Income Inequality: United States vs. Romania

Income Inequality: United States vs. Romania

Income Inequality: United States vs. Romania Joseph Leeson III and Michael Lindenfelser Introduction For countless generations, the lopsided distribu...

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Income Inequality: United States vs. Romania Joseph Leeson III and Michael Lindenfelser

Introduction For countless generations, the lopsided distribution and allocation of income has plagued society and spurred the creation of social classes based on wealth. No country is immune to this development as most countries, if not all, suffer from income inequality. Even countries under communist or socialist rule that dictate that the earnings of their citizens be relatively equally distributed, may possess gaps between different income groups. In this research, two countries, the United States and Romania, will be used to examine this phenomenon and the numerous economic and social factors that lead to it. The implications of income inequality include a potential threat to the existence of the middle class and their social mobility. The Economy of the United States The United States’ economy is the largest and one of the most technologically advanced of all nations in the world. The Gross Domestic Product (GDP), or the total value of all final goods and services produced within a nation in a given year, is the largest of any nation in the world at $14.26 trillion (2009). With a GDP per capita of $46,400, the U.S ranks eleventh (CIA World Factbook, n. d.). The American economic system is capitalist, where both private and public firms continuously conduct business with each other with great flexibility and limited government intervention in the market, especially

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when compared to their counterparts in Europe. The flexibility granted to businesses and firms allows them to expand capital, employ or lay-off workers, offer their services, and respond to market demands faster than other systems might. Following World War II, the overwhelming advances in technology created a two-tier labor force of unskilled, uneducated workers and educated workers who were able to learn to keep up with the expanding technological changes. This divergence in the workplace created an income inequality between income classes that is still felt by households today. As represented in Table 1, personal income is unequally distributed in the U.S., with the top twenty percent of households receiving just over one-half of total income in 2006. In an equal distribution, all five categories would receive twenty percent. Table 1: U.S. Personal Distribution of Income, 1986, 1996, 2006 % of Total

Income Segment (Median Income)

1986

1996

2006

Lowest Quintile ($8,596)

3.9

3.7

3.4

Second Quintile ($21,097)

9.7

9.0

8.6

Third Quintile ($35,486)

16.2

15.1

14.5

Fourth Quintile ($54,922)

24.5

23.3

22.9

Highest Quintile ($115,514)

45.7

49.0

50.5

Source: U.S. Bureau of the Census.

As can also be seen, unfortunately, the income inequality gap is widening over time, and it seems that the poor are getting poorer and rich are getting richer. Income inequality, which had been expected to fall as the recession started in December of 2007dropping the highest earners closer to the rest, was essentially unchanged in 2008 by various census Bureau measures. The top five percent of households received 36

21.5 percent of income in 2008, up from 21.2 percent in 2007 half of all income went to the top fifth of the American household. What is alarming is that as income rises, the disparity between earning classes progressively widens. Over the past thirty years, the share of income generated by the top ten percent of Americans has grown by about a third; the share of the top 0.01 percent- the 13,000 or so households with average income of $10.8 million in 2002- has multiplied nearly four times (Rattner, 2005). The Romanian Economy Regarding Romanian income distribution, review of their economy is helpful. Romania began to transition from Communism to market-based economy in 1989, as their output produced from an obsolete industrialbased system proved unsuited to meeting the country’s demand requirements. On January 1, 2007, Romania became a member nation of the European Union, although it still is not a member of the European Monetary Union (EMU). A combination of corruption and bureaucratic red tape hinders the business environment, making business expansion somewhat difficult to pursue. Over the last decade, the GDP growth of Romania has been fueled by increasing domestic consumption and investment. This sudden boom in GDP growth has sparked the creation of a new middle class and the means to address the widespread poverty throughout the country, as twenty five percent of the population currently falls below the poverty line (CIA World Factbook, n. d.). However, GDP fell 6.9 percent in the 2009 fiscal year to $256.3 billion (U.S. dollars) from $275.3 billion in 2008 as the result of the worldwide recession rendering Romania forty fouth in the world, in terms of GDP (CIA World Factbook, n. d.). The labor market was also affected by the recession, just as in the United States, as the unemployment rate swelled from 4.4 percent in 2008 to 7.6 percent in 2009 (CIA World Factbook, n. d.). History of United States Income Inequality In a society with equal distribution of income, as noted, the dispersion

