Free market?

I’ve been reading quite a lot of articles and comments about the recent Comprehensive Spending Review (CSR) and there is – as you would imagine – a wide variety of different views. What I find quite interesting (to put it politely) are those people with what I think of as right wing (or conservative) views who seem to believe that the state should be smaller and that there should be more of a free market approach to how to provide things in society. The kind of things that I’ve read are along the lines of “get money out of the public sector into the private where it can work to generate wealth”.

What I would really like is for someone to explain (without using the typical rhetoric that uses words like “waste” and “efficiency”) why a smaller state with services being provided through a free market would be better than what we have now. Let me lay out, in general, the reason why I find this free market ideology confusing in certain circumstances. I assume that most people accept that there are some things that should be provided by the public sector. Examples would be the military, policing, etc. There are others, such as education and healthcare, that are probably amongst the kind of things that some would like to see provided by the private sector, rather than by the public sector.

Here’s where I get slightly confused – and hence would like someone to explain the free market ideology to me. If we consider healthcare, it has a total cost of something like £100 billion per year and makes up about 15% of public spending. We could presumably privatise healthcare, reduce public spending by 15%, and return £100 billion back into the marketplace (assuming that we actually do reduce the deficit). Let’s assume that the goal is to continue to provide healthcare for all, but just to do so through the private sector rather than the public. How do we achieve this? To first order, providing healthcare for all must cost about the same whether done through the private or public sector (any efficiency savings will probably be cancelled out by the fact that some profits will have to be made for those who have invested). The cost per person will therefore be about £1500 per year and the cost per family will be something like £5000 – £6000 per year. Currently 50% of jobs in the UK pay £19000 per year or less and 50% of household have income of £25000 per year or less. Given that very little of the £100 billion that is returned to the private sector will go to the lowest earners, how are these people meant to suddenly start paying for healthcare?

One option is that the private sector redistributes wealth so that everyone in employment can afford healthcare. The other is that it is provided directly by employers, although this then begs the questions of what happens to the unemployed and those who are retired. What I want to know is how this is significantly different from what we already have? Roughly £100 billion a year will be spent providing healthcare for people in the UK. This money isn’t going to be available for anything other than providing health coverage, so how does it suddenly generate wealth in the private sector when it supposedly wasn’t when in the public sector?

Possibly my initial assumption is wrong and that those who want a reduced public sector actually do not believe that everyone should get reasonable healthcare. Maybe the idea is that providing health coverage through the private sector would introduce choice. You could choose to have no healthcare, pay very little and get very basic healthcare, or pay a lot and get the best possible healthcare. Presumably this then implies that the unemployed would have no coverage, the lowest earners would only have basic coverage, and only the highest earners could afford coverage similar to what we all get today. If this is what is essentially being suggested by those who support small government, then they are probably correct that the total cost of healthcare will be less than it is today and some money will be consequently available for other, potentially wealth creating, enterprises. What is possibly not recognised, however, is that having a healthy workforce is, in itself, a way of creating wealth (or at least of creating more wealth than a comparable society in which many do not have health coverage).

The third possibility that I can imagine is that those who want small government and more private sector involvement in providing services, really haven’t given it much thought at all and simply believe all the rhetoric that is being thrown around by various conservative thinktanks. You can probably work out that my view, at this stage, is that providing services like healthcare and education through the public sector is preferable to providing it through the private sector. I’m more than happy to accept that some kind of savings could be made and that there may well be inefficiencies in the system, but I’m not – at this stage – convinced that it would be significantly different if it were in the private sector. I am, however, genuinely interested in having someone explain – including all goals and assumptions – why providing certain services through the private sector is preferable to providing it through the public sector.

Quantitative easing

So the results of the Comprehensive Spending Review (CSR) have now been announced and they are -in the my view – very depressing. I was listening to George Osborne on Radio 4 this morning and essentially his argument is that this has to be done (some – myself included – disagree) and that he doesn’t even need to have a plan B as his plan A is what we need to do. What is available, according to Osborne, is the ability of the Bank of England to use monetary stimulus if growth should suffer as a result of the spending cuts.

