INCOME INEQUALITY AND DEVELOPMENT

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INCOME INEQUALITY AND DEVELOPMENT

• Audrey Delbos
• Nick Papageorge
• Angela Bohse
• Simon Smend
• Senta Wooten

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OUTLINE OF PRESENTATION

• Preliminaries Ideas and Some Empirics
• Competing Theories
• Political Economy, Incomplete Capital Markets,
  Conflict
• Technology Shocks
• Model Framework (An Example)
• New Empirical Studies

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INEQUALITY AND GROWTH IN A PANEL OF COUNTRIES,
Robert J. Barro (2000)
Discusses the macroeconomic relations between
inequality and economic growth in an empirical
aspect.
OVERVIEW
net effects of inequality on investment and
growth are ambiguous.
Up to now, empirical findings, are not more
robust. Ex Relationship of inequality to
generate or not lower economic growth in
cross-country regressions
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THE KUZNETS CURVE
Relation between GROWTH and INEQUALITY
DEF inequality first increases and later
decreases during the process of economic
development
THE KUZNETS CURVE
PART A Early stages of economic
development INEQUALITY INCREASES
PART B Later phases of the development
process INEQUALITY DECREASES
THE CRITICAL POINT
B
A

• Ex
• workers migrated from agriculture to industry
• rural workers moved to urban jobs

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THE GINI COEFFICIENT
Cumulative share of income earned
Measure of INEQUALITY
Perfect distribution line
GINI INDEX
Gini coefficients for the United States at
various times 1970 0.394 1980 0.403 1990
0.428 2000 0.462 Source US Census Bureau
Lorenz curve
Cumulative share of people from lower income
THE GINI COEFFICIENT
GINI COEFFICIENT number between 0 and 1, where
0 corresponds with perfect equality and 1
corresponds with perfect inequality
GINI INDEX Gini coefficient expressed in
percentage form, equal to the Gini coefficient
multiplied by 100
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FINDINGS
Study effects of inequality on growth and
investment for a panel of countries
(1) Little overall relation between income
inequality and rates of growth and investment.
However
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Per capita GDP gt 2070 Positive estimated
relation
Per capita GDP lt 2070 Negative estimated
relation
2070 ESTIMATED BREAK POINT
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FINDINGS
Study effects of inequality on growth and
investment for a panel of countries
(1) Little overall relation between income
inequality and rates of growth and investment.
(2) Negative effect of inequality on growth for
poor countries
but the same relationship for rich countries is
positive
However, the overall effects of inequality on
growth and investment are weak
(3) Critical Point around 2000 capita GDP
(4) the Kuznets curve emerges as a clear
empirical regularity
However, this curve explains relatively little
of the variations in inequality across countries
or over time.
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OUTLINE OF PRESENTATION

• Preliminaries Ideas and Some Empirics
• Competing Theories
• Political Economy, Incomplete Capital Markets,
  Conflict
• Technology Shocks
• Model Framework (An Example)
• New Empirical Studies

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Competing Theories linking income distribution
Growth
INEQUALITY AND GROWTH, Ronald Benabou

• Political Economy
• Imperfect Capital Markets
• Sociopolitical Conflict
• Purchasing Power
• Technology Shocks

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Political Economy

• Complete Asset Markets

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Political Economy

• Inequality defined as
• Lower ratio of MEDIAN to MEAN pre-tax wealth

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Political Economy

• More Inequality leads to
• More Redistribution
• Slower Growth due to Lower Returns on Investment
• Reduced Efficiency

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Political Economy

• Bias in Political Systems (Abstraction from one
  person one vote ideal
• Decisive Voter NOT at 50th percentile of the
  wealth distribution, but rather at p-th
  percentile
• Pgt1/2 gtgt system biased against poor

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Political Economy

• Bias in Political Systems
• More bias against poor gt higher growth
• If inequality is not too large
• Positive effect on Redistribution negative
  effect on growth are weaker the less favourable
  the political system is to the poor.

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Political Economy - Problems

• Only Redistribution that is Detrimental to Growth
  is allowed into the model
• What about Land Reform / Public Education
• (Redistribution leading to greater investment)
• Positive Effect Plausible only under Imperfect
  Capital Markets.

