Poverty and Inequality
Poverty and Inequality
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Some people are poor because they cannot buy enough food or shelter; others because they have far less than the people around them.
Think of two families. One lives in a village and on many days cannot buy enough food. The other lives in a city. It eats every day, but it cannot afford a phone, school trips or the bus fare to work that most families there pay.
The first family cannot meet its basic needs (food, safe water, shelter and clothing). The second family can survive, but it has far less than the households around it. Each kind of poverty has its own name.
Absolute poverty: exists when a person's continued daily existence is threatened because they have insufficient resources to meet their basic needs.
Put simply, a person in absolute poverty is struggling to survive from one day to the next, like the village family.
Relative poverty: exists when a person is poor compared with others in their society.
Put simply, a person in relative poverty can survive but cannot live the ordinary life of their society, like the city family.
The key difference is the standard each one is judged against. Absolute poverty is judged against a fixed standard: what it costs to meet basic needs. The food a person needs does not change when a country grows richer, so this standard stays where it is.
Relative poverty is judged against what is normal in that society, so its poverty line (the income below which a person counts as poor) is set as a fraction of a typical income there: the income of a person in the middle of that society. When typical incomes rise, what is normal rises, and the line rises with them.
This is why a family can escape absolute poverty and still be relatively poor. It can now buy enough food, but it still has far less than the families around it. The reverse can also happen. If nearly every family in a society has a very low income, no family is far below the others, so there is little relative poverty even though many families are in absolute poverty. In many high-income countries, almost every family can meet its basic needs, so most of the poverty that is measured is relative.
To measure absolute poverty, a government counts how many people fall below a fixed income level, and how far below.
How many people are poor, and how poor are they? A government must know both to reduce poverty.
Poverty line: the level of income below which a person is counted as poor.
Put simply, it is the cut-off that decides who is counted as poor, so that people are counted the same way each year.
The World Bank's international poverty line is $3.00 a day per person, in 2021 prices. It is measured at purchasing power parity (PPP: prices are adjusted so that a dollar buys the same set of goods in every country). It replaced an older line of $2.15.
Tessar is a country of 20 million people. Rank them from poorest to richest and split them into ten equal groups, called tenths: each tenth is 2 million people. Daily income per person, poorest tenth first:
Headcount ratio: the percentage of the population whose income is below the poverty line.
Put simply, it tells you how many people in every 100 are poor: people below the line ÷ the whole population × 100.
Poverty gap: how far the incomes of poor people fall below the poverty line, on average.
Put simply, it tells you how much more, on average, each poor person needs to reach the line. This is the depth of their poverty.
One person in five is poor, and the poor need $0.80 more a day, on average, to reach the line.
Why measure both? Suppose a grant (money from the state that is not repaid) lifts only the second tenth, which is just $0.40 short. The headcount ratio halves, from 20% to 10%, but the poorest tenth still lives on $1.80. The headcount ratio hides this: it counts everyone below the line the same, however far below they are. After the grant, the poverty gap rises from $0.80 to $1.20 a day, even though fewer people are poor, because the only people left below the line are the poorest tenth, who are $1.20 short of it. The poverty gap shows what the headcount ratio hides: the poorest have not been helped at all.
Multidimensional poverty is poverty measured by counting what people lack directly, in several areas of life such as schooling, clean water or electricity, instead of measuring income alone.
Real Example: The global Multidimensional Poverty Index (MPI) is published by the United Nations Development Programme with the Oxford Poverty and Human Development Initiative. It counts deprivations across ten indicators of health, schooling and living standards. It shows that poverty can be measured by what people lack, not only by their income.
Exam Matters: In a Calculate, write the step in words before the numbers, then give the unit: per cent of people for the headcount ratio, dollars a day for the poverty gap.
Relative poverty is measured against a line set at a share of a typical income, so the line moves when that income moves.
A fixed line cannot show who is poor compared with their own society. That needs a line built from the society's own median income: the income of the person exactly in the middle when everyone is ranked from poorest to richest.
Relative poverty line: an income threshold set at a percentage of a country's median income, often 50% or 60%.
Put simply, it marks how far below the middle a person can fall before they count as poor in their own society.