Essentially – as far as I’m aware – this refers to the process of Quantitative Easing. I’m not an economist and I have to admit that I don’t fully understand this, but what I gather is that this involves the Bank of England essentially creating money (crediting its account) and then using this money to buy various financial products. The idea then is that there is more liquidity in the markets, things can be bought and sold, and money can make its way out into businesses who can then pay salaries and carry on operating.

One consequence of quantitative easing is that it is likely to result in inflation. At first glance this seems fairly obvious as money has simply been added into the economy, without actually increasing the net value of the economy. What £1 can buy should therefore decrease. It’s probably not as simple as that since it presumably depends on the actual values of the products that the Bank of England has bought in order to get the money out into the marketplace. If they are able, reasonably quickly, to resell these products for a value consistent with what they paid for them, they could then remove this money from the marketplace and everything cancels. Presumably the amount of inflation must depend – to a certain extent – on the difference between the actual realisable value of the products bought by the Bank of England and the amount that they paid for these products.

The net effect of quantitative easing is presumably then that there is more money in the marketplace and so products can be bought and sold and salaries can be paid. However, it will probably result in some amount of inflation, so everyone would presumably effectively be taking a pay cut of – possibly – a few percent. The alternative would be to make a few percent of the working population redundant, so quantitative easing does something reasonably positive, since it could be preventing some unemployment. However, it is clearly not progressive in that everyone sees their salary devalued by the same percentage. Since low income workers probably spend almost all of their disposable income, they are probably more affected by this inflation than high earners who can save some fraction of their income and earn interest.

Presumably an alternative to quantitative easing would be simply to increase tax for a few years. It could amount to the same thing since it would be reducing people’s salary by a few percent, and the money raised would make it into the marketplace through public sector projects or by paying public sector workers. It’s presumably a little safer in that the consequences of quantitative easing could be quite unpredictable, and it could be more progressive in that it could be aimed at the higher earners (of course being progressive doesn’t appear to be high on the current government’s agenda). Essentially, the government has chosen to make massive public sectors cuts – rather than raising money through taxation – and the only mechanism they have for stimulating growth (if it is required) could have the same effect as taxation would have had. Still not obvious that the government’s approach is the only one that makes sense, or maybe I’m completely wrong and don’t understand anything.

The “greatest macro-economic mistake in a century”

Interesting article in the Guardian today about David Blanchflower’s views on the upcoming cuts. David Blanchflower was, until recently, a member of the Bank of England’s Monetary Policy Committee and is known for being something of a maverick; regularly voting in the minority.

Essentially Blanchflower thinks the government is making a huge mistake in making cuts of this magnitude and are, in fact, being extremely cowardly. As the title of this post indicates, he has also described the proposed cuts as the “greatest macro-economic mistake in a century”. I hope he’s wrong, but my gut feeling is that he is not. What I think makes perfect sense is his comment that even though you do need to cut the deficit, there is no economic theory that says you have to do it extremely quickly. Why is there an insistence that it has to happen within this government? I’m getting somewhat tired of hearing government ministers insisting that there is no alternative and that it is all the previous government’s fault (although there is some merit to the latter). It’s clear that the longer it takes, the greater our total debt will become. However, if we cut too fast and too deep, we risk another recession, reduced revenues and having to borrow more money anyway.

I notice that Alan Johnson, the new shadow chancellor, has now released his plan for cutting the deficit. He is proposing a combination of cuts and tax rises – aimed primarily at the banking sector. It’s probably a little too late, but I much prefer this to the government’s plan of reducing the deficit mainly through cuts. Firstly, I think that the cuts are going to influence a number of things that are fairly crucial to the UK’s well being. Higher education and research funding being things that influence me directly, but the benefits system and policing are two other areas that may be severely affected. There is a second reason why I think tax rises are justified together with cuts.

