Thursday, August 31, 2006

Income inequality has risen here in the last 10 years but it is a necessary evil for economic growth.

a Comment on the above statement. [10]

Rising income inequality is a phenomenon experienced by many developed and developing economies globally; Singapore is not an exception. In fact, Singapore’s Gini coefficient, a measure of the level of inequality in an economy, has risen from approximately 0.43 to about 0.47 in the past decade, confirming the first part of the statement: income inequality has indeed risen in Singapore.

However, what is more uncertain is whether income inequality is necessary for economic growth; to address this issue, one needs to consider how income inequality is related to growth. In particular, the magnitude of the inequality present is of great relevance. It is only after considering these factors will one be able to draw a semblance of a conclusion about whether, firstly, income inequality is ‘evil’, and secondly, whether it is necessary for economic growth.

Rising income inequality is often experienced together with economic growth, of which Singapore’s economy is a prime example, having grown steadily at a rate of about 6 – 7% in the 1990s. The presence of income inequality arises because of a difference in wages and income, which further arises because of, among other things, an increased demand in expanding sectors in the economy as compared to decreased demand in contracting sectors, resulting in higher wages in the former, as well as, more subjectively, an increased work effort.

Hence income inequality diverts resources to where demand is highest (as workers seek to increase their incomes, they look for jobs in the expanding sectors of the economy), and provides an incentive for workers to increase their work effort, hence increasing the productivity of the economy in general.

Hence some level of inequality does seem necessary for efficiency, and hence, growth in the economy.

However, high levels of income inequality can hinder growth. Income inequality arises for reasons other than those mentioned before; in particular, income inequality may arise because of inherent differences in ability or differences in inherited wealth.

Income inequality that arises because of these reasons are more likely to persist in the long term, and if present in large amounts, has the potential to cause social unrest and a lack of social cohesion because of rising discontent in the lower income classes. This will necessary hinder economic growth as it causes instability, and may reduce the confidence the world has in the at economy; Singapore, luckily, has as yet not experienced something that serious.

Income inequality is sometimes regarded as an evil purely because of ideological reasons; however, too much of it is also an evil in the economic sense since it hinders growth. Yet, some level of inequality is still necessary for economic growth.

3b) Discuss whether the minimum wage law is the best policy in helping low income earners in your country. (15)

The minimum wage law is an artificial floor on wages that attempts to raise wages of low income earners to more acceptable levels.

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In imposing a minimum wage that firms must pay for labour, the government is legally assigning a minimum value of wages (P1) as the feel the equilibrium wage rate (P) is too low. However, while individuals who retain their jobs benefit, there are many (Q – Q1) who lose their jobs as producers find them too costly to hire. Furthermore, there is disequilibrium unemployment as Q2 workers want to work but only Q1 workers are wanted.

In trying to help low income earners, if the Singapore government puts in place a minimum wage, they might instead be doing the exact opposite for some of these workers. This is especially so as the market structure of the Singapore economy is very much a competitive one rather that that of say, monopsonies.

Instead, perhaps the government should look into alternative measures to help these workers. As most of Singapore’s unemployment is structural, perhaps the government should look into retraining these workers instead. Although this might be costly, the government can count, to some extent, on increased tax revenues from these workers who earn higher wages in the future, to finance this expenditure. Furthermore, this would solve Singapore’s structural problem directly to some extent, which is certainly desired.

One must also not forget welfare policies, Welfare benefits funded by progressive taxes on high income earners could be used to increase the income of the low income earners. This, unlike the minimum wage law, does not create unemployment. However, while this way of redistributing income is beneficial in this sense, progressive taxes are a disincentive on high income earners from working harder, whereas welfare benefits might serve to discourage low income earners from taking up an available job as they have a safety net to fall back on. These problems are not easily solved, and hence this method of helping low income earners require careful thought before being put into place.

The government, then, might want to cut regressive taxes to ease the tax burden on these individuals. They can also subsidies essentials such as rice and electricity alongside retraining policies. While this has little impact on income inequality, at least the low income earners are truly being helped, unlike in the case of the minimum wage law that distorts the labour market and brings along allocative inefficiency with it (refer to Q2 – Q1).

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