That is more than the 20% below $3.00, because $3.60 is a higher line.
Because the line is a fraction of the median, relative poverty changes only when incomes at the bottom change compared with the middle. Suppose the two richest tenths gain: the ninth rises from $12.40 to $16.40, and the richest from $22.00 to $37.00. The person in the middle earns the same, so the median stays $6.00, the line stays $3.60 and relative poverty stays at 30%. The reverse happens when the middle gains and the bottom does not. The median goes up, so the line moves up with it. People who were just above the old line can now be below the new one, although their own income has not changed.
Inequality means how unevenly income is shared between people. Here incomes are now more unequal, because the two richest tenths have gained and the rest have not. Relative poverty compares the bottom with the middle, while inequality is about the whole spread. So relative poverty is not the same as inequality.
Real Example: The European Union measures relative poverty with its at-risk-of-poverty rate. It counts people whose disposable income (income after taxes and benefits) is below 60% of their own country's median. Each country's line is set by its own median, so the line differs from one country to the next.
Exam Matters: In a Calculate, show the step and give the unit: 60% of a $10.00 median is $6.00 a day.
When a country's total income grows, absolute poverty falls only if the growth raises incomes at the bottom.
When a country's total income rises, do fewer people live in poverty? A rise in total income is economic growth: a rise in real GDP, the value of everything the economy produces. Whether poverty falls depends on whose incomes rise.
So when every income rises by the same percentage, absolute poverty falls, provided some people were close enough below the line to cross it, but relative poverty stays the same. The absolute line is fixed, so people cross it. The relative line rises with the median, by the same 25% as the incomes of the poorest, so the three poorest tenths stay below it. Relative poverty falls only if incomes at the bottom rise faster than the median.
Growth does not always reach the poor. Labour-intensive growth (using many workers for each unit of output) spreads jobs and wages widely, as in factories, farming and tourism. Capital-intensive growth (using many machines and few workers) creates few jobs, as in a mine or an oil field. Its income goes mainly to the owners and the few workers, unless the government taxes the field's income and spends the revenue (the money the tax raises) on the poor. Growth centred in cities can also miss households in the countryside, because the new jobs and higher wages are in the cities, not in the villages.
Real Example: In Vietnam's 1992-93 household survey (a survey that asks households about their income and spending), about 64% of people were below the international poverty line of the time, $1.25 a day. Twenty years later, after years of fast growth, fewer than 3% were. These figures show how far absolute poverty fell in Vietnam over twenty years of fast growth.
Exam Matters: In an Evaluate on growth and poverty, judge by the pattern of growth: who gets the new jobs, and whether the government spends the revenue on the poor.
Education and training can lift people out of poverty, because skills raise what their work is worth to an employer.
Think of three people: a farm labourer who learns to read, a school-leaver who trains as an electrician, and a stallholder who learns to keep accounts. Each can now do work that is worth more. How does that become a higher income?
A skill raises productivity (output per worker): a trained electrician wires more houses a day than an untrained one. Work that produces more is worth more to an employer, so employers will pay more for it. A stallholder who works for herself gains in the same way: customers pay more for better work, and fewer costly mistakes waste less of her stock, so she earns more from the same hours. The higher pay raises household income and can lift it above the poverty line.
Education can cut relative poverty too. The poorest usually have the least schooling, so spreading it to them raises incomes at the bottom compared with the middle, and fewer people fall below the relative poverty line.
It has limits. It is slow: a child who starts school today starts work years later. It needs jobs that use the skills: if no employer needs electricians, the training does not raise pay. And if only better-off families can pay for secondary and university education, incomes in the middle rise faster than incomes at the bottom, so the relative poverty line rises and relative poverty can increase.
Exam Matters: In an Explain on education and poverty, build the chain from the skill to income, and end by comparing that income with the poverty line.
Payments from the state raise poor households' incomes at once, so they can cut poverty faster than growth or new skills.
Growth and new skills take years to raise the incomes of the poor. A payment from the state raises a household's income on the day it arrives.
Welfare benefits: payments made by the state to households, such as pensions, unemployment pay, child allowances and cash transfers.
Put simply, welfare benefits move income straight to a household, without waiting for a new job or a pay rise.