A cut of £83 billion is equivalent to 3.3 million people earning an average salary (£25000). I’m not necessarily suggesting that 3.3 million people will lose their jobs, but 10% unemployment is not necessarily unlikely. The cuts also mean that £83 billion has left the UK economy, it hasn’t simply gone back into private industry. Private industry is unlikely to suddenly generate £83 billion in wealth overnight. Private industry is also unlikely to reduce profits and the salaries of those in employment simply to reduce unemployment levels (they can’t really employ more people without finding the money to do so). The unemployed are therefore likely to remain unemployed for quite some time. Combining cuts with tax rises means it’s more likely that we will be able to manage a smooth transition from the public to the private sector. I know the CEOs of major corporation will argue that this will inhibit growth, but I’m not convinced. What is more, essentially insisting that 10% of the working population are forced into unemployment so that the wealthiest can continue to get wealthier seems entirely wrong. That doesn’t really feel as though we’re all making equivalent sacrifices for the future of the UK. I hope the government rethinks its strategy before Wednesday’s CSR announcement, but I doubt it.

Tuition fees – Do they really know what they’re doing?

Although not surprised, I am quite disappointed with the Browne report. I haven’t read it in detail, but at first glance it reads as something in which the outcome was essentially known from the beginning. There appears to be very little discussion of the fundamental reasons for the existence of a higher education (HE) sector, and it appears to assume that the current funding model has to change. The basic idea from the report is that tuition fees would be uncapped and that students would be lent the money to cover the tuition fees, and to help cover the cost of living. It seems unlikely that fees will actually be uncapped, but will probably rise to about £6250 per year with an additional £3750 per year for living expenses. Students will therefore accrue debts of about £10000 per year. If this does end up being the case, Universities will supposedly actually gain nothing, in that the government is likely to cut the HE budget by an amount equivalent to the extra amount that the HE sector will get through tuition fees. The main thrust of the Browne report is that the money lent to a student will only be paid back once the student earns more than £21000 per year and would be written off 30 years after the person has finished their degree.

Fundamentally I think it is wrong and I believe that a free market Higher Education (HE) sector will not be as effective as one that is primarily funded by the public and that is largely free to pursue excellence. However, rather than going into a long discourse about why I think this is the case, I thought I would present some basic consequences of the Browne report – assuming that it is accepted as the new model for funding the HE sector.

A little while ago I was playing around with distribution functions and managed to produce one that largely matches the income distribution in the UK. It’s shown in the figure below. It’s not perfect but it has approximately the correct mean (£25000), the correct median (£19000) and the 10th, 25th, 50th, 75th and 90th percentile incomes are very close to the actual values for 2007/2008.

The table below is taken from the Browne report and it shows the amount of money that someone will pay per month to repay the loan they were given to cover tuition fees and cost of living expenses.

At first glance it doesn’t seem unreasonable; the highest earners pay more per month than the lower earners. There are, however, a couple of things one can do straight away. The payment as a percentage of total income is straightforward. It is also likely that there will be interest, at about 2.2%, that will accrue once someone crosses the £21000 threshold. One can therefore calculate how long it will take for someone to repay the loan. These are both shown in the figure below. The solid line is the payment as a percentage of income, while the dashed line is the number of years it will take for someone to repay the loan, capped at 30 years after which the remainder is written off. Included in this calculation is the assumption that people’s salaries will rise with inflation at a rate of 2.2 % per year (for simplicity, the same as the loan interest rate).

What the above figure shows is that everyone earning, today, between £21000 and £32000 per year will repay for the full 30 years. Those earning close to £32000 per year will be paying almost 3% of their income for the entire 30 years. If we go back to the income distribution figure that I showed at the beginning of this post, one can calculate that about 45% of those in employment (about 15 million people) earn £21000 per year or more. Since slightly more than 40% of school leavers go to university, we can assume that almost everyone earning £21000 per year or more will have gone to university and will therefore be repaying a student loan. If this is the case, almost 5 million people will have their income reduced by between 1% and 3% for 30 years. If one considers those who will pay for 10 years or more it amounts to almost 9 million people. Someone earning £50000 per year will pay almost 5% of their income for 10 years in order to pay back their student loan. Almost half of all those earning £21000 per year or more will therefore effectively have their tax raised by 1% or more for 30 years, while 2/3 will have an effective increase of 1% or more for at least 10 years. Of course, inflation could be higher than I assumed and so the repayment period may reduce slightly, but it is unlikely to change things significantly.

