Is economic inequality as bad as we perceive it to be.

Economic inequality has constantly been an issue at the center of the politics. The government, media and public in Western societies, especially in Israel are trying to create different ways to reduce this phenomenon. Israel has spent many years as one of the leading countries affected by economic inequality in the Western world.

To explain briefly how economic inequality can be measured, the most popular index for measuring economic inequality is the Gini index. A Gini coefficient of zero expresses perfect equality, where all values are the same, for example, where everyone has the same income. A Gini coefficient of one expresses maximal economic inequality among values, an example of this is when only one person has all of the income or consumption and the others have none.

Similar to many Western countries, Israel has seen an increase in economic inequality since the 1970s. There are many reasons for this increase in economic inequality; I will now explain several examples of this.

The development of technology:

The development of technology, created the increase in wages for highly-qualified workers. This development in technology was extremely important for Israel due to the contribution of the Israeli hi-tech industry towards the national GDP.

The rise of globalization:

Globalization increased the demand for advanced industrial products from developed countries and also reduced the demand for traditional industries due to the competition from the rest of the developing countries and the leader among them is China, these processes, of course, affected the Israeli economy, which caused an increase in the high-tech industry and increase the wages of those with a higher education all this happened in parallel to the decline of traditional industries and the closure of traditional factories due to competition from more developed countries.

Transfer payments and taxes:

A significant factor causing economic inequality that politicians tend to minimize is the transfer payments and taxes that distort the decision of individuals. Transfer payments, mainly child benefit and income support grew from the early 1980s to 2002 as a result of legislation in the Knesset..This created less incentive to work among poorer communities and not to acquire the necessary skills for work. Between the years of 2002 and 2005 there was a decrease in transfer payments which caused an increase in employment in Israel furthermore resulting in a decrease in economic inequality as more people where joining the labour force. It is important to note the increase in the participation rate among women (nearly 4%) is also part of an ongoing historical process in recent decades.

The main question is whether economic Inequality is necessarily a negative factor in the national economy. Economics literature is full of many studies indicating the downside of socioeconomic equality and the impact of that on the economic activity and GDP. It is important to consider that there is widespread understanding among most economists, that is also backed up by numerous studies, which shows that extreme economic inequality causes a deceleration in national economic growth. This negative relationship between economic inequality and economic growth is less of a problem in developed countries such as Israel compared to in developing countries. In this article I am referring to economic inequality in a theoretical way and not specifically to the inequality that exists in Israel. I want to show that economic inequality is not necessarily harmful to the national economic system. I believe that economic inequality is not really too detrimental for the economy and even benefits the economy. In my opinion economic inequality that is based on personal ability and efforts of individuals is ideal for economic activity and also for employees that cause the GDP to increase. Countries that were founded with economic equality grew more rapidly, East Asian countries are an example of this compared to  countries in South America that have had constant economic inequality. The countries that began with economic equality do not have to adopt anti-growth policies in order to reduce economic inequality as opposed to countries that have always suffered from economic inequality.

I will now explain why economic inequality creates innovation and a more competitive economy with higher human capital and a higher productivity which contributes to GDP growth.

Incentives:

Every job requires effort from employees, when the work involved demands greater effort it also makes their productivity higher. The main motivation for employees to increase their work efforts is of course their salaries; therefore people have more incentives to achieve a higher education to increase their chances of getting a higher salary, furthermore leading to high human capital. In a country with higher productivity the GDP is larger. An economy with equal socioeconomics creates a lack of incentive from individuals to seek out an education, therefore their salary does not change, and this is not good situation.

Many studies show that a positive relationship between salary and education exists, for example if a labour market does not have opportunities for employment this will lead to a low human capital. This relationship is also an incentive for lower and middle classes in society to get an education and thus increase their wages and their labour productivity. It is also an incentive for the higher classes to maintain their position by acquiring an education and an investment for the long-term in human capital for the younger generation; therefore economic inequality is an incentive to the individual in the economy to invest in the human capital. In Israeli economy human capital contributes to almost 40% of economic growth. Increasing the productivity labour in the sectors leads to a strong and rich economy. Countries cannot be developed without high productivity labour.

Capital and Technology:

In sectors that have a high salary for employees, there is also a incentive for innovation and for technological improvement. The main reason for this is innovation and technological improvements led to huge savings in manpower .Buying expensive technological equipment occurs when the cost of employees is expensive. In poor countries because of the cheap cost of employees, there is almost no incentive for business owners to buy expensive technological equipment such as machinery and equipment in order to improve the productivity of their employees. The business owners do not pay for the expensive equipment because their employees’ wages are low and they do not need to replace the workers with high cost technology, this is true for developing countries. In Israel, the best example of this is the construction industry; the employees cost is relatively low in this sector, so there is no incentive to improve technology. Foreign workers such as Palestinians, the Chinese and Eastern Europeans working in these sectors are relatively cheap compared to Israeli workers; this does not create an incentive to improve the technology therefore the productivity labour of this sector increased far less than other sectors according to the Bank of Israel.

Policies to reduce economic inequality:

To reduce economic inequality it is crucial to have a political policy in place that would change direct taxes (progressive taxation) and indirect taxes (transfer payments) to lower the levels of economic inequality. Governments that want to reduce the levels of economic inequality have to do several things such as increasing the tax progressive for those with a high-income and increase transfer payments to those with a low-income, this causes distortions among individuals and leads to reducing economic activity and a slowdown in economic growth. A large majority of economics studies that were conducted in various countries during different periods in time using different statistical methods have found a negative impact of taxation on GDP growth. In other words a society can pay a high price for a policy of reducing a socioeconomic gap; this type of policy can be harmful to the standard of life of the citizens and also the economic activity.

Finally it is important to question whether economic inequality is really as bad as it is perceived to be. This also depends on how economic inequality is created and how wealth is divided and accumulated. There are several ways to accumulate wealth; one way is to take money from others an example is the owner of the Nesher Israel Cement Enterprises who gained his wealth due to government policies because the government limits imports thus preventing competition so consumers are forced to buy cement from this company charging monopolistic prices. In this specific case the owner of a company was able to become rich due to fact that he managed to extort more money from Israeli consumers by being a monopoly and charging higher prices, the profits just moved from one place to another without creating economic growth. Another example of how to accumulate wealth is a more productive way that also contributes to the whole economy and underlines Adam Smith’s principle of ”The invisible hand”. When people are able to become rich because of their ability to create and produce innovative products the whole economy grows and the wealth permeates every level of society. An example of this is Waze which is the world’s largest traffic and navigation app, it was sold to Google for $966 million dollars and resulted in the creators becoming very wealthy. Waze being sold for such a high amount caused two things, the first was that the statistical level of economic inequality has increased in Israel and secondly it has also significantly increased the ease in which drivers can travel in the country. In cases when ambitious people successfully produce and sell a product or service this can create more jobs for employees with a high human capital and enables people to earn higher salary with more opportunities. It can also lead to foreign investments in the domestic market.

A sector that could increase economic inequality is the hi-tech sector. The hi-tech sector creates an incentive for the acquisition of skills and investment in human capital, this sector is also a huge contributor towards Israeli innovation and technology which contributes to the GDP. It is a fact that the market must pay a price; this of course is economic inequality. In sectors such as high-tech the labor productivity is higher than in other industries, therefore workers wages are often higher than people that don’t work in hi-tech, this increases economic inequality. It is common that economic inequality is portrayed as something negative however the whole economy benefits from a market that is based on innovation, human capital, a high productivity level and advanced technology.