A benefit paid only at the bottom raises the bottom against an unchanged median, so it can cut both kinds of poverty, provided it lifts some households over each line.
Now suppose the government cuts benefits instead. The poorest lose income at once, with nothing to replace it. Households that were just above the $3.00 line, or just above the relative line, can now fall below it. Benefits go mainly to households below the middle, so the median barely moves and the relative line stays where it was. So both absolute and relative poverty can rise.
Benefits can also miss the poor. Many poor people do informal work (work with no contract, which the state does not record). Others have no bank account or identity papers. The state may not be able to find them, so the payment may not reach them. Paying the same benefit to every household would reach them, because no one has to be found or shown to be poor first, but most of the money would go to households that are not poor, so it would cost far more for each poor person helped.
Real Example: Brazil's Bolsa Família pays cash each month to poor families with children. In return, the children must attend school and follow the vaccination schedule and attend health check-ups. This is a benefit that raises a family's income now and also aims to protect the children's health and education.
The same tax can take a larger share of a poor household's income than of a rich one's, so who pays matters.
Two households face the same 10% sales tax (a tax on what people buy). One earns $100 a day and spends it all. The other earns $1,000 a day and spends half.
The share of its income that a household pays in tax is its tax burden. The rich household pays more tax, but its burden is smaller, 5% against 10%, because the half it saves is not taxed.
Tax structure: the mix of taxes a government uses, and how much of the tax burden falls on households with different incomes.
Put simply, it decides which households carry the most tax, as a share of their income.
A sales tax is an indirect tax (a tax on spending). Here it is regressive (it takes a larger share of a poor household's income than of a rich one's). A direct tax is a tax on income or wealth. An income tax with higher rates on higher incomes is progressive: it takes a larger share of a rich household's income than of a poor household's. Three cases show how who pays decides what happens to poverty.
Many poor workers earn too little, or work informally, so a cut in income tax gives them nothing, while a tax on basic goods reaches nearly every household.
Real Example: Saudi Arabia introduced a value added tax (VAT), a tax on spending, at 5% in 2018. On 1 July 2020 it raised the rate to 15%. A tax like this is paid on most purchases, so it reaches every household that buys them, whatever its income.
Exam Matters: Say what the government does with the revenue, because that decides whether the poor gain.
When an industry shrinks, its workers may not fit the new jobs, so poverty can rise and last.
Picture a town whose main employer is a textile mill (a factory that makes cloth). Cheaper imported cloth arrives, and the mill closes. New jobs are growing in software and tourism, but mostly in the capital.
Structural change: a lasting change in what an economy produces and where its people work, such as a shift from farming to manufacturing or from manufacturing to services.
Put simply, some industries shrink for good while others grow, and workers must move between them.
Why can't the mill workers take the new jobs? Their skills may not match: a weaver cannot write software. This is occupational immobility (workers' skills do not fit the jobs that exist). Or the jobs may be far away, and moving costs more than they can pay. This is geographical immobility (workers cannot move to where the jobs are). The lost jobs may not come back, so the poverty can last until workers retrain or move.
The poverty from a closed mill is concentrated in the mill's town. When the mill workers lose their pay, the town's shops and suppliers (the firms that sold to the mill) lose customers too, so more jobs can go.
Structural change can also reduce poverty. When farm workers move into factory jobs that pay more than farming, their household incomes rise. This works when the new jobs are near and use skills they can learn quickly.
Exam Matters: In an Analyse, take one mechanism, such as occupational immobility, and develop it in linked steps from the closing industry to incomes below the line.
Help from abroad can reduce poverty at once, or slowly by helping the economy grow; what it pays for decides which.
A poor village might receive two kinds of help from abroad: cash sent each month to families' phones, and a new irrigation scheme that waters the fields.
Aid: money, goods or services given, or lent on better-than-market terms, by foreign governments, international organisations or charities.
Put simply, aid is help from outside the country that the receiver does not pay for in full.
Aid changes poverty by two routes, and each works for its own reason:
Aid can also fail the poor. Corrupt officials can steal money before it reaches them. Donors may pay for what they want, not what local people need. Tied aid (aid that must be spent on the donor's own goods or services) can buy less than the same money spent elsewhere, because the donor's goods may cost more.