One can also determine how much each person will pay. This is shown in the figure below. The full amount will only be repaid by those earning £32000 per year or more. Someone earning £32000 per year will end up paying more than £40000 over a period of 30 years, while someone earning £100000 per year will pay £32000 over a period of about 4 years. This illustrates that the middle income group will pay much more than the highest earners who will be able to repay the loan very quickly.

We can also use the distribution function that I showed at the beginning of the post to determine how much money the government can recover every year. It’s not necessarily exact, but here is what I assumed. Everyone earning over £21000 per year went to university and has to repay a student loan of £30000 pounds. Everyone works for 40 years after graduating, but the loan is only repaid for the first 30 years (any remaining parts of the loan are written off after 30 years). The fraction of people in a given income bracket who will be repaying at any given time is therefore the number of years those people have to repay for, divided by 40. It turns out that if this was already in place and people today were repaying a student loan, the government would recover about 8 billion pounds. Here’s where I have a problem. There are currently 1.2 million people at British universities today. If the government is lending them £10000 each, they are then lending £12 billion and recovering £8 billion. Unless I’m mistaken, this ratio will always remain the same. The government will only ever recover 2/3 of the money because at least 1/3 of those who go to university will not finish paying within 30 years and quite a lot of those are only paying back interest.

If I’ve got this right (which maybe I haven’t as I’ve been trying to do this while my son keeps clambering all over me) the government is about to cut the HE budget by about 4.2 billion and will recover this money by increasing tuition fees. The money for the increased tuition fees will be loaned to students, resulting in an increase in the effective taxation of about 2/3 of those earning above £21000 by at least 1% for at least 10 years after they graduate. Ultimately, however, the government will only recover 2/3 of the money lent which, in today’s terms, will amount to a loss of about £4 billion. Furthermore if they simply increased the level of taxation for those earning above £21000 by 1.5%, revenues would increase by £9 billion. I don’t know about everyone else, but I would rather pay 1.5% more in tax and have a publically funded HE sector, than pay something like 4% for 10 years after graduating (or 1% for 30 years) and end up with a supposedly free market HE sector. I’m of course ignoring that this is still £3 billion less than the £12 billion required for all the 1.2 million students so students would still need to borrow something to cover cost of living expenses and to pay some top-up fees.

Maybe I’ve made some kind of silly mistake or maybe my assumptions are too simplistic but it seems quite possible that – to reduce direct funding to the HE sector by £4.2 billion – the government is going to introduce a graduate tax that could result in some paying 4% more in tax for a decade after they graduate, and after all that the government will still end up paying £4 billion per year to the HE sector. Effectively the government will introduce a very complicated taxation system for middle earners who will lose significant amounts of money just when they’re trying to have families and buy houses and as a result of this, the government will effectively save £200 million. Am I stupid or are they?

Gross Domestic Product

I was in the process of writing a post about science becoming an election issue, but have been somewhat distracted by an article in the Guardian by George Monbiot. The basic idea of the article is essentially that we are so fixated on growth that some people now believe that we should consider using all the resources on our planet if it allows us to then explore other worlds. What I found interesting was, however, the discussion of Gross Domestic Product (GDP), in particular the use of GDP growth as a measure of an economy’s success.

I’ve always had a bit of a problem with using GDP as a measure of a country’s wealth. Although I’m not an economist, it seems a little simplistic to just use this, especially since it gives no real indication of how the wealth is distributed. It is simply a measure of a country’s total economic output. I have argued before (here) that we should really use something like the Gini coefficient (indicating wealth distribution) and GDP, in order to optimise a country’s wealth together with how it is distributed. We could consider accepting a lower GDP if the wealth is more evenly distributed, especially since there doesn’t seem to be any strong evidence showing that giving excessive amounts of money to a select few ultimately benefits everyone.