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Imperfect Capital Markets

• Same model as before...
• ...simply turn off the loan markets.
• Main Idea Credit Contraints prevent the poor
  from undertaking the efficient amount of
  investment.

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Imperfect Capital Markets

• Models embody tradeoff between
• Growth benefits of land-reform, public schooling,
  etc
• Traditional costs due to depressed incentives for
  savings and labor supply.
• (Redistribution effects must occur in time to
  effect resources available for investment)

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Imperfect Capital Markets

• Inequality reduces growth (and intertemporal
  efficiency). This loss decreases with
  pre-investment redistribution
• Growth max. tax rate increases with inequality

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Social Conflict

• In Median Voter model, redistribution is an
  orderly process
• What if agents or groups can simply grab part of
  someone elses wealth
• This becomes more likely when inequality
  increases.

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Social Conflict

• Fear of such redistribution (lack of property
  rights) impedes growth
• Lowers expected return on investment.
• Prisoners Dilemma model with capital
  accumulation

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Social Conflict

• There is a maximum sustainable growth rate
  constrained by conflict
• Inequality limits growth - rich might be better
  off transfering to poor

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Social Conflict

• Rich can expropriate from poor, too!
• What matters is not inequality in distribution of
  income per se
• Important is the relative distribution of earning
  and political power.

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Technology Shocks

• To be discussed in next part of presentation

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Income Distribution

• Under costly trade, profitable industrialization
  requires large domestic markets
• Enough to cover setup costs

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Income Distribution

• Who profits from a boom?
• Wealthy?
• Will purchase imports / luxury goods

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Income Distribution

• Who profits from a boom?
• Broader Population?
• Will purchase manufactures

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OUTLINE OF PRESENTATION

• Preliminaries Ideas and Some Empirics
• Competing Theories
• Political Economy, Incomplete Capital Markets,
  Conflict
• Technology Shocks
• Model Framework (An Example)
• New Empirical Studies

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TECHNOLOGICAL PROGRESS, MOBILITY, AND ECONOMIC
GROWTH, Galor and Tsiddon (1997)

• Analyzes relationship between technological
  progress, wage inequality, intergenerational
  earnings mobility and economic growth

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TECHNOLOGICAL PROGRESS, MOBILITY, AND ECONOMIC
GROWTH, Galor and Tsiddon (1997)

• Cycles of technological progress may play a
  significant role in determining the evolution of
  earnings inequality and intergenerational
  earnings mobility.
• Earnings mobility may govern the pace of
  technological progress and output growth.

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Assumptions

• Individual earnings increase with ability
• Individual earnings increase with parental human
  capital

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Assumptions

• c) Major technological progress (i.e.
  inventions) increase relative return to ability
  and diminish relative return to parental specific
  human capital
• d) Improved accessibility of technologies (i.e.
  innovations) decrease relative return to ability
  and enhance relative return to parental specific
  human capital

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Assumptions

• e) Technological progress (or the rate of
  adoption of new technologies) is positively
  related to the average level of human capital in
  technologically advanced sectors

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Conclusions (I)

• Periods of major technological inventions
• decline in relative importance of initial
  conditions raises inequality, enhances mobility,
  generates a larger concentration of high-ability
  individuals in technologically advanced sectors
• gt stimulates future technological progress
  and growth

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Conclusions (II)

• Periods of improved accessibility of
  technologies
• mobility is diminished, inequality decreases but
  becomes more persistent
• Reduction in concentration of ability in
  technologically advanced sectors
• gt diminishes likelihood of technological
  breakthroughs, slows future growth

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OUTLINE OF PRESENTATION

• Preliminaries Ideas and Some Empirics
• Competing Theories
• Political Economy, Incomplete Capital Markets,
  Conflict
• Technology Shocks
• Model Framework (An Example)
• New Empirical Studies

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INCOME DISTRIBUTION AND MACROECONOMICS,
Oded Galor and Joseph Zeira (1993)