Food aid can even make some poor farmers poorer. Free grain that is distributed or sold cheaply in local markets increases the supply of grain there, so its price falls. Local farmers then receive a lower price for their own grain, so if they sell the same amount, their incomes fall.
Exam Matters: When you weigh aid, say which route it takes, direct or indirect, and judge it by what it pays for and who controls it.
Fighting destroys incomes, property and public services at the same time, so it can push many people into absolute poverty fast.
Picture a farming district where fighting begins. Conflict causes poverty through four channels at once:
Why does poverty last after the fighting ends? Children who missed years of school tend to earn less for the rest of their lives. Land mines can stop fields from being farmed. Investors may not return until they trust the peace. So incomes can recover slowly.
Poverty can also feed conflict. Armed groups can offer pay, food or a share of what they seize. Young people with no income and no prospects have less to lose by joining them, so poor regions can face more fighting.
Exam Matters: In an Explain or an Analyse, develop one channel in linked steps. For displacement: lost land, then no income, then children out of school.
What a person receives each month and what a person owns are different things, and each can be shared very differently.
A retired farmer owns valuable land but has little money coming in. A young doctor earns a high salary but owes a large loan for her studies. Which is better off? That depends on whether you look at what each receives or what each owns.
A flow is an amount received over a period of time, such as a month. A stock is an amount owned at one moment.
Income is a flow: wages, profits, rent, interest, dividends (the part of a firm's profit paid to its owners) and benefits received over a period. Wealth is a stock: the value of what a household owns (its assets), such as land, housing, savings and shares, minus its debts. So the farmer has low income but great wealth; the doctor, the reverse.
When either is shared unevenly between people, there is inequality:
Income inequality: differences in people's income flows, such as those from wages, dividends and rents.
Put simply, it is about who receives more each year: a surgeon's pay against a cleaner's.
Wealth inequality: differences in people's stock of assets.
Put simply, it is about who owns more: one family owns three flats, and the family next door owns none.
The two are linked: wealth produces income, such as rent or interest, and a high income can be saved to build wealth.
In many countries, wealth is shared far less evenly than income. Tessar, a country of 20 million people, shows the pattern:
The richest tenth receives under a third of income but owns half of all wealth, while the poorer half owns only 7%. Many poor households own almost nothing.
A household with wealth can sell what it owns, or borrow against it, so it can manage for a while with no income. A household with none can fall into poverty as soon as its income stops.
Real Example: The World Inequality Report 2022 estimated that the richest 10% of the world's people received 52% of global income but owned 76% of global wealth. The poorer half received 8.5% of income and owned just 2% of wealth. This is the same pattern as in Tessar: wealth is shared far less evenly than income.
One curve can show how a country's whole income is shared, from its poorest people to its richest.
A table of ten income shares is hard to compare at a glance. One line on a diagram can show the whole spread.
A cumulative share is a running total: each group's share added to the shares of all poorer groups.
Lorenz curve: a curve that plots the cumulative share of income (or wealth) against the cumulative share of the population with that income (or wealth), ranked from poorest to richest.
Put simply, each point answers one question: the poorest so many per cent of people receive what per cent of income?
People go along the bottom (the horizontal axis) and income up the side (the vertical axis), both as cumulative percentages from 0% to 100%.
If everyone had the same income, the poorest 40% would receive 40% of income, and every point would sit on a straight line from the bottom left corner to the top right corner of the diagram.
Line of equality: the diagonal on a Lorenz diagram, showing where every person would have the same income.
Put simply, it is the line that a country's Lorenz curve would follow if nobody earned more than anyone else.
A real curve sags below the line. In Tessar the poorest tenth receives 2.4% of income, not 10%, and the poorer half 22.9%, not 50%. The further a curve sags, the more unequal the country.
Can the curve rise above the line? No. If the poorest 30% received more than 30% of income, their average would be above everyone else's, so they could not be the poorest.
A curve that lies closer to the line of equality at every point is more equal. But curves can cross. Then one country gives its poorest groups a larger share of income, while the other gives its richest groups a smaller share, and ranking them needs one number.