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of income would be equal among the quintiles of households, where each group would account for twenty percent of personal gross income. In fact, the United States, just like many other nations in the world, has suffered from a disproportionate allocation of income for many generations. Occasionally the income gaps between the five quintiles shrink, bringing them closer to equality; however, the gap remains extremely large. Saez, has stated that “analyzing long-term trends (of income distribution) are often hampered by a lack of good data” since “household income surveys virtually did not exist prior to 1960” (2009). Therefore, determining actual inequality before the 1960s is nearly impossible to achieve. Saez does conclude, however, that between 1914 and 1945 (the two World Wars through the Great Depression) the U.S. experienced dramatic fluctuations in the proportion of income earned by each group (Saez, 2009). “The top percentile share declined during WWI, recovered during the 1920s boom, and declined again during the Great Depression and WWII,” resulting in a gradual reduction in the gap between the upper and lower quintiles (Saez, 2009). Saez suggests that the top earners were financially hindered during the World Wars and the Great Depression because they were capital owners, or owners of financial assets, and relied heavily on dividend and business income. The shocks of war and the stock market crash adversely affected the top quintile’s overall share of national income. Well into the 1960s, the income inequality gap experienced earlier in the century slowly diminished in the United States. In spite of this diminishment, according to Berliner, the top fifth of households still owned a large portion of the nation’s income at roughly forty percent (2007). But during the 1970s, and continuing into the present, there has been a remarkable increase in the earnings of the top quintile yet again. Berliner stated, “between 1975 and 2005, U.S. households in the bottom 80 percent income bracket saw their share of national income fall,” and that “only the top 20 percent of households experienced an increase in their share of the total national income” (2007). The “households in the top fifth of the income bracket earn almost half of the nation’s income,” according to 2005 statistics (Berliner, 2007). An explosion of top wages 38

and salaries since 1970 have accounted for the surge of income obtained by members in the upper-quintile. Over the past generation, the financial gulf between the rich and everyone else has grown wider. Meanwhile, unequal growth of income distribution in the United States shows no signs of slowing down in the near future. The historical decline of income inequality during the 1960s in the United States can be partly attributed to the expansive modernization of the American education system. Due to technological advances and the development of more efficient production methods, demand for workers with more advanced education and training has increased substantially. In a 2003 interview, Jared Bernstein, a chief economist in the Obama administration, theorized that the income disparity between education levels has grown over time. Part of the growth of disparity that Bernstein has noticed, can be attributed to the growth of the difference in earnings between workers with high school diplomas and workers with college degrees. According to Levy, there has been a rapid increase in income inequality since the beginning of the 1970s, a time of massive technological growth (2008). In 1972 college graduates earned 1.43 times as much as highs school graduates and in 1992 that number increased to 1.82. In 1972 workers with advanced degrees earned 1.72 times as much as high school graduates but by 1992 that number had increased to 2.54 (Levy, 2008). Development of the American financial markets has created more effective methods of doing business but has also made for an income distribution that heavily favors more highly educated workers. Recent Trends in the United States Recent trends show that immigration and outsourcing have played major roles in the changing distribution of income. Foreigners that have recently immigrated to the United States frequently lack the education and training demanded in the U.S. workforce, and therefore increase the supply of low-income laborers. This increase in supply results in widening the gap between middle level and lower level incomes. 39

In addition to immigration enlarging the lower class, outsourcing has contributed to a decrease in the number of middle level income jobs. Regev and Wilson point out that most jobs being sent offshore are manufacturing jobs, which have traditionally been a major source of employment for middle income workers (2007). This decline of middle-income jobs has contributed to the reduction of the middle class. These two factors are a major influence on income distribution, increasing the gap between the lowest and highest classes. A contributing factor to the degree of inequality recorded yearly in the United States is the number of workers per household. The Census records income distribution by household in its reports. This creates a widened income gap between multiple and single worker households. Families with multiple workers in their household tend to record more income than families dependent on a single worker. This discrepancy in income records allows for a more unequal distribution to be present in census statistics. This creates a minor issue of accuracy of data regarding income inequality. Distribution of Jobs Within all general economic entities, distribution of income is directly related to the distribution of work throughout the general labor force. Heardman and Rector stress the importance of considering the amount of work contributed and the amount of income earned (2004). These authors claim that households within the top one fifth of income distribution in the United States perform about one third of the total labor in the economy. Lower class families, on the other hand, have less educated and productive workers and contribute less to total labor output, but are compensated for it disproportionately generously, after taxes. According to this theory, inequality of income in the United States can be considered a consequence of an unequal distribution of work. The more work a laborer does, the more income he/she accumulates.

