Income composition inequality

What is this research about and why did you do it?

This paper is about introducing a novel lens through which we can view and understand the world. I call this lens compositional inequality. Compositional inequality describes differences between rich and poor in terms of the labour share and capital share of their income. When compositional inequality is high, the rich and the poor are earning from different sources – capital and labour income respectively. When, by contrast, compositional inequality is minimal, the rich and poor are earning income from capital and labour in the same proportion.

‍

How did you answer this question?

To measure the degree of compositional inequality in capital and labour income in a society I introduce a novel indicator: the Income-Factor Concentration (IFC) index. The IFC varies between 1 and –1: it is equal to 1 when the rich earn entirely capital income and the poor entirely labour income, while it is equal to zero when the rich and the poor earn from both income sources in the same proportions. The higher the IFC index, the higher is compositional inequality. Compositional inequality links the functional with the personal distribution of income. The functional distribution of income describes the distribution of profits and wages in overall GDP, whilst the personal distribution describes how overall income is divided among individuals.

The higher is compositional inequality, the stronger the link between the functional and personal distributions: a ceteris paribus increase in profit share translates into an increase in income inequality, as profits are concentrated among the rich. This is well aligned with the discussion of the two distributions presented by Atkinson (2009) and Glyn (2011).

‍

What did you find?

While classical political economists have described a historical demarcation between top income shares composed primarily of capital income and lower income shares fuelled by labour income, this separation fails to depict the world we live in today. Compositional inequality is in fact found to be far below its maximal value in almost all countries in the world, as shown in a recent article jointly written with Branko Milanovic (see figure below). The time and cause of the disappearance of this separation is an interesting matter for future time-series investigation.

Not all countries have, however, the same level of compositional inequality. Latin American countries like Mexico and Brazil are, for instance, characterised by high levels of compositional inequality. They can, therefore, be regarded as forms of classical capitalism, where rich individuals are capital income abundant and poor individuals labour income abundant. Interestingly, Nordic countries display similarly high compositional inequality, despite famously low income inequality. This raises important questions about the desirability of compositional equality.

Meanwhile, countries like Taiwan and Slovakia are characterised instead by low levels of compositional inequality. Intuitively, land redistribution in Taiwan may explain the lack of concentration of capital income among the rich. These countries are examples of an unprecedented ‘new capitalism,’ where rich and poor alike earn from both capital and labour incomes.

The graph shows on the horizontal axis compositional inequality, as measured by the IFC index, and on the vertical axis inter-personal income inequality, as measured by the Gini coefficient.

‍

What implications does this have for the research on wealth concentration or economic inequality?

Is a society where rich and poor individuals simultaneously earn from capital and labour sources of income good for equality? This question is especially prompted by the observed coexistence of a high Income Factor Concentration Index with a low Gini. Further, compositional equality could carry implications for political stability and growth: while such equality could foster cooperation between income classes, could there be counterweighing efficiency losses from dispersing the gains of each factor? The notion of IFC proposed in this paper thus stimulates structured thinking on crucial economic questions. Their answers will allow us to think about the nature of a more equitable capitalism.

‍

What are the next steps in your agenda?

The next step it about the development of a new theory of compositional equality, articulated through an interdisciplinary research agenda, to answer these fundamental questions about the nature of capitalism in the 21^st century.

‍

Citation and related resources

This paper can be cited as follows: Ranaldi, M. (2022). "Income Composition Inequality." Review of Income and Wealth, 68(1), pp. 139-160.

‍

The following is other work by the author on the subject of compositional inequality:

• Ranaldi, M., and Milanovic, B. "Capitalist Systems and Income Inequality." Journal of Comparative Economics, 50(1), pp. 20-32.
• The paper above is discussed in a VoxEU Column (3 December 2020) and as a VoxEU Talk podcast (29 January 2021).

‍

For the interested reader, the following are resources alluded to in the summary above:

• Atkinson, A. B. (2009). "Factor Shares: The Principal Problem of Political Economy?" Oxford Review of Economic Policy, 25(1), pp. 3-16
• Glyn, A. (2011). "Functional Distribution and Inequality." In Nolan B., Salverda, W., and Smeeding T. M. (eds). The Oxford Handbook of Economic Inequality. Oxford: Oxford University Press, pp. 101-126.