Exam Matters: When an Analyse answer needs a Lorenz diagram, label both axes and the line of equality, and draw the curve from the origin (the bottom left corner, at 0% and 0%) to the top right corner.
One number can sum up a Lorenz curve: the larger the gap between the curve and the line of equality, the larger the number.
Crossing Lorenz curves cannot be ranked by eye, so economists turn each into one number, using two areas.
O is the bottom left corner (0% of people, 0% of income), X the top right (100%, 100%) and Y the bottom right (100%, 0%). The line of equality is the diagonal OX.
The Lorenz curve runs below OX, from O to X. A is the area between OX and the curve; B is the area between the curve and the axes OY and YX.
Gini coefficient: a measure of inequality calculated from the Lorenz diagram as the area between the line of equality and the Lorenz curve (A) divided by the whole area under the line of equality (A + B).
Put simply, it is the share of the triangle under OX that the gap A takes up, so a curve closer to OX gives a smaller number.
Why is A + B always 0.50? Write each percentage as a fraction, so that 100% becomes 1 and both axes run from 0 to 1. The square's area is then 1 × 1 = 1. The diagonal OX cuts it into two equal triangles, and A + B fills one of them, OXY. So A + B is half of 1.
With equal incomes, the curve lies on OX, so A = 0 and G = 0. If one person has everything, the curve runs along OY and up YX, so B = 0 and G = A ÷ A = 1.
Tessar's income Gini coefficient, 0.39, lies between these two ends and is closer to 0. Its wealth Gini coefficient is 0.65, so its wealth is far more unequal than its income.
Its limits: different curves can share one Gini coefficient, so it cannot say where the inequality lies. Surveys (questionnaires that ask households about their income) often miss the richest. And an income Gini says nothing about wealth.
Real Example: World Bank figures for 2023 give the Slovak Republic a Gini coefficient of 0.238 and Colombia one of 0.546. Tessar's 0.39 lies between them. Colombia's Lorenz curve sags much deeper below the line of equality than the Slovak Republic's, so its income is shared far less evenly.
Exam Matters: In a Calculate, write G = A ÷ (A + B) before the numbers. If the question gives only B, find A first: A = 0.50 − B.
Within one country, one main reason incomes differ is that the market pays a scarce skill far more than a common one.
In one city, an engineer may earn twenty times as much as a street trader, though both work long hours. The difference lies in what each sells, and how many others can sell it.
Few people can design a bridge, but many can sell fruit. Employers who need an engineer must compete for the few who qualify, so they offer more pay. A trader has many rivals selling the same fruit: if she charges more, buyers go to the next stall, so her prices and her income stay low. A scarce skill earns more than a common one.
The main causes of income inequality within a country, some widening the gap and some narrowing it:
These causes often act together: a worker with a common skill, no union and no assets has three causes holding her income down.
Exam Matters: In an Examine, develop two causes as chains: which group the cause reaches, and what it does to that group's pay against others. End with a judgement on which matters more in the country named.
Wealth gaps grow because assets are passed down and earn income, such as rent and interest, that can buy more assets, even when two people work equally hard.
Two friends of the same age earn the same salary. One inherits a flat from her parents; the other inherits nothing and pays rent. Years later, their wealth gap is wider. Why?
Four causes of wealth inequality within a country:
They build on each other:
The first friend gains more wealth because she pays no rent, so she saves more of the same salary, and her flat may rise in value. Her friend, working as hard, is unlikely to close the gap.
So wealth is more unequal than income: income gaps add to it every year, and returns widen it further.
An hour of work earns far more in some countries than in others, mainly because each worker there produces more.
Why can an hour of work earn far more in one country than in another? The workers may try equally hard. The difference is in how much each hour produces.
Income per head (a country's GDP divided by its population) depends mainly on output per worker. Output per worker depends on:
The gap in wealth between countries is large, and it is slow to close. Rich countries have a large stock of machines, housing and firms, built up over generations, and this stock earns returns every year. Poor countries have had less income to spare, so they have saved less and spent less on new machines, housing and firms (invested less), and their stock has grown more slowly. A smaller stock earns smaller returns, so the gap is slow to close.
