14 Apr

‘Big government’ anti-relational? Not when it comes to income inequality!

Goldfish income inequality for RTN website

Over the last decade, research on well-being has increased exponentially. While the main focus of economists is on the relationship between well-being and GDP per capita, they are becoming increasingly aware of the role of income inequality. This is an important topic for relational thinking as well, since income inequality is closely related to social cohesion and trust within a society. While relational research often focuses on interpersonal relationships directly, the structure and organization of societies and their economies can be a major source of stress. The impact of poverty is widely understood, yet income inequality can put relationships under a similar kind of pressure. Much is still unknown about how inequality affects well-being and what can be done about it. This blog aims to give a first glance at ongoing research on the matter, from a relational perspective.

When discussing income inequality, we should first ask ourselves what do we mean, and why is it worth to be studied? A classic approach is to look at absolute income differences within a country. Yet, as humans are social beings whose well-being depends on interaction and comparison with others, it is relative income inequality that social scientists should be most concerned about. A commonly used measure is the Gini-coefficient, a complex mathematical function that unfortunately tends to overestimate inequality between incomes in the middle of the distribution. Due to the nonlinear nature of income inequality, a better alternative is to look at the % of national income that is earned by the richest 10% of the population of a country. For European countries this number ranges from about 24% in Denmark, up to more than 40% in the UK. This means that on average one third of all income in a country goes to 10% of the population, leaving two thirds to the remaining 90% . This may not sound very alarming. Yet a similar pattern can be seen within the 90% group. In the end, high inequality means that a relatively large group is left with relatively little income. Several researchers have argued that the current level of inequality causes polarization of societies, as different income groups tend to become isolated from one another through consumption patterns, education, and even residential areas. When inequality is furthermore perceived as a sign of unfairness, it can pose a serious threat to social cohesion and mutual trust, even further deteriorating relationships.

Closer investigation of the matter shows that while perceptions of inequality are important, countries with higher levels of income inequality have lower average life satisfaction irrespective of cultural differences. This is especially true for countries with relatively high standards of living, and the relationship is causal. The question is then what causes income inequality, and can it be influenced without major distortions to the functioning of the economy. Ideally, productivity should determine one’s income. Productivity can however not be directly observed, while differences between supply and demand of labor may lead to unequal bargaining positions. Thus, market structure and government institutions have a major impact on the distribution of income. More formally, these are called the degree of economic freedom of a country. As an indicator, economic freedom is usually divided into five sub-indices, being size of government (consisting of government expenditures and fiscal policy), the quality of the legal system, sound money, free trade, and the degree of regulation of capital, labor, and credit markets. Of these sub-indices, tax policies and low regulation have a strong and very significant impact on income inequality. As suggested by Piketty (2014), a country’s tax structure has an important signal function regarding what kind of earning system and income distribution are acceptable to a society. In addition, government regulation of an economy strengthens the bargaining position of the weak and poor and offers them protection against abuse of power. In addition to its potential direct positive impact, this leads to more equal outcomes, strengthening both work and family relationships.

What does this mean for relational thinking? While a lot of things can be left to the responsibility of local communities, sound macroeconomic structures are essential to contain income inequality, strengthening these communities and supporting healthy relationships. Thus, how paradoxical it may sound, ‘big government’ is not always such a bad idea!

Bjorn Lous is a second-year PhD-student at Tilburg University, studying the relationship between economic freedom, income inequality and life satisfaction.