[Diagnosis and Prescription] Income Inequality, Income Polarization, and Economic Growth: Problems, Causes, and Solutions

Table of Contents

I. Raising the Issue

II. International Comparison of Income Inequality and the Severity of Income Polarization

1. International Comparison of Income Inequality

2. The Severity of Income Polarization

III. Causes of Income Inequality

1. Voluntary Causes

2. Involuntary Causes

3. Overview

IV. Solutions to Income Inequality

1. Voluntary Causes

2. Involuntary Causes

V. The Relationship Between Income Inequality and Economic Growth

VI. Conclusion

References

I. Raising the Issue

When the 2008 financial crisis that originated in the United States spread to major countries around the world, claims emerged that income inequality and income polarization were the main culprits behind the economic crisis. However, income inequality and income polarization have nothing to do with economic growth. “In economic theory,” that is. But if many people think so and struggle for income redistribution, or if the government implements various welfare policies to alleviate income inequality and income polarization, economic growth slows down. That is, compared with a situation in which such welfare policies are not implemented. This is because such welfare policies consume capital and therefore have a negative impact on economic growth.

Recently, the ruling Democratic Party of Korea proposed a variety of measures, arguing that the so-called “social safety net” should be strengthened in order to alleviate (income) inequality and (income) polarization. At the root of such claims lies the policy of an inclusive (welfare) state.

If the ruling party’s argument that welfare policy should be strengthened leads to actual policy, it seems clear that economic growth will slow even further than it has now. This is for the reasons presented above.

There are three major questions to be addressed in this series. First, how bad is income inequality? Since there is no “absolute” standard for income inequality, this paper gauges the extent of income inequality in Korea through an international comparison of income inequality.

Second, it examines the severity of income polarization based on the concepts of market income and disposable income. By the standard of market income, income polarization worsened during the 2006–2016 period. However, by the standard of disposable income, income polarization showed no significant change during the same period. This shows that the government’s income equalization policies have been effective to some extent.

However, while government welfare policy helps improve income polarization, the average income of each income class is leveled downward. The average income of the nation as a whole is the same. The government’s income redistribution policies during the 2006–2016 period played a major role in improving income polarization, but the average income of each quintile and the average income of the nation as a whole declined. We cannot, however, demonstrate the magnitude empirically. That path is “the road not taken,” so it can be understood only through theory. Politicians and experts who advocate introducing policies to alleviate income polarization need to understand that such policies lower not only the average income of each quintile but also the average income of the nation as a whole.

Third, if income inequality is reduced, there is a strong possibility that the problem of income polarization will also be alleviated. Here, by analyzing the causes of income inequality, this paper seeks to devise measures to mitigate income inequality. The causes of income inequality can be divided into voluntary and involuntary ones. For the Korean economy, which aspires to capitalism, this paper will focus on the involuntary causes of income inequality and propose measures to resolve income inequality (and, as a result, income polarization).

In short, what we must do for sustainable economic growth is not to implement welfare policy or welfare programs. Such welfare policies instead make economic growth unsustainable. In other words, welfare policy or welfare programs only worsen economic growth further.

The Bank of Korea publishes each year an indicator called the labor income share. The labor income share is the ratio obtained by dividing employee compensation in a given year by the sum of employee compensation and operating surplus. The Organisation for Economic Co-operation and Development (OECD), unlike the Bank of Korea, calculates the labor income share by dividing employee compensation in each year by total national income. However, it is inappropriate to use either of these figures as statistics representing income inequality or income polarization. This is because today’s workers (including heads of household), in addition to earned income, also receive considerable business income and property income, and because, with the implementation of many welfare policies, public transfer income is also substantial. Therefore, labor income share statistics are not used in this series.

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Original title: [진단과 처방]소득불평등과 소득양극화, 그리고 경제성장: 문제, 원인 그리고 해법

Author: Yong-deok Jeon

Date: 2019-06-19

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=report&pn=2&idx=20269