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Distribution of Income in Romania Just as the United States suffers from a wide income disparity, Romania also battles with that dilemma which has proven to be a growing problem over the last few decades. “In 1989, the top ten percent of the population [in Romania] earned around 2.1 times more than the bottom ten percent,” and this trend has since been on the rise (Romaniapoverty and wealth, n.d.). Unlike the United States, Romania has an unusually large percentage of the population living in poverty. Romania’s rank amongst the world’s worst countries in poverty is eighty-third, with twenty five percent of the population below the poverty level. Romania’s extreme amount of poverty can be attributed in part to the unequal distribution of income. Romania has a small upper class, a large bottom class, and a middle class that lacks foundation. The top ten percent of income households consume approximately twenty one percent of the country’s total GDP while the lowest ten percent only consumes around one percent (CIA World Factbook, n. d.). The lopsided distribution in Romania is the result of numerous factors, but the largest influencing factor has been the transition from communism to capitalism. The inequality that plagues the Romanian economy is a major side effect of the country’s economic woes that accompany massive federal change. In 1989, Romania transformed from a command based system to a market system. During this change, the top ten percent of the population earned around two times more than the bottom ten percent (Romania- poverty and wealth, n. d.). According to a 1994 survey conducted by World Development Indicators, Romania’s highest quintile accumulated 37.3% of income whereas the bottom quintile earned only 8.9% (Romania- poverty and wealth, n. d.). The inequality gap continued to widen throughout the 1990s and into the new millennium. Molnar has revealed that in 2008, the “share of the income of the 20% of the population with the highest income was almost five times larger than that of…the population with the lowest income” (2009). During that year, the upper quintile received

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thirty nine percent of before-tax income whereas the lower quintile earned only eight percent (Molnar, 2009). However, due largely to the worldwide economic crisis and a substantial increase in minimum wage and pensions in Romania, the income gap has been growing at a slower pace than it had been between 2000 and 2006 (Molnar, 2009). Given the conditions of the crisis and political pressure, Molnar predicts that a continual decrease in the income gap is probable. Nevertheless, even with this recent deceleration, the income distribution in Romania is the widest of all European Union members. Although Romanian income inequality dramatically increased during the few years after the transition, the country has had an explosion of economic growth over the past ten years. Romania has been one of the leading European countries in terms of GDP growth and in 2006 the nation experienced a GDP growth of eight percent (Romania- poverty and wealth, n. d.). As a result of the large amount of financial expansion, foreign investment in the country has risen. Alongside the setbacks the country has seen from its transition to capitalism, there have also been beneficial changes that have accompanied the economic transformation. Table 2: Romanian Income Distribution, 2008

Source:

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The Impact of Corruption Another major issue that Romania has had to contend with during the past twenty years has been the corruption that has spread throughout the country’s upper class. Corrupt financial and political practices have sprouted from the economic instability that was a result of the government’s transition. One of the most notable cases of corruption in Romania was the indictment of former Prime Minister Adrain Nastase. During Nastase’s term as Prime Minister between 2000 and 2004, he was accused of numerous cases of bribery and other fraudulent acts, compromising his political integrity (EU criticizes judicial systems in Bulgaria and Romania, 2010). In 2009 alone, 244 high-ranking officials in the administration and politics were sent to court (EU criticizes judicial systems in Bulgaria and Romania, 2010). The corruption in Romania has caused income to flow disproportionately into the hands of the upper class. The weak judicial system allows for dishonest financial practices and prevents citizens from being able to seek justice. A step forward for Romania in fighting corruption has been the creation of the Agency for National Integrity, which is meant to oversee all officials, even those in Parliament. The Working Middle Class The working middle class has been considered one of the more important classes in preventing inequality because of its role as a medium for the distribution of income. Economist and political philosopher Karl Marx created a federal system that had its foundation built around the working class, because of the significance of labor. During the eight years after Romania’s transition to capitalism in 1989, the lowest quintile’s percentage of national income dropped from ten percent to 7.9 in 2007. This increase in poverty weakened the middle class and created a distinct separation between the upper and lower classes. As can be seen in Table 4, the first four quintiles of Romania’s distribution of national income all declined between 1989 and 2007, while the fifth quintile expanded. 43