What I found interesting in George Monbiot’s article was the suggestion – which came from a paper published by someone called Sir Parth Dasgupta – that another problem with GDP is that it doesn’t take into account the effect of GDP growth on a country’s resources. A country with a rapid growth in GDP could be doing this by depleting its resources in an unsustainable way so that even though GDP is growing, the total effective wealth is decreasing. Maybe we need to consider total wealth, GDP and how the wealth is distributed when trying to determine the strength of an economy. Maybe we also need to stop being so fixated on growth and start to consider how sustainable our economy’s are. As the current financial crisis has shown us, rapid growth is unsustainable and we would probably have been much better off if the financial sector had been more cautious and accepted a lower growth rate that would have been more sustainable (we probably can’t get rid of boom and bust completely, but we can probably minimise the amplitude of the perturbations).

Although I’m pleased to see more discussion about how a country’s economy is measured and would personally be very in favour of us considering how wealth is distributed and how sustainable our economy’s are when determining the wealth of a country, I’m not convinced that we are going to be seeing any paradigm shifting changes in the near future. It’s not really in the interests of today’s business leaders (who probably have a great deal of influence with our political leaders) to change the way in which we measure a country’s economic strength, especially if – in order to have an sustainable economy that would ultimately be of long-term benefit to the country, and possible even the world – this would involve them accepting a smaller fraction of the total wealth.

The tax burden

Fascinating article in the Guardian by Polly Toynbee , called
cooling the cutting fisticuffs – take a long, hard look at tax . What the article claims, and what I found particularly interesting, is that the bottom 10% of earners pay 46% of their income in tax, while the richest 10% pay only 34% of their income in tax. What is more, the top fifth of earners take 51% of the national income while the bottom fifth take 3%. This comes from a report by a centre-left pressure group called Compass , and I have no real reason to doubt its veracity.

Apparently the reason for this discrepancy is that the highest earners can take some (or most) of their income in the form of capital gains which is only taxed at 18%. So even though their salary is taxed at a high rate, their actual salary only makes up a small fraction of their total earnings – most of it coming in the form of capital gains. When I first read this I immediately thought that although this may be true, most low earners effectively recover what they lost through taxes in benefits, but I think this doesn’t really make a difference. The public sector makes up something like 40% of the UK’s economy. If we want to sustain what the public sectors offers people in the UK, we have to roughly recover 40% of the total income. We could of course decide that the public sector should only make up 30% of the UK economy which we could achieve by privatising some parts of the public sector, but I happen to believe that this would not be improve things in any way.

So assuming that we accept that the public sector is going to make up about 40% of the UK economy, how do we fund that? Well a simple way would be to take 40% of everyone’s income. This could be through both direct and indirect taxation, but at the end of the day we need this to fund the public portion of the economy. What you could then choose to do is to take a slightly higher fraction of the top earners’s income, leaving those on lower incomes with more money. You can even give some of money back to the lowest earners through benefits since they take such a small fraction of the total income, that this won’t really have a significant impact on government revenue. What you certainly don’t do is take less than 40% of the highest earners’s income. They take such a large portion of the total income that this will have a huge effect on the total amount of government revenue. How can we possibly expect to both sustain the public sector – which I think we should be doing – and draw down the deficit if we don’t at least tax the the highest earners at a rate that will give the government sufficient revenue.

In some sense this isn’t even a discussion about what is fair or not, it seems logical that the simplest way to ensure that government revenues are sufficient is to start by making sure that the highest earners are taxed appropriately. If not enough is recovered from the highest earners, it becomes increasingly difficult to get the remainder of what is required from the lowest earners since they take a smaller fraction of the total income. It seems ridiculous that we are only taking 34% of the total income of the top 10% of earners in a country that intends to have a public sector that makes up 40% of the economy. The top earners presumably would argue that they don’t rely on the public sector to the same extent as the lowest earners, but this is nonsense. Also, in an average sense, something like 40% of their income presumably comes from the public sector. In fact, since they take such a large fraction of the total income, more than 40% must come from the public sector and so taxing them at a higher rate, to a certain extent, is simply recovering public money.

