To what extent can the problem of poverty in the UK be solved through the operation of market forces?

AQA A-Level Economics Paper 1 June 2017

To what extent can the problem of poverty in the UK be solved through the operation of market forces? Justify your answer. (25 marks)

• Paragraph 1
  • Argument: poverty can be controlled through market forces
  • Diagram: price mechanism
  • Evaluation: free market only allocates resources to those who are willing and able to pay
• Paragraph 2
  • Argument: government intervention can reduce poverty through minimum wages and better education and training
  • Diagram: minimum wages
  • Evaluation: government failure

In the UK, the biggest form of poverty is that of relative poverty, which exists when an individual does not have enough income to enjoy the standard of living that is enjoyed by most people in society; generally those who learn less than 60% of median income.

On the one hand, a better long-term solution could be to reduce poverty through market forces alone, and that leaving labour markets to the price mechanism results in the most efficient outcomes, without any risk of causing government failure. One of the biggest causes of relative poverty in the UK is wage differences. In perfectly competitive labour markets, low pay can be explained through low demand for labour or high supply of labour. One example is retail staff since companies like Lidl and Aldi are able to replace retail assistants with self-checkout machines, causing a shortage in demand for retail staff. The diagram below shows that the price mechanism works to ration this excess demand. The diagram on the left shows that, at w1, there is an excess supply of labour. This is because there are more people who are willing and able to work at the current wage, compared to the number of workers that firms are willing and able to employ. Therefore, firms reduce the wage rate on offer until the market clears. The new equilibrium wage (w2) is lower, causing a contraction in supply and an expansion in demand, which is due to the incentive function. Enough workers are incentivised to leave this labour market. Even more importantly for the question of poverty, the long-term effect could be that more people consider changing careers as they aim to increase their pay. Other labour markets with an excess demand have increasing wage rates, incentivising new workers to enter. Therefore, through the functions of the price mechanism, relative poverty can be reduced over time.

However, the price mechanism only allocates workers to firms who are willing and able to pay, and only allocates jobs to those who are willing and able to work. Whilst higher wages should in theory incentivise people to work harder, some people may find it difficult to increase their pay without additional support. Government intervention is important to support certain workers have an equal opportunity, such as those with disabilities. Additionally, elderly people may not have the time or the motivation to retrain, so arguably it is still important they are not exploited and that firms still pay them at least a living wage.

On the other hand, you could argue that government intervention is necessary, and also a more effective method to alleviate poverty in the UK. In the UK, relative poverty and inequality are controlled through a system of progressive taxes and benefits. Income taxes are direct taxes on incomes. As incomes increase, the percentage of income that is taxed increases. This can reduce the gap in real incomes between high earners and low earners, thus reducing the Gini coefficient. The diagram below shows how the Lorenz curve becomes closer to the line of perfect equality through the use of progressive income taxes. Additionally, higher income taxes on higher earners allow for the government to collect higher levels of tax revenue. This tax revenue is fundamental as it can allow for re-distribution in the forms of benefits to those who are out of work, but also allows for the government to maintain spending on public services such as schools and libraries. The second diagram below shows how the UK government are able to guarantee a provision of services like education and healthcare. The government are able to guarantee a supply of q1, which people can access free of charge. A combination of free state education, libraries, and subsidised leisure centres allow families to attain decent levels of health and education which boosts human capital and allows them to access jobs in the service sector. Although the free market provides incentives for people to work hard, it is clear that a minimum level of government intervention is required to prevent absolute poverty and also provide as close to equal opportunity to those who grow up in the UK.

However, the Laffer curve illustrates how government intervention can lead to sub-optimal outcomes. As tax rates increase past an optimal rate of T*, tax revenues actually fall. This illustrates that high tax rates incentivise people to work less, either forcing people to reduce over-time, take early retirement, or migrate to another country to seek better opportunities. This is a genuine risk as the UK are currently maintaining the same income tax bands until at least April 2028. The effect of this in terms of relative poverty is that incentives to increase income beyond roughly £50,000 are significantly reduced due to the 40%+ marginal income tax rate on income past that. High levels of income inequality mean that wealth inequality would remain high, which can cause further differences in opportunities that young people have as children from wealthier families have the options to go to private schools and hospitals unlike others. 

Overall, I believe that poverty should not be left completely to market forces as this would cause pay gaps to increase, especially for young people and elderly people working part-time jobs, and those with disabilities. Whilst means-tested benefits and progressive income taxes certainly help to control inequality, it is crucial that they are well thought through to prevent incentives being reduced, as government intervention should be in place to make markets work even better than they do alone.

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