The Relationship between Economic Inequality and Economic Growth - Case Study Example

Inequality & Development Inserts His/Her Inserts Grade Inserts 30/7 INTRODUCTION Inequality refers to a disparity between individuals or groups. The world we live in is wrought with many inequalities; these include gender inequality, political inequality and economic inequality. For the purpose of this paper, I will expand primarily on economic inequality and its relationship with economic development. Gender inequality refers to disparities amongst the sexes and political inequality refers to disparities between different groups in a political system. Both forms of inequality tend to be abstract and lack a concrete method of measurement. In comparison, economic inequality is far more quantifiable and measurable. To put it in simple terms, economic inequality is a disparity in income. This disparity can exist within a village, a country or between different countries. According to Ray “it permits one individual certain material choices, while denying another individual those very same choices.” There are several methods to measure this inequality, which, I will elaborate on later. According to noted economists Sen and Foster (1973), inequality is deeply interlinked with rebellion and the fall of dynasties. It has been said, that the French and Russian Revolutions were brought about ultimately by the inequality that persisted within the respective societies and the failure to address them. The relationship between inequality and growth or development is often controversial and existing research is still inconclusive in terms of ascertaining the actual cause and effect each variable has on the other. Development in the terminology of economics refers primarily to economic growth and expansion, which usually leads to an increase in incomes. The crux of equality or inequality is how much of the population (i.e. which segments) benefits from this growth. If only one segment of the population witnesses an increase in incomes than economic, inequality exists. Different economists and researchers have come to different conclusions on the relationship between economic inequality and economic growth, these range from inequality having a positive impact on development to inequality causing economic stagnation. As mentioned before both of these conclusions are a cause for debate and neither has been accepted as definitive. What is clear, however, is the fact that both inequality and growth are affected by several factors that are independent of either. The many volumes of research and economic literature available on the subject focuses on the basic question of whether development and inequality have a negative or a positive correlation in order to establish whether inequality is beneficial for development or whether growth has to be sacrificed in order to reduce inequality. ECONOMIC INEQUALITY & DEVELOPMENT Since we have established that economic inequality exists in terms of disparities between incomes, the question arises of whose income can be considered so disparate that it leads to economic inequality? The answer to this is firstly the personal distribution of income which includes individuals and households and secondly the functional distribution of income, which involves the income received by various factors of income such as land, labour and capital. There are several ways of measuring economic inequality. The most prominent of these are measuring income shares via the Kuznets Ratio technique and secondly the establishment of gini coefficients based on the Lorenz curve. The first method involves comparing the distribution of national income between the rich and the poor. The respective shares of the richest 20% and the poorest 40% can be used to establish the level of inequality within the society. The shares are then used to formulate a ratio. A higher share for the top 20% naturally results in a lower share for the bottom 40%, this in turn results in a more unequal economy. The second method involves plotting the share of each segment of the population in terms of their income (i.e. poorest to richest) graphically creating a Lorenz curve. This curve is then compared with a straight diagonal line on the graph representing the economy if it was perfectly equal. The total area (signifying the entire economy) is divided by the gap between the curve and the diagonal line giving us a value between 0 and 1. The closer the value is to 1 the higher the inequality within the economy. As mentioned earlier a great deal of research has been conducted and many volumes of literature have been written on the relationship between economic inequality and economic development. Among these, possibly the most prominent is Kuznets hypothesis which states that initial economic growth results in an increase in inequality. Kuznets emphasis was on the initial migration of rural populations to urban area’s and the transition from agricultural to more industrial methods of production in formulating his hypothesis. Using the example of the introduction of new technology in an economy, we can explain this hypothesis in terms that would be accessible to the common man. Supposing that this new technology revolutionizes production by increasing efficiency exponentially and in turn increasing economic development, there is a possibility that demand for labour skilled with this new particular technology will increase and the demand for labour that is unfamiliar with the technology will decrease. This will result in growing inequality due to the increase in income of the skilled labour while decreasing the income of the unskilled labour (World Bank, 2004). Kuznets hypothesis has been proven true in many situations such as in the case of the country Bangladesh. Founded in 1971, the country had no real infrastructure to speak of but witnessed rapid economic development throughout the 1990’s. Average monthly income in Bangladeh in the year 1988-89 was 517 Bangladeshi Taka, whereas in the year 2000 this figure increased to 1128 Bangladeshi Taka, a phenomenal rise in incomes by any account. However, inequality and income disparity also witnessed a proportionate increase during this period. In the 1988-89 the Gini coefficient for Bangladesh was 0.379 and by the year 2000 it had increased to 0.472. During the same time period the income share of the poorest 10% of the population decreased from 2.64 to 1.84. While the income share of the richest 10% increased from 31.00 to 40.72. This inequality has been attributed to the rapid development of the urban professional middle class and the stagnation of the rural agricultural