Globalisation (the growing links between countries through trade and investment) works in both directions. Some countries that attracted factories and grew exports have closed much of the income gap. Some countries that still depend on one crop or mineral have fallen further behind.
Exam Matters: In an Examine on causes between countries, develop two causes as chains that end in output per worker, then judge which matters more for the kind of economy named.
Some inequality gives people a reason to train and to start firms, but extreme inequality can shut the poor out.
A car mechanic studies at night for a qualification, because qualified mechanics in her town earn more. That gap in pay is an incentive: a reward that persuades someone to act.
Incentives. The prospect of higher pay persuades people to train, work harder, take on responsibility and move to where workers are needed. If everyone received the same pay whatever they did, these incentives would weaken.
Enterprise means starting and running a business, and taking the risk that it fails. The chance of a large profit rewards that risk. Without it, fewer people would leave a safe job to start a firm, so fewer new jobs and products would appear.
These are two separate effects. Incentives are about whether people train and work harder for higher pay. Enterprise is about whether people start firms, and that needs money to begin with, as well as a reward.
Extreme inequality can weaken both:
So the effect depends on how large the inequality is, and on whether people can move up. A gap that can be crossed rewards effort. A gap that cannot be crossed discourages it.
Real Example: Bangladesh's Grameen Bank began in 1976 as a project to lend small sums to poor villagers. Ordinary banks would not lend to them, because they had no collateral. Grameen used small groups of borrowers, who back each other's repayments, in place of collateral. It shows how a lack of collateral can keep poor people out of enterprise.
Richer households save a larger share of their income, so who receives income changes how much a country saves.
Two households live in one country: one earns $200 a day, the other $20. Saving means income that is not spent. The poorer household needs almost every dollar for food and rent. The richer one does not need to spend all it earns, so it saves a larger share.
Total saving rises because each moved dollar goes to a household that saves a larger share of it. When $10 a day moves the other way, from the richer household to the poorer one, the richer household saves $2.50 less and the poorer one saves $0.50 more, so total saving falls by $2.00 a day.
This supports one argument for some inequality: banks lend savings to firms, so savings can fund investment (spending on new machines and buildings), which can raise growth. But the rich may buy existing property or assets abroad, which adds no new machines at home. And when income moves from the poor, who spend almost all of it, to the rich, who save more of it, total spending on firms' goods falls. Firms that sell less can already make all they sell with the machines they have, so they have less reason to buy new ones and invest less.
At the bottom, many households have no savings at all, so one illness or lost job can push the family into debt.
Children from poor families get less and worse schooling, so unequal incomes today become unequal incomes in the next generation.
Two able children live in the same city. One comes from the poorest fifth of families, the other from the richest. Will both finish school?
Often they will not, because schooling takes a far larger share of a poor family's income:
In Tessar, 35% of children from the poorest fifth finish secondary school (the years of school after primary school), against 91% from the richest fifth.
This is how the gap is passed down a generation:
The whole economy loses too. When many able children leave school early, they never produce what they could have, so output is lower than it could be.
Exam Matters: In an answer on how inequality affects education, follow the link from income to schooling first. Then use the lower pay of the next generation as the consequence.
Inequality pulls people towards places where pay is higher, and their move can narrow one gap while widening another.
A nurse in a small country is offered a hospital job abroad at five times her pay. Many of her colleagues have already gone. Should she go?
Inequality is a main reason people move. Within a country, large gaps between village and city incomes pull people from farms to cities. Between countries, large gaps in income per head pull workers from poorer countries to richer ones.
The move then changes inequality, in both directions:
So migration can narrow the gap between places while widening the gap within one. The net effect depends on how large the remittances are, and on who leaves.
Real Example: In 2024, Filipinos working abroad sent home a record $38.3 billion, according to the Philippines' central bank. That was about 8.3% of the country's GDP. It shows how large remittances can become for the incomes of a sending country.
Poorer people tend to die younger, and ill-health then makes them poorer still.
Why do poorer people die younger in many countries? Life expectancy is the average number of years a person can expect to live, and it tends to rise with income, for several reasons:
In Tessar, life expectancy is 64 years in the poorest fifth and 76 years in the richest fifth: a gap of 12 years.
