Unit 1 Micro: Poverty and Inequality and Market Failure

In a market economy an individual’s ability to consume goods & services depends upon his/her income or other resources such as savings An unequal distribution of income and wealth may result in an unsatisfactory allocation of resources and can also lead to alienation and encourage crime with negative consequences for the rest of society. The free-market system will not always respond to the needs and wants of people with insufficient economic votes to have any impact on market demand. What matters in a market based system is your effective demand for goods and services.

When we are discussing inequality and poverty, we cannot escape making value judgements i.e. normative views about what is an acceptable scale of inequality and what is not

Absolute poverty

Absolute poverty measures the number of people living below a certain income threshold or the number of households unable to afford certain basic goods and services. What we choose to include in a basic acceptable standard of living is naturally open to discussion. This may vary from country to country at different stages of development.

Relative poverty

Relative poverty measures the extent to which a household’s financial resources falls below an average income level. Although living standards and real incomes have grown because of higher employment and sustained growth, Britain has become a more unequal society over the last 30 years

The most commonly used threshold of low income in Britain is 60% of median household income after deducting housing costs.

Poverty hits British families

The distribution of income in the UK

In the UK there is a large degree of income inequality:

In 2009, income before taxes and benefits of the top fifth of households in the UK was £73,800 per year on average compared with £5,000 for the bottom fifth, a ratio of 15 to one.

After taking account of taxes and benefits, the gap between the top and the bottom fifth was reduced with average income of £53,900 per year and £13,600, respectively, a ratio of four to one. This shows that the tax and benefits system works in a progressive way to reduce the scale of income inequality.

The Poverty Trap

• The poverty trap affects people living in households on low incomes. It creates a disincentive either to look for work or work longer hours because of the effects of the income tax and welfare benefits system. For example, a worker might be given the opportunity to earn an extra £60 a week by working ten additional hours. This boost to his/her gross income is reduced by an increase in income tax and national insurance contributions. The individual may lose some income-related welfare benefits and the combined effects of this might be to take away over 70% of a rise in income, leaving little in the way of extra net or disposable income. When one adds in the possible extra costs of more expensive transport charges and the costs of arranging child care, then the disincentive to work may be quite strong.

Government Policies to Reduce Poverty

When evaluating different policies to reduce poverty consider some of these related issues:
• Cost
• Effectiveness
• Impact on others in the economy

1. Changes to the tax and benefits system: For example, increases in higher rates of income tax would make the British tax system more progressive and reduce the post-tax incomes of people at the top of the income scale. The risk is that higher rates of taxation may act as a disincentive for people to earn extra income and might damage enterprise and productivity.

2. A switch towards greater means-tested benefits: Means testing allows welfare benefits to go to those people and families in greatest need. A means-test involves a check on the financial circumstances of the benefit claimant before paying any benefit out. This would help the welfare system to target help for those households on the lowest incomes. However means tested benefits are often unpopular with the recipients.

3. Linking the state retirement pension to average earnings rather than prices: This policy would help to relieve relative poverty among low-income pensioner households. Their pension would rise in line with the growth of average earnings each year

4. Special employment measures: Government employment schemes seek to raise employment levels and improve the employment prospects of the long-term unemployed.

5. Increased spending on education and training: Unemployment is a cause of poverty and structural unemployment makes the problem worse. There are millions of households in the UK where no one in the family is in any kind of work and this increases the risk of poverty.

6. The National Minimum Wage: The National Minimum Wage (NMW) was introduced in April 1999 - employers cannot legally undercut the NMW. Since 1999, the beneficial impact of the minimum wage has been concentrated on the lowest paid workers in service sector jobs where there is little or no trade union protection.

Oxfam: UK Poverty - John and Donna’s story