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Income Inequality

Causes of Income Inequality

There is no single reason for income inequality. Slow wage growth is a strong factor, as are the effects of globalization, an increase in technology in the workforce, and various institutional policies.

There is no single root cause for the rise of income inequality. However, slow wage growth among the middle- and lower-classes is a key factor. Workers are producing more, but the real minimum wage in the last 25 years across the country has hovered around $8 per hour, rather than growing in response to economic and production growth. The real household income for those in the bottom 50% of the economy has remained almost stagnant for the last 50 years. There are three main causes of this slow wage growth and rising income inequality: trade and globalization (the process of businesses, organizations, countries, and other agents engaging in international interactions, manufacturing, monetary exchange, influence, or trade), institutional policies, and technology and education.

One cause for rising income inequality is globalization and trade. Growing trade between the rest of the world and the United States has increased the number of imports in the US economy, leading to a loss of US jobs in industries that once produced the now-imported goods. Some have argued that as a result of the North American Free Trade Agreement (NAFTA), a trade agreement involving the United States, Canada, and Mexico, one million US jobs were lost. It is estimated that from 2000 to 2007, 800,000 jobs were lost in the United States because of growth in Chinese manufacturing for many industries, including computer and mechanical goods. Additionally, globalization has contributed to an increase in offshoring (a strategy used by firms to produce parts or whole products in a different economy than the one in which they are based in order to take advantage of lower costs), negatively affecting US wages. As companies move operations out of the United States in order to lower production costs, jobs leave the country in favor of lower-wage workers elsewhere. Increased trade and offshoring both lead to lower employment and weakened wage growth. The companies that have remained in the United States try to keep wages down in order to be competitive with companies that produce in low-wage countries.

A second cause arises from the country's institutions. More specifically, economists point toward the role of government policies in creating an institutional framework that perpetuates increased inequality. In the United States, for example, many policies have effectively reduced wages and employment, including tax changes, de-unionization, and corporate deregulation (removing government regulations that inhibit corporate behaviors such as environmental degradation) dating from the late 1970s. Some policies have hurt workers, such as airlines' deregulation by Congress with the Airline Deregulation Act of 1978, which allowed the free market to set airline fares. Prices for flights were lowered, and when the price of gas was raised, many employees lost their jobs. Deregulation also hurt rural workers, such as when passenger trains were no longer required to go to rural areas where they were not profiting. High-investment returns for individuals, such as the purchase of stocks, has also grown income equality. Those who invest and have the capital to do so often earn a return, thus greatly increasing the income gap between investors and those who do not have the funds to invest. Investors typically have disposable income and are in the top-earning percentiles of the economy. They are able to invest extra funds into the stock market, for example, growing their funds. Those without disposable incomes cannot take advantage of this income source.
Households in the highest income categories own the majority of U.S. stocks. Note that the top 1% of households own nearly 40% of stock holdings and the top 10% own over 80% of all stocks. The bottom 60% of earners own only about 2.5% of stocks. (These stock holdings includes stocks in mutual funds, 401K plans, etc.)
A third cause for rising income inequality is technology and education; more specifically, a widening wage gap because of an increased demand for highly skilled workers with the rapid progression of information technology. Today's workplace invests more heavily in creating highly skilled workers, leading to a rise in wages for highly skilled workers. The demand for highly skilled technological workers creates a necessary demand for education. People from high-income families are more likely to receive an advanced education than those from low-income families; this factor in itself directly increases inequality. The rise in wages and the demand for highly skilled and educated workers causes a decrease in the wages of low-skilled workers as their importance is de-emphasized.

The increased role of financial capital has also impacted workers. Firms that focus on Wall Street tend to make more money from financial sources than from producing goods, as firms in previous decades did. For example, investment brokerages and banks do not produce a tangible product; they earn profits through financial transactions alone. Thus, the focus in business has shifted from product creation to growing money through investments. This often keeps the profits in the hands of those already in the higher percentiles of income.