Health then feeds back into income. An illness can stop a person working, and paying for treatment uses up the family's savings. So ill-health is both a result of low income and a cause of it.
Free health care can narrow the gap, but the other causes remain. Diet, housing, water and dangerous work still differ by income, and a visit to a doctor changes none of them.
Real Example: A 2016 study of tax and death records in the United States found that the richest 1% of men lived about 14.6 years longer than the poorest 1%. For women, the gap was about 10.1 years. It shows that the gap can be large even in a high-income country.
As a poor farming country grows richer, the gap between rich and poor may first widen and then narrow.
Picture a farming country where almost everyone grows food on small plots. Incomes are low, but they are similar, so inequality is low. What happens to the gap as the country develops?
Economic development is a rise in living standards that includes health, education and income. The economist Simon Kuznets suggested a pattern for inequality along the way.
Kuznets hypothesis: the idea that, as income per head rises, inequality first increases and then falls.
Put simply, the gap grows in the early years of industry, then shrinks once most people share in its gains.
With income per head on the horizontal axis and inequality on the vertical, the pattern is an inverted U: a curve that rises, then falls. Each stage has its reason:
The evidence is mixed. Taiwan, for example, grew fast while its inequality fell, partly because land reform (moving land from large landlords to the farmers who work it) spread the gains widely. And inequality has risen again in many high-income countries, which the simple curve does not predict. So the pattern depends on policy, not only on the level of income.
Real Example: Between 1949 and 1953, Taiwan cut farm rents and let tenants (farmers who rent the land they work) buy the land they worked. The share of farmland worked by tenants fell from 41% to 12% by 1965. Taiwan then grew fast while its inequality fell. It shows that a rise in inequality is not certain as a country grows.
Exam Matters: In an Examine on development and inequality, use the stages to explain a rise, then judge it with a counter-example, such as Taiwan.
Technology and trade raise pay for some workers and lower it for others, so average pay can rise while the gap widens.
A bank replaces its clerks with software and hires engineers to build and run it. The clerks lose their jobs, and the engineers are paid more than the clerks were. The bank's average pay has risen, because its remaining workers are better paid. But the former clerks now earn nothing from the bank, so the gap between them and the engineers has widened.
Economic change alters inequality through what it rewards:
The effect is not fixed. Where schooling keeps up with the demand for skills, more workers can take the new jobs, so the skill stays less scarce and its pay rises less. Where displaced workers retrain, they can move into the growing jobs. In both cases, the rise in inequality is smaller.
When markets set incomes, people earn from what they own as well as from their work, so incomes tend to spread apart.
There are two ways to earn an income: sell your work for a wage, or own something that earns money, such as a factory, land or shares in a firm. Most people can only do the first.
Free market economy: an economy in which resources are privately owned and prices and incomes are set by the forces of demand and supply, with little government intervention.
Put simply, people and firms own the land, buildings and machines, and markets, not the state, decide who earns what. Its other name is capitalism.
A free market creates inequality in three ways:
In Tessar, the poorer half receives 5% of its income from owning assets, while the richest tenth receives 45%. So even if every worker in Tessar were paid the same wage, incomes would still be unequal, because nearly half of the richest tenth's income comes from what it owns.
There is another side. The same system has produced the growth that has cut absolute poverty in many countries, and its inequality gives incentives to train and start firms. Strong growth can also lift the lowest wages: it creates many new jobs, and once firms struggle to fill low-paid jobs, they must offer more to hire anyone. Market economies also differ widely in inequality, because taxes, benefits, public services and minimum wages change the outcome.
So a free market tends to create inequality, but how much remains depends on what the state does.
Real Example: In 2016, Hong Kong's Gini coefficient for household income before taxes and benefits was 0.539, its highest since records began in 1971. After taxes and benefits in kind (services given instead of cash) were counted, it was 0.473. It shows a market economy with high inequality, and how far its taxes and benefits narrowed the gap.
Exam Matters: In an Evaluate on markets and inequality, weigh the three sources of inequality against growth and incentives, then judge how much depends on what the state does.
Some people are poor because they cannot buy enough food or shelter; others because they have far less than the people around them.
To measure absolute poverty, a government counts how many people fall below a fixed income level, and how far below.