• Mean analysed
• Investment in Human Capital (HC)
• Dynamic Model
• To show
• Different Wealth Distribution
• gt different growth paths leads
• gt different Steady States

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Background

• Income is more equally distributed in wealthier
  countries
• Positive Correlation between income distribution
  and rate of growth

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Assumptions of the Model I

• 2 Periods
• Overlapping Generations
• Inter-generational Altruism
• Utility from Consumption and Inheritance to the
  next generation

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Assumptions of the Model II

• Credit Markets are imperfect
• Interest Rate for Borrowers higher than Interest
  rate for Savers
• Euribor 2,536 vs.
• Billiger.de Credit 4,48

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Assumptions of the Model III

• Single Good
• unskilled and without any capital
• or skilled and capital intensive

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Assumptions of the Model IV

• 2 wage unskilled lt
• wage skilled Education Cost

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Assumptions of the Model V

• Fixed Restrictions
• Preferences, Skills at Birth
• Variable Restrictions
• Bequest

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Assumptions of the Model VI
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Short-Run No Credit Market

• Individual derives Utility (U) from Consumption
  (c) and Inheritance to next Generation (xt1)
• max U (c, xt1)
• s.t. w xt h xt1 c
• Wage Inheritance
• Investment in Human Capital Consumption
  Inheritance

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Short-Run II

• max U (c, xt1)
• s.t. w xt h xt1 c
• wage skilled h gt 2 wage unskilled
• xt h
• Individual will remain unskilled
• xt h
• Individual will acquire skills

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Short-Run III with credit market

• max U(c, xt1)
• s.t. w xt -h- xt1 -c0
• 2wage unskilled lt wage skilled - h amount of
  debt(1r)
• xlth
• Individual will acquire skills
• if interest is small enough
• gt critical inheritance f
• xh
• Individual will acquire skills for sure

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Short-Run III with credit market
f
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Short-Run III with credit market
f
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Dynamics
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Dynamics
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Dynamics
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Dynamics
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Dynamics
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Dynamics
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Dynamics
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Dynamics
Xt1
Two stable equilibria, rich and poor, Skilled
and unskilled
Xt
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From Static to Dynamic
g
g
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Pareto ?

• The government can subsidize education, which
  reduces (...) h, and finance these cost by a tax
  on skilled workers in the next period.

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OUTLINE OF PRESENTATION

• Preliminaries Ideas and Some Empirics
• Competing Theories
• Political Economy, Incomplete Capital Markets,
  Conflict
• Technology Shocks
• Model Framework (An Example)
• New Empirical Studies

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NEW WAYS OF LOOKING AT OLD ISSUES INEQUALITY
AND GROWTH by Klaus Deininger and Lyn Squire

• Find negative relationship between inequality
  and development
• Question causal relationship behind Kuznets
  hypothesis

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Data

• Use new cross-country data on income and asset
  (land) distribution.
• New empirical approach

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Data

• i) New data on land distribution as a proxy for
  the distribution of assets rather than income
  distribution.
• ii) Use data on income shares to measure income
  change of bottom 20 or 40 of population

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Findings

• i) Strong negative relationship between initial
  inequality in the asset distribution and
  long-term growth

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Findings

• Initial income inequality not robust determinant
  of future growth
• Initial inequality of assets (land distribution)
  significant effect on growth in overall sample
  and in developing countries

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Findings

• ii) Inequality reduces income growth for the poor
  but not for the rich

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Findings

• Credit rationing (in education for example) may
  prevent poor from making economically profitable
  investments.

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Findings

• iii) Available longitudinal data provide little
  support for the Kuznets hypothesis

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Findings

• Countries with low per capita income grew rapidly
  without experiencing increase inequality
• Countries which failed to grow not immune to
  swings in aggregate measures of inequality

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Conclusions

• Evolution of income and inequality is affected by
  initial conditions and policies not a universal
  law.
• Investment benefits poor more than rich.

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Conclusions

• Policy variables affect growth of income through
  their effect on investment.
• Creation of new assets will have greater impact
  on poverty reduction and growth than
  redistribution of existing ones (land).

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THANK YOU