Arrogance personified

The Guardian has reported that the vice-chairman of Goldman Sachs, Lord Griffiths, has given a speech at St Paul’s cathedral in London about morality in the marketplace in which he argued that society (the British public) should “tolerate the inequality as a way to achieve greater prosperity for all” . Not only do I disagree with the premise that giving lots of money to a few people will make everyone else more prosperous, it also seems as though his primary argument is that if we don’t accept this, banks will relocate overseas.

I didn’t see the speech and haven’t read a transcript so don’t know if there was more to it than that suggested above, but it doesn’t seem like a particularly moral argument to me. Give us what we want or else. Personally I think we should stand up to these kind of threats. I don’t believe that there are any strong arguments in favour of the trickle-down effect. There must be some kind of conservation in the system: the more the bankers keep the less there is for the rest of us. What is more, since banks don’t really build anything or invent any new technologies, the more money they keep the less there is for industry to work with.

There’s no question that banks do provide a valuable service, but is it quite as valuable as they seem to think. I agree that at the moment individual banks may be forced to pay ridiculous salaries in order to retain good staff, but there is no real reason why we as a society cannot push for a global change such that this is no longer the norm. It seems as though banks pay much higher salaries to a much larger percentage of their staff than other comparably sized business. Although banks may well have a larger percentage of highly-trained staff than many other industries, this still doesn’t seem to justify such huge salaries. If anything, if more of these bright people were encouraged to go into other industries that may develop technologies that can change the way we live – rather than being seduced by huge salaries in the banking sector – we may all benefit.

Although I am pleased that Alistair Darling, the Chancellor, has criticised the banks for paying huge bonuses so soon after being bailed out by the government, I have to admit that I suspect that this is more for political effect than because he truly believes it is wrong.

Goldman Sachs

It has been reported that Goldman Sachs will make a record profit in 2009 and will consequently pay record staff bonuses, setting aside as much as $18 billion. Personally I find this obscene, as do many others, and was really hoping that the banking industry would show some restraint and try to illustrate that they recognise the damage that has been done to the world economy by their risk taking.

On the other hand, some argue that this is simply capitalism working and if they choose to distribute some of their profits amongst their staff, that is entirely up to them. In principle this is fine, but I thought I would try to see if their was some reason why this argument wasn’t quite correct. In the past few years Goldman Sachs has had revenues of about $50 billion. It may be slightly higher in 2009 since there are fewer banks operating, but it probably isn’t more than $100 billion. The bonus pot is about half of their total profit, suggesting a total profit of $35 billion. This means that their profit is something like 35 % – 70 % of their revenue (depending what their actual revenue is). How does this compare with other large companies. Well, I quickly looked up Toyota and in the last few years they’ve had revenues of about $220 billion and profits of about $15 billion, about 5 % of their revenue.

The above isn’t particularly statistically significant. I thought I would try to have a slightly deeper look at this. I downloaded data for the top 100 companies (by revenue) in the world and worked out the average percentage profit. It is about 6.5 %. When I do the same for the Banking sector only, it turns out to be 9.5 % (it is the same whether I take the top 20, top 25 or top 50 banks in the world). This may not seem like a lot, but it does suggest that the banking sector operates in a way that allows it to make a larger percentage profit – in general – than most, if not all, other industries.

Maybe the above is fine, I don’t really know. Personally I have a problem with it. Although banks compete amongst themselves, unlike many other industries, there isn’t really an alternative to banking. We don’t have to buy a car, we could use public transport or ride a bike. If, however, we want to buy a house or invest some money, we need to use a bank (there may be some exceptions, but this is generally true). Is the reason that banks can attain larger percentage profits than comparable industries in other sectors because they have the brightest most capable staff, or simply because the type of competition they face is different to what other industries face. Personally I favour the latter interpretation. I don’t know how to change this, and even if there is a way to do so, but it is my opinion that our economy would be better off if more of the money remained in industries that actually build things and develop new technologies than being swallowed up by banks and divided up amongst their staff and investors.