TABLE 4: Percentage of National Income in Romania, 1989-2007

1989 1992 1994 1998 2000 2001 2002 2005 2007

Lower Quintile 10.0 9.3 8.9 8.7 8.2 8.1 7.9 8.2 7.9

2nd Quintile 14.9 14.3 13.6 13.3 13.0 12.9 12.8 12.8 12.7

3rd Quintile 18.7 18.4 17.6 17.3 17.4 17.3 17.1 16.8 16.8

4th Quintile 23.2 23.4 22.8 22.6 23.0 22.9 22.8 22.3 22.3

Upper Quintile 33.2 34.6 37.2 38.2 38.4 38.7 39.4 39.9 40.3

Source: www.tradingeconomics.com

This example shows the lopsided distribution in Romania that heavily favors the upper class. This distribution problem has carried over to the new capitalist government and has raised concerns in the economy over the enlarged upper class and minimized lower and middle classes. Romanian industrial engineer Ioan Gheorghiu is quoted as expressing his concern for the lack of social stability due to a small middle class (Muller, 2007). On a positive note, a recent analysis of Romania concludes that the recent economic expansion in Romania has helped to reenergize growth of the middle class which in turn may help to reduce income inequality in Romania (CIA Factbook, n. d.). These concerns regarding income distribution in Romania are similar to those issues raised by income distribution in the United States. Rattner has expressed the same concerns about the United States income disparities that limit social mobility, or the opportunity for individuals to move up the ladder (2005). The same squeezing of the middle class has occurred in the U.S. A similar trend over time can be seen in Table 5, which illustrates income distribution for selected years between 1967 and 2009.

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TABLE 5: Percentage of National Income in the United States, 1967-2009

1967 1972 1977 1982 1987 1992 1997 2002 2007 2009

Lower Quintile 4.0 4.1 4.2 4.0 3.8 3.8 3.6 3.5 3.4 3.4

2nd Quintile 10.8 10.4 10.2 10.0 9.6 9.4 8.9 8.8 8.7 8.6

3rd Quintile 17.3 17.0 16.9 16.5 16.1 15.8 15.0 14.8 14.8 14.6

4th Quintile 24.2 24.5 24.7 24.5 24.3 24.2 23.2 23.3 23.4 23.2

Upper Quintile 43.6 43.9 44.0 45.0 46.2 46.9 49.4 49.7 49.7 50.3

Source: http://www.stateoftheusa.org/content/new-census-estimates-providesnapshot.php

Russian-American economist Simon Kuznet won the Nobel Prize in economics for his theories on the relationship between economic growth and income inequality. Kuznet theorizes that there is a u-shape relationship between economic growth and income disparity in countries. This can be interpreted to mean that while some level of income inequality is beneficial to economic growth, too much disparity in income distribution diminishes the possibilities of growth (Levy, 2008). Kuznets’s theories can be applied to the situations of Romania and the United States in comparing the distribution of income of each country. Due to the restructuring of the Romanian economy, the country has struggled with poverty and income inequality. As the country has grown and matured, there has been a rebirth of the middle class and the government has undertaken a more active role in narrowing the income gap. Evidence of the success of these changes has yet to appear in the data on income distribution, however. Over the years, the United States has made attempts to improve income inequality through increases in minimum wage, various forms of government intervention in the markets, as well as progressive taxes, but existing data does not support the success of such attempts.

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Conclusion The allocation of national economic output has been one of the most statistically complicated tasks facing countries worldwide in the past two hundred years. Household income measurements, allocation of funds, and finding the appropriate balance of class income distributions are just a few of the problems preventing governments from having the capabilities of efficiently allocating income. Romania and the United States are two nations that help represent the current worldwide struggle in achieving an equitable allotment of income. Each country has made great efforts to combat the growing income disparity in their regions with little success. This is signified by the widening distribution gap as the largest quintile continues to expand and the other quintiles contract. Upon examination of these two countries, the results indicate an international trend towards unequal distribution levels that leans heavily in favor of the upper classes. A major side effect of this trend is the contraction of the middle and lower class income levels creating more poverty and decreased living standards for a large portion of the countries’ populations. Both the United States and Romania need to address income distribution, as it should be acknowledged as a primary concern in establishing better economic health. Countries need to provide more education and training to correct the problem of too many low skilled workers. A thriving middle class is an important component of economic, political, and social stability of any nation. Issues of immigration and outsourcing also need to be addressed. Countries can provide more protection for those at risk, such as better wage insurance to cushion the effect of globalization. If countries do not pursue policies to fix inequalities, social pressures may force unwise, even extremist moves, like protectionism.

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