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Retirement Planning and Income Inequality July 24, 2008

Posted by retirementwithaplan in Uncategorized.
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This post originally appeared on another blog server on 12.10.07

Income Inequality

Let’s spend a moment looking at income inequality and the idea of retirement. This, whether you are aware of it or not, works against the notion of how you view some of the social programs you may have been counting on in your retirement years.

One of the most popular measures of this was developed by almost a century ago. The Gini index was developed by the Italian statistician Corrado Gini and published in his 1912 paper “Variabilità e mutabilità” (“Variability and Mutability).

There are several ways to express the degree of income inequality in a society. The simplest way is to arrange whatever units you choose persons, families, or households in rank order, from poorest to richest; divide the hierarchy into fifths (quintiles) or tenths (deciles); and compute either the average income by decile or quintile or the share that each grouping has of the society’s total income. Then, the shares or averages of rich and poor can be compared.

The chart above puts the poorest person at zero and the richest at one. The curved line represents all of those who fall in-between those two points

A low Gini index suggests that there is a great deal of income equality while a high number would show a society that has great disparity in income distribution. This is expressed as a number from zero to one.

But like all attempts to measure the economy and the persons who live in it, the Gini index has both its pluses and minuses. Let’s first consider why it works.

The Gini index does not consider the “who earns what” in its calculations nor does it take into consideration the size of the economy. The population of an entire country being measured is not accounted for in the index. The transfer of wealth, as would happen from the rich to the poor is measured in the changes of inequality over a period of time.

But the Gini index is a general measure that does not hold up well when the attempt to drill these numbers down to regional observations. This would force the index to compensate for purchasing power, which might be better for some in areas of the country that were more developed as opposed to other regions where the ability to spend wealth may be hampered.

Gini- Generally speaking

Efficiency is also a consideration. Generally speaking, wealthier households use money better than those who must make living standard decisions about each dollar available to spend. In other words, one household could own half of all the available wealth and the country might have the same index reading as one where distributions were divided equally – one household with no income compared to one household with.

How does this measurement, which often does not take into consideration how much social assistance a household might receive, affect retirement planning.

Consider a study made by Harvard and Berkeley, done separately but with the same attempted goals. Absolute standard of living, a measure of how well you do as it corresponds with death rates found that income distribution did have an effect on not only how well you live, but how long and what social services you might need as a result of your shorter life span and the causes.

At the heart of what many of us expect, is the presence of some social support. Janet Yellen, president and chief executive officer of the Twelfth District Federal Reserve Bank, at San Francisco believes that support comes with a paradox. You can have generous social insurance programs and employment protections, much as they do in Europe, but are they efficient or equitable? In order for these types of programs to be equitable, they would need to be good for everyone. Efficiency suggests programs that take the nation as a whole into consideration.

The Importance to Your Retirement Plan

Why is this important to retirement planning? Two reasons come to mind. First, the US is seen as highly productive, social mobile, and economically innovative. On the flip side of that coin is Europe. Because of its guarantees to its workers, many companies have stagnated creating higher-than-necessary unemployment. This restricts growth.

The second reason we should all consider is referred to as the American Business Model, which does not treat companies as living entities but as tradable and expendable. In some ways, the employee can get caught up in this kind of thinking making retirement planning more of a personal endeavor rather than a state sponsored or even company sponsored reward for long years of toil.

While Europe may be criticized by America business and folks like Ms. Yellen for what it does for its workers, there has to be a happy medium that allows for both equity and efficiency. Unfortunately, that is not likely to happen.

To see how the Europe (currently) supports its citizenry through its social programs, here is a list:

Country Summaries

Albania | Andorra | Austria | | Belgium | Bulgaria | Croatia | Cyprus | Czech Republic | Denmark | Estonia | Finland | France | Germany | Greece | Hungary | Iceland | Ireland | Italy | Liechtenstein | Lithuania | Luxembourg | Monaco | Netherlands | Norway | Poland | Portugal | Russia | Serbia | Slovak Republic | Slovenia | Spain | Sweden | Switzerland | Ukraine | United Kingdom



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