The Wealth Gap

I have recently become quite interested in the wealth (or more accurately income) distribution in the UK. This was partly motivated by a couple of what I thought were interesting articles by Polly Toynbee in the Guardian. In the first article (which I can no longer find – maybe it wasn’t Polly Toynbee) a group of people are asked if they believe that a wealth gap exists in the UK. Most answered that they did, but when asked to guess the salaries of some top earners (solicitors, investment bankers, etc.), they generally guessed salaries significantly lower that what these top earners typically earned.

In the second article (which you can find here ) a group of high earners are again asked some questions about the wealth distribution in the UK. More than 50 % of people in the UK earn less than what this group thought was the poverty line, and less than 1 % earned more than what this group thought would put you in the top 10 %. Essentially these two articles illustrate – or supposedly illustrate – that the lowest earners believe there is a substantial wealth gap, but don’t realise quite how big it is, and the highest earners believe there isn’t really a substantial wealth gap, but only because they don’t really realise how little most people earn.

Although I haven’t investigated this in extensive detail, I have looked up some numbers related to the distribution of wealth in the UK. When considering any distribution it is quite important to understand the difference between things like the median and the mean (Stephen Jay Gould has an excellent book called Full House that explains some of these statistical terms extremely clearly). In the UK in 2004/2005 the mean annual income (pre tax) was about £23000. This, however, can be distorted by a small proportion of the population earning extremely high salaries. A better measure is the median which tells you, in some sense, the middle salary (i.e., 50 % of the population earns less than the median and 50 % earns more). In 2004/2005 the median, pre-tax income was about £16500, significantly less than the mean.

Although the median income has increased somewhat since 2004/2005, to something around £18500, I still find it quite remarkable that 50 % of the British working population earn £18500 per year or less. If, rather than considering indivduals, one considers households, it is slightly higher, but not by much. The mean household income for 2004/2005 was £31800 while the median was £24700. Again, these numbers will have increased slightly in the last couple of years, but I still find somewhat disturbing that 50 % of households survive on about £25000 or less, but does this indicate the presence of a wealth gap in the UK? Certainly, trying to run a household on less than £25000 per year must be pretty tough. That the top 1 % of earners have salaries more than 17 times greater than the bottom 10 % may suggest that a gap does indeed exist.

None of these numbers, however, convincingly illustrates that there is a substantial wealth gap in the UK. I then found a figure from the government’s office of national statistics which illustrates to a certain extent how wealth is redistributed. The figure (which you can read more about here) shows the average annual household income broken up into 5 groups (bottom 20 %, next 20 % etc. – known as quintile groups). The dark blue columns are the original annual household incomes and the light blue columns show the annual household incomes after tax and benefits. The bottom 20 % more than double their income to about £ 15000 per year, while the top 20 % lose almost 30 % of their income. The median (which would be roughly the 3rd quintile group) have a household incomes of just over £20000 per year which isn’t affected much by tax or benefits. The figure suggests that the top 20 % have average household incomes only 3 times greater than the bottom 20 %. The figures also suggests that the top 40 % of households end up with about 60 % of the total amount of money earned in a year, and the top 20 % end up with about 37 % of the total. Does this suggest an unfair distribution – I don’t really know. My first impression was that it actually looks quite reasonable.

Having started this post expecting to illustrate that there is indeed a wealth gap in the UK, I am finding myself now less convinced than I was when I started (interestingly Polly Tonybee was on the BBC news this morning stating once again that the UK – along with the US – does indeed have a very big wealth gap). Having said that, I do still find it disturbing that most households survive on less than about £25000 per year (after tax and benefits). I have also been using wealth here to mean income, so this doesn’t really illustrate how the actual wealth is distributed. Most of the numbers here are also based on taxable income. What I also don’t know is how much of the country’s income is given out in a manner that allows the receiver to avoid tax and therefore isn’t included in the analysis here. I was going to continue and talk about the Gini index which is an index for illustrating how income/wealth is distributed in a country but, since this is already quite long, I will leave it for a later post.