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Income inequality is usually measured by the Gini ratio, a set of figures that focus on the percentage of a population receiving a certain percentage of the income of the total population. The nearer the resulting outcome is to 1.0, the greater the income inequality under the Gini ratio. Income is more equal when the Gini ratio is closer to zero.

In general, the average Gini for developed and developing countries is around 0.35 (0.45). Income inequality tends to be greater in poor countries because there are fewer opportunities for growth. The Gini ratio is not a perfect measurement. It gives just a snap shot and offers no dynamic picture of income growth, nor does it reflect improvements in social upward mobility.

It is quite impossible to achieve equality of income in modern economies, because education trains people and according to their training, they receive different incomes. In the case of Hong Kong, our post-World War II growth experience led to significant improvements in the Gini ratio, from near 0.45 in the 1960s and 1970s to around 0.35 in the 1980s when economic growth permitted greater social mobility and a corresponding reduction in poverty.

However, in the 1990s, overheating of the economy followed by the onset of the Asian financial crisis resulted in a prolonged period of economic recession in Hong Kong. Similar to other economic recessions, the fall in income would have meant a decline in the number of highly-paid jobs. The income pyramid would have changed, the acute angle at the apex would become flatter, the narrow base would be wider. In sum, there would be fewer "wealthy" people and more "needy" people. This necessarily means a rise in the Gini ratio and an increase in income inequality.

It is true that the Gini ratio in Hong Kong has deteriorated, probably now closing in on 0.5. However, one should try to understand the origin of this condition. The answer rests with the ability to raise income and the restoration of more high paid jobs, so that social mobility can lift people up to the income ladder and improve the Gini ratio. Although welfare advocates have mistakenly thought that a redistribution of income by taxing the rich and heavy government spending on the poor is the solution. Such a view is more of a political popularity than a practical solution.

In Hong Kong, the tested economic policy is the "supply driven" strategy that provides a solution from the "supply-end", where more investment is needed in order to create more jobs, employment and high pay for both skilled and unskilled workers, including the job opportunity for the immigrants.

The first Policy Address given by our new Chief Executive on January 16 specifically pointed out that Hong Kong cannot practice income redistribution through a high tax system. In many ways, it is poverty that is the more important concern than inequality. Equally, welfare advocates have taken a simple view of looking at the poverty issue from a static point of view by working on the stock, namely the quality of poor people in Hong Kong. This is a simple answer but not a solution.

Even if there is a "poverty line", the welfare supporters are simply calculating the number in the poverty pool. Their solution would simply involve in the amount of government spending and welfare support that would be given to the "poor".

The issue of poverty should be examined from a dynamic point of view, namely one has to consider the channel through which people fall into the poverty pool, and ways through which the poor can exit from the poverty pool. Typically, it would be most desirable to have policies that minimize the number of entrants and maximize the number of exits from the poverty pool. Over time, while there are new entrants of people with difficulty in securing jobs, appropriate "supply-led" policies will minimize the quantity in the poverty pool at any time.

Again "supply-led" policies include improvement in Hong Kong's competitiveness and attractiveness to investment, especially investment that creates jobs and expands the physical economy rather than portfolio investment that leads to speculations in stocks and properties. With increases in physical investment, jobs of different natures may be promoted, which will generate a positive multiplier effect on the economy creating additional employment opportunities in related fields.

Once there is a sufficient increase in physical investment and jobs, equality of opportunity should allow gradual improvement in upward mobility. It is only through such a strategy that the Gini ratio can be improved over time, not by massive amount of fiscal redistribution, though there should be sufficient assistance given to the needy in the fiscal framework.

The author is an associate professor of the Department of Economics and Finance at City University of Hong Kong.

(HK Edition 01/24/2013 page3)