0.4 Income distribution

Overview

The central focus of efforts to foster economic growth worldwide has long been drastic reductions in absolute poverty: to lift people from low levels of nutrition health, housing and education.

There is abundant evidence that these efforts have borne fruit, especially over the past half century. For example, of the total number of the world’s very poor in 1980, 323 million, or half were in India. Jagdish Bhagwati&Arvind Panagariya (2014), Why Economic Growth Matters, New York, NY: Public Affairs, p.247 Economic growth in India. But since major economic reforms in 1992, nearly 190 million people exited from poverty even by 2005. The Indian experience has been repeated in dozens of other nations: the proportion of families living below nationally-established poverty lines has fallen sharply since 1980.

Reduction of absolute poverty remains a prime aim in virtually all nations, save perhaps North Korea. However, governments in emerging as well as developed nations are clearly concerned not merely with absolute differences in income, but relative differences as well. The distribution of income matters greatly around the world.

For several decades after 1960 economists, utilizing the work of Harvard’s Simon Kuznets, believed that there was a necessary connection between economic growth and inequality. Kuznets held that as growth and development begins in a nation, inequality first tends to rise, largely because of a shift out of agriculture (low wages, but more equal wages) into industry (more unequal wages). But, as the nation develops, Kuznets conjectured that inequality would begin to fall. The Kuznets hypothesis (Kuznets curve) is not widely accepted today.

In several recent empirical studies there seem to be no necessary connection between rapid growth and rising inequality. Michael Bruno and colleagues instead found that in a sample of 44 nations from 1981-92, inequality slightly rose with higher rates of economic growth rates in 22 nations, but in the other 22 with higher growth, inequality actually fell . Michael Bruno, Martin Ravallion,&Lyn Square (1996, January), “Equity and Growth in Developing Countries”, Policy Research Working Paper No. 1563, Washington, DC: World Bank. And in the “Gang of Four” nations (Korea, Taiwan, Singapore and Hong Kong) very rapid rates of growth (>8% year over 3 decades) were associated with rising income equality , not inequality during the sixties and seventies.

At least four factors seem to be positively associated with experience with high growth and improving income equality.

1. Initial conditions: where the initial distribution of income and assets before growth takes off, is not highly skewed (leads to more equality later).
2. Human Capital: High quality education system (conducive to greater equality).
3. Labor Intensive Growth Strategies that avoid underpricing of capital, leading to rapid employment growth (more equality).
4. Limited scope for rent-seeking activities and corruption. Where damages from rent-seeking are held in check, whether by constraints on government corruption, the presence of free press or openness to foreign trade (Rent-seeking is covered in Chapter 9).