Cutler, D.M. and Katz, L.F., 1992. Rising Inequality? Changes in the Distribution of Income and Consumption in the 1980s.

Downes, P.M., Hanslow, K. and Tulip, P., 2014. The effect of the mining boom on the Australian economy. Reserve Bank of Australia research discussion paper, (2014-08).

Fleming, D.A. and Measham, T.G., 2015. Income inequality across Australian regions during the mining boom: 2001–11. Australian Geographer46(2), pp.203-216.

Gilfillan, 2021. Inequality and disadvantage. Available from < https://www.aph.gov.au/About_Parliament/Parliamentary_Departments/Parliamentary_Library/pubs/BriefingBook46p/Inequality> [Accessed 2 October 2021]

Greenville, J., 2013. Trends in the Distribution of Income in Australia-Productivity Commission Staff Working Paper.

Johnson, D. and Wilkins, R., 2004. Effects of changes in family composition and employment patterns on the distribution of income in Australia: 1981–1982 to 1997–1998. Economic Record80(249), pp.219-238.

Long, S. and Janda, M. (2019), “The rich get richer as wages stagnate and the poor get left in their wake”, available at: https://www.abc.net.au/news/2019-07-12/household-income-and-wealth-absdata-shows-rich-are-richer/11302696.

 Marjit, S. and Sarkar, S., 2017. Distribution-neutral Welfare Ranking-Extending Pareto Principle.

McManus. S., 2019. Inequality in Australia An Economic, Social & Political Disaster. Available: https://www.actu.org.au/media/1385450/actu_inequality_briefing.pdf. [Accessed 2 October 2021]

OECD 2011. Divided We Stand: Why Inequality Keeps Rising, OECD Publishing, <http://dx.doi.org/10.1787/9789264119536‐en>.

OECD, 2021. Income inequality (indicator). Available from < https://data.oecd.org/inequality/income-inequality.htm >. [Accessed on 4 October 2021].

Pappas, N., 2001. ‘Family Income Inequality’, in Borland, J., Gregory, B. and Sheehan, P. (ed.s) Work Rich, Work Poor: Inequality and Economic Change in Australia, Centre for Strategic Economic Studies, Victoria University, Melbourne.

Pendakur, K., 2001. Consumption poverty in Canada, 1969 to 1998. Canadian Public Policy/Analyse de politiques, pp.125-149.

Piketty, T. and Saez, E., 2014. Inequality in the long run. Science344(6186), pp.838-843.

Productivity Commission, 2018. Rising inequality? A stocktake of the evidence.

Saunders, P., Stott, H. and Hobbes, G., 1991. Income inequality in Australia and New Zealand: international comparisons and recent trends. Review of Income and Wealth37(1), pp.63-79.

Saunders, P.,1993. ‘Longer Run Changes in the Distribution of Income in Australia’, The Economic Record, 69(207), pp.353‐66.

Sen, A., 2000. Social justice and the distribution of income. Handbook of income distribution1, pp.59-85.

Slesnick, D.T., 1998. Are our data relevant to the theory? The case of aggregate consumption. Journal of Business & Economic Statistics16(1), pp.52-61.

Whiteford, P., 2013. ‘Australia: Inequality and Prosperity and their Impacts in a Radical Welfare State’, HC Coombs Policy Forum, Crawford School of Public Policy, ANU College of Asia and the Pacific, Australian National University, Canberra.

Wright, S. (2020), “China dispute threatens the economy”, Sydney Morning Herald, Vol. 2 December, available at: https://www.smh.com.au/politics/federal/china-dispute-threatens-australia-seconomic-recovery-oecd-20201201-p56jih.html. Wu, D., Rao, P., Trivedi, P., Tang, K.K. and Rohde, N., 2021. Measuring inequality of opportunity using sampling-based Shapley decomposition: Application to Australian data 2001-

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