The labour market is defined by the Office for National Statistics (2011) as those between the ages of 16 and 64 inclusive. They are typically categorized as either employed, unemployed or inactive. Income inequality refers to the spread of income throughout the labour market. The most common measure of income inequality is the Gini coefficient. The indicator reflects the distribution of income among economic classes and is expressed as a percentage, the higher the number the greater the degree of income inequality. The Gini coefficient for the United Kingdom has increased from 28 to its current level of 34. The level of inequality is a long-term increasing trend in Britain (JRF, 2007). The behavior of the Gini coefficient tends to be that the coefficient increases during times of economic growth as the incomes of the wealthiest increase at a faster rate than other incomes during these periods (Joyce et al., 2010). During recessions, income behavior across all income classes is roughly the same (ONS, 2010). This paper will analyze income inequality, outlining the main reasons why it has increased over time and making the case for the government to reduce inequality over the long and short run. Some strategies to limit inequality will be proposed as well.
Causes of Inequality
There are four main explanations for the increase in income inequality in Britain since 1980 -- globalization, labour demand patterns, increased international competition and bargaining power declines. These issues are at times interrelated, which further complicates efforts to address income inequality. Globalization is a function of reduced trade barriers combined with improvements in communication and transportation. These three factors have provided opportunities for many nations to enter the global trading system. This has resulted in a number of outcomes. The most important of these is that specialization has increased, changing the nature of the British economy. Liberalization of trade in particular is based on the concept of comparative advantage, in which specialization plays an important role in economic development. In the era preceding specialization, there were a wide range of jobs throughout the economic spectrum. This provided a relatively smooth income curve for British workers. Increased specialization has compromised that. Jobs remain at the high end, where Britain retains some comparative advantage in activities requiring a high level of education, and jobs remain at the low end in the service sector, as many face-to-face positions cannot be offshored. In the middle, however, Britain has lost its cost comparative advantage as trade barriers and transportation costs have been reduced.
The broader trend that has in part been spurred by globalization is reflected in changes in labour demand patterns. Demand for highly skilled workers remains. Wages for these workers increase as their value increases. Not only do high-skilled workers generate substantial income for firms, but their relative scarcity drives up their cost as well. This causes incomes to rise at the high end. At the low end, there is reduced demand for many types of unskilled workers. These workers are cheaper elsewhere, so demand in Britain declines. This puts many into the unemployed or inactive categories of the labour market, drawing earnings much lower than they would if they were employed. In addition, a surplus of supply relative to demand causes wages at the low end to stagnate, their fall bound only by the constraint of minimum wage. The net effect of these changes, combined with the disappearance of middle-income jobs, is that wage inequality increases.
A third contributor to the rise of income inequality in Britain is the increase in international competition. The competition in labor markets has been discussed, but it is also relevant in corporate markets. When the British market was dominated by local or European firms, competition levels were lower and all competitors had roughly the same cost structure. International competition is more intense, and there are more low-cost providers in most industries. As a result, it is possible that firms in Britain are less profitable. This leaves a smaller pool of profits from which labour can draw. In addition, the firms that do exist often rely on increasing productivity (increasing output relative to wages) to maintain whatever profits remain. Workers compete with managers and shareholders for a piece of a smaller pie.
Lastly, bargaining power for workers has declined over this time. Unions have ceded some of their power in order to preserve jobs, and overall unionization is on the decline. Non-union workers have also seen a reduction in bargaining power, as there is a relative surplus of unskilled labor. As a result, incomes among unskilled workers have not risen to the same level as those of skilled workers. Further compounding the problem, workers who find themselves chronically unemployed or underemployed typically see their work skills erode. This results in long-term un- or under-employment, permanently depressing the incomes earned by such workers. This effect can also partially explain why skilled worker incomes increase more during economic boom times -- they start with jobs so their skills are at a higher level. Those who start booms unemployed may find work, but they will not have the skills to find good work.
It is desirable for the UK government to reduce income inequality for a few reasons. The economic case has been made above -- earning power tends to be correlated with work skills, and compounds over time. Thus, income inequality in the short run is correlated with income inequality in the long run; the problem is self-perpetuating. In addition, there are compelling social reasons for reducing inequality. High levels of income inequality correlate to higher levels of social unrest. At the levels the UK is currently experiencing, this typically takes the form of petty crime, mental illness, substance abuse and other blights -- all of which are self-perpetuating as well. At higher levels, the social unrest is more akin to that seen in the developing world. The disturbances seen in the Middle East in 2011 reflect societies with very high levels of income inequality. This also provides a compelling political case for reducing income inequality -- politician's jobs depend largely on their being able to deliver jobs and high standards of living to their constituents.
How to Reduce income inequality
Knowing that income inequality needs to be reduced and achieving that goal are two different things. There are a number of ways to reduce inequality -- methods that address the root issues and methods that address distribution after generation. The root issues of globalization, specialization and the erosion of labour bargaining power are all intertwined. Dealing with these issues effectively is a challenge for politicians, however. Even though Britain has been an enthusiastic supporter of globalization, globalization is largely an external force that acts upon nations, except for those who have gone to unusual lengths to exclude themselves from the global economic system (North Korea). Thus, putting the genie back in the bottle is not an easy task for government to achieve. Indeed, globalization does have economic benefits -- it is only the distribution of those benefits that is in question. An unusual step would be to press to include labour in trade negotiations, to ensure that labour's interests are represented. That alone, however, is unlikely to counterbalance the power of globalization and its related trends. It is more effective to welcome the increased income that comes from globalization and address the issue of income distribution at the domestic level.
This is done via the taxation and benefits system. In the broadest terms, this means increasing taxes on the wealthy and spending that money to help break Britain's poor and working class from their cycle of income stagnation. Improvements in education and training will not only help improve the job prospects of Britons, but they will also increase the level of innovation in the economy. Further to increasing innovation is having a tax structure that encourages small business while taxing heavily big business. In big business, income is concentrated in the executive ranks and among shareholders, which makes the case for increasing big business taxation. In small businesses, wealth is more diffused throughout the economy, as each business owner has a small portion of the economy's wealth. It has been argued that such progressive tax policies will reduce innovation by driving investment offshore, but as long as Britain has a strong education system, much innovation will remain at home. There is as yet no offshore substitute for intelligence and creativity. Stifling taxes have not prevented other European nations from excelling both economically and socially. Indeed, those who wish to become wealthy are not discouraged by higher taxes -- they will still be wealthy.
The current government policy of "austerity" for its own sake is a disaster as far as reducing income inequality. Government workers, tens of thousands of whom will now be unemployed, bear the brunt of current policy as do the beneficiaries of the nation's social programs. While the impacts of this policy are also felt by businesses -- there has…