class. Despite the economic development, the World Bank was worried by the indicators of inequality and warned that a situation similar to ones that occurred in Indonesia and Iran could occur if the disparity was not curbed (Haque, 2007). This suggests that an institution with the authority of the World Bank feels that inequality cannot result in sustainable development. Kuznets held the same view as he found that proceeding the initial development stage, inequality decreased as development continued. The school of thought which suggests that inequality may actually be good for growth has three primary arguments. Firstly that an absolutely equal distribution of income reduces incentives for efficiency and a preference for the status quo resulting in no growth. The second argument relates to the marginal propensity to save of the rich, which is naturally higher than that of the poor. If more savings equals more investment than according to this particular argument growth will be increased in a more unequal economy, as the rich will control a larger share of the national income meaning more of it will be invested resulting in more growth. The third argument relies on a lack of organized capital markets and credit facilities. In such circumstances the concentration of wealth in the hands of a few will be beneficial as it will lead to a quicker amalgamation of resources for the purposes of an entrepreneurial venture (World Bank, 2004). Others feel that inequality is ultimately detrimental to economic growth and development. The first major argument for this point of view is based on the assumption that in a state where widespread economic inequality exists the government will attempt to take corrective action in the form of progressive taxation and other methods to redistribute income. It is believed that measures such as progressive taxation will discourage investment and business activity resulting in the stagnation of economic growth. A second argument involves credit constraints. If an individual due to an unequal distribution of income does not have sufficient funds to invest in education than the overall quality and efficiency of human capitol will decrease or remain where it is resulting in an economic impasse (World Bank, 2004). The third argument is fairly popular and views economic inequality from a sociological perspective. The belief is that an unequal distribution of income resulting in the poorest segment of the population having insufficient incomes, will lead to a strong sense of frustration among this segment. This will increase the likelihood of members of this segment committing criminal acts leading to political and social instability. This will result in a decrease in investment and hence a decrease in economic development (World Bank, 2004). The book “Spirit Level” written by Richard Wilkinson and Kate Pickett examined the relationship between inequality and certain statistics that could lead to instability and hence decrease growth in a country. The book concentrated primarily on developed countries and States within the US. For example the most deprived individuals in the United Kingdom and Wales also had the lowest life expectancy. It was also found that countries with the highest level of income inequality had the worst social and health problems, in this instance from the sample of countries surveyed Portugal had the most income inequality and the worst social and health problems. Similarly, countries with high inequality such as the USA where the richest 5% are 8.5 times richer than the poorest have the worst rate of child well being. This trend continues to hold true in terms of teenage pregnancy statistics. All of these factors which can have a destabilizing effect on the economy are at their most intense in economically unequal countries, even in those countries, which have higher per capita incomes than others (Wilkinson and Pickett, 2009). CONCLUSION A great deal of Empirical research conducted on the relationship between income inequality and economic development has found no link between the two variables whatsoever. It can be argued that independent and subjective factors depending on country-to-country can give a better rationale for growth and inequality. Other research shows that asset inequality has a stronger relationship with growth than income (World Bank, 2004). An unequal distribution of assets such as land can lead to low growth in an economy. This can be explained using the example of an entrenched elite that at the time of the country’s inception has an unfair advantage in terms of distribution of land. This initial advantage allows them to increase their incomes during every limited growth boom that the economy experiences allowing them to further consolidate their advantage. It is to be expected that in such a country, this landed elite would dominate political and governmental affairs. They would use this dominance to not only further consolidate their advantage and to expand further but also to prevent other segments of society from accumulating wealth and political control. It can also be argued that this landed elite would prevent new technologies and production methods from being employed that may increase efficiency but also threaten their stranglehold on the country. This would lead to a high level of corruption and nepotism, which are factors that contribute to low economic development. Redistribution of income, however, has proven to be an impetus for growth (World Bank, 2004). To conclude it appears that income inequality definitely has an impact on social and political aspects of a country that may or may not result in low growth. Other aspects may have a larger role to play in affecting growth and inequality than the tow have on each other such as the country’s culture, political institutions and the time span in which the economy is analysed (World Bank, 2004). Other forms of inequality such as racial, political and gender all have a deep seated impact on the world we live in. However each of these inequalities is ultimately explained in terms of an economic inequality i.e. women receive a lesser income than men. REFERENCES Haque, M.O., 2007. Preliminary Evaluation of Economic Development and its Effect on Income Distribution in Bangladesh. International Journal of Economic Development, 9 (1&2), pp.32-58. Ray, D., 1998. Development Economics, New Jersey: Princeton University Press. Sen, A. and Foster, J., 1973. On Economic Inequality. Oxford: Oxford University Press. Wilkinson, R. and Pickett, K., 2009. The Spirit Level: Why Greater Equality Makes Societies Stronger. New York: Bloomsbury Press. World Bank (2004) Read More