BS Thesis in Economics Development of the distribution of wealth in Iceland 1997-2017 Katrín Svava Másdóttir Advisor: Gylfi Zoëga Faculty of Economics June 2019 Development of the distribution of wealth in Iceland 1997- 2017 Katrín Svava Másdóttir Thesis towards a BS degree in Economics Advisor: Gylfi Zoëga Faculty of Economics School of Social Sciences, University of Iceland June 2019 Development of the distribution of wealth in Iceland 1997-2017 This thesis is equivalent to 12 ECTS credit towards a BS degree from the Faculty of Economics at the University of Iceland. © 2019 Katrín Svava Másdóttir This thesis cannot be reproduced without the author´s consent. Printing: Háskólaprent Reykjavík, 2019 3 Preface This thesis is a 12 ECTS final project for a B.S. degree at the Faculty of Economics at the University of Iceland. The advisor of this thesis is Professor Gylfi Zoëga, to whom I am extremely thankful for valuable comments and guidance throughout this process. I would also like to thank my family and friends for their support and patience throughout my studies, to them I am forever grateful. 4 Abstract Inequality exists in every economy. Economist Thomas Malthus believed that inequality within societies are inescapable (Piketty, 2014). Iceland is no exception to the general structure of wealth inequality within advanced economies (AEs). In this thesis the distribution of wealth between 1997-2017 in Iceland is analyzed focusing on what are the main drivers of wealth inequality and how has the distribution of wealth changed during these twenty years especially following the 2008 financial crisis. To analyze the development of wealth distribution a principal component analysis is performed as well as comparing net wealth between percentiles. In Iceland, between 1997-2017 the top 1% wealthiest individuals of the population owned more than half of total net wealth and in 2010 that percentage increased to over 70% of total net wealth. Wealth inequality reached its high point in 2010, then decreased yearly but in recent years has risen again. Between 1997 and 2007, the years before the financial crisis, the cause of wealth inequality was mostly due to the fact that the lower percentiles did not own any assets and most had negative net wealth. Following the financial crisis their net worth decreased significantly, with the bottom 10% reaching a negative net worth of more than nine million ISK in 2010. Since 2010 the lower percentiles have increased their net worth yearly although the bottom 10% have not yet reached a positive net worth in 2017. The difference between total assets of the lower percentiles, i.e. bottom 30% of the population, compared to the top 1% has decreased since 2010. Yet the difference between total assets of the middle percentiles compared to the top 1%, has gradually increased since 2010. The analysis in this thesis of the distribution of wealth in Iceland concludes that wealth inequality rose during the years prior to the financial crisis, reached its high point in 2010 and then decreased again. Yet what is also interesting from the analysis is that the structure of wealth inequality during the period has also changed. The main reason for wealth inequality in the twentieth century and the first decade of the 21st century was due to the fact that the lower percentile groups did not own any assets and had a net worth of zero or even negative. In the last few years these groups have all improved their net worth position, with only the bottom 10% still having a negative net 5 worth value in 2017. Even though net worth for all percentiles has improved, the top 1% has taken a significant lead compared to other percentiles. The difference between the net worth value of the top 1% compared to all other percentiles has increased in recent years. Therefore a main cause to economic inequality today is due to the fact macroeconomic conditions have given those individuals who sit on top of the wealth ladder the opportunity to increase their wealth proportionally more compared to other wealth groups which drives up economic inequality. 6 Contents Preface ...................................................................................................................... 4 Abstract ..................................................................................................................... 5 Contents .................................................................................................................... 7 Table of Figures ......................................................................................................... 9 Table of Tables ........................................................................................................ 10 1 Introduction ...................................................................................................... 11 2 Theoretical approach ........................................................................................ 13 2.1 What is wealth ........................................................................................... 13 2.2 Negative wealth ........................................................................................ 13 2.3 Thomas Piketty on wealth inequality ........................................................ 14 3 Development of wealth distribution ................................................................ 16 3.1 Global development in the postwar era .................................................... 16 3.2 Bubble economy starts emerging .............................................................. 17 3.3 Financial crisis 2008 ................................................................................... 17 3.4 Debt relief .................................................................................................. 18 3.5 Recent years .............................................................................................. 19 4 Data .................................................................................................................. 21 4.1 Principal Component Analysis ................................................................... 21 4.2 Total asset distribution .............................................................................. 22 4.3 Liabilities distribution ................................................................................ 25 4.4 Total net worth distribution ...................................................................... 28 4.5 Total annual income distribution .............................................................. 30 4.6 Total disposable income distribution ........................................................ 32 7 4.7 The income life cycle: ................................................................................ 34 5 Influential drivers of wealth distribution .......................................................... 37 5.1 Fiscal policy ................................................................................................ 37 5.2 Rate of return on capital vs. economic growth ......................................... 38 5.3 The housing market ................................................................................... 39 6 Conclusion ........................................................................................................ 41 7 Bibliography ...................................................................................................... 43 A The Kuznet ratio and the kuznet curve ............................................................. 47 B Karl Heinrich Marx ............................................................................................ 49 C Thomas Malthus ............................................................................................... 50 D Data .................................................................................................................. 51 E Measuring wealth distribution ......................................................................... 57 E.1 The wealth over people curve ................................................................... 57 E.2 The Lorenz Curve ....................................................................................... 58 E.3 Gini Coefficient .......................................................................................... 58 F Principal component analysis ........................................................................... 59 8 Table of Figures Figure 1. Total asset distribution through the first principal component 1997- 2017 ..................................................................................................................... 23 Figure 2. Total asset distribution through the second and third principal component 1997-2017 ........................................................................................ 24 Figure 3. Development of total asset comparison between the tenth percentile and first percentile and comparison between the fifth percentile and first percentile 1997-2017 .......................................................................................... 24 Figure 4. Development of total asset comparison between the tenth and fifth percentiles 1997-2017 ......................................................................................... 25 Figure 5. Liabilities distribution through PCA 1997-2017 ................................................ 27 Figure 6. Percentage change in household debt for the first percentile, fifth percentile