Relationship between Income Distribution and Firm Size - Essay Example

Running Head: INCOME DISTRIBUTION Relationship between Income Distribution and Firm Size of the of the Relationship between Income Distribution and Firm Size Introduction Trends related to income inequality in the United States have received considerable attention recently. While the extent of inequality and the degree of change depend on how it is measured, there is general agreement that overall inequality in the distribution of income and wealth in the U.S. has been increasing since the 1970's. Throughout the 1980's, overall employment growth in nonmetropolitan areas lagged behind metropolitan growth, while the earnings gap increased. In every rural industrial sector, the percentage of workers whose full-time wage was insufficient to raise a family of four above the poverty line increased in the 1980's. Recent years have witnessed increased polarization in income levels both among countries and among various income groups and classes within countries. Rapid and steady growth in developing countries is clearly necessary to close their income gap with the advanced industrial countries and improve standards of living. There may be some scope for raising income through reallocation of existing resources, but restoring rapid growth depends in large part on raising the rate of capital accumulation. Experience shows that while rapid growth as such may not lead to a significant improvement in income distribution in the short to medium term, it is indispensable for attaining a more balanced pattern of distribution in the longer term. More importantly, policies can be designed so as to strengthen the forces making for greater equality while promoting growth and absorbing the surplus labor that prevails in many developing countries. Firm Size The ability of market mechanisms and locally-based initiatives to provide for the economic well-being of those persons at the low end of the income distribution is questionable. In practice, much of the concern for distributional issues is lost in the transition from an academic or policy discussion to the implementation of local economic development programs (Leigh 1995). While there is some evidence that economic growth will benefit low income workers (Bartik 1991), there is also a possibility that explicit local redistribution policies may create local comparative disadvantage (Bartik 1992). More work is needed to understand the distributional characteristics of private markets. If greater responsibility for the economic welfare of citizens defaults to the community level, it becomes important to focus attention on income distribution at the scale of local labor markets. Further, to the extent local economic development policy can affect the activity levels of targeted production sectors, it also has an effect on distributional patterns. Thus, it becomes important to understand the implicit distributional biases of local policy in its promotion of selected economic activities, and to question whether explicit distributional objectives can be incorporated into local economic development programs. Other important factors influencing the distribution of income are the institutional structures that organize wealth. Institutions are the entities that engage in transactions, own assets, and incur liabilities (Pyatt 1988, 1991). Conventional institutional specification is as households, enterprises, and government. Within this general framework, institutional accounts can be disaggregated in considerable variation to permit the study of policies (development strategies, tax systems, laws) that influence distributional patterns. For example, SAM research has disaggregated household accounts by landholding status (Adelman et al. 1988; Lewis and Thorbecke 1992), while other research disaggregated forest enterprises by land tenancy group (Marcouiller et al. 1995). Thus, the process of wealth accumulation consists of two parts: the generation of income through productive activities, and its distribution to households. This distribution is fundamentally influenced by variable structural patterns in production and policy processes. Several points related to the approach taken in this research are illustrated in Figure 1. Shown is a simplified flow diagram of the SAM used in this research. The center column shows the major SAM accounts used to track income flow, and the infusions and leakages are shown on either side. To understand processes associated with the generation of income, attention is focused on those factors contained in the box labeled income generation. It is generally assumed an economic infusion changes the level of productive activities with the result to regional income observed as value added. Firm Size and Income Distribution The study of income distribution is different, and may be more complicated. Following the Rose et al. (1988) conception, it is possible to investigate the distributional impacts associated with the structure of productive activities (industry mix) in several ways. The first would be to look at the connection between production and value added, requiring the transformation of value added into factor returns (returns to land, labor, and capital). Additionally, disaggregating labor returns by occupation also provides insight into the distribution of income. More complex yet would be tracking income into the institutional matrix within which households are a sub-account. The difficulty with this approach is differentiating the processes associated with the generation of income from those associated with income distribution. While both the study of income generation and distribution must account for infusions and leakages, the investigation of distributional processes focuses on the connection between factor income generation and its distribution to local households. Some policies might directly alter levels of productive activities, as in the case of an import substitution program. Here, it may be appropriate to follow the full flow of income from production to households. If the research is concerned with the study of distributional impacts associated with other types of policies (taxes, transfer programs), the focus can be more narrowly defined to a subset of the structures within the endogenous economy. Alternative specifications of institutional income opens additional possibilities for asking questions related to land reform, land tenancy, or local development strategies. By carefully tracking how factor income is reorganized by institutions, accounting for the additional infusions and leakages, and observing the resulting distribution in the household account, it is possible to more clearly identify the distributional effects of the policy without being obscured by processes associated with income generation, or the numerous external factors affecting income flow. To date, considerable attention has been devoted to the generation of income from production sectors, while little attention has been paid to subsequent processes associated with the distribution of income. A second important reason to employ an alternative regional specification is to improve understanding of rural economic conditions. Rural areas typically serve as the periphery for central places in functional economic regions. The focus of a functional economic area is invariably the center, with the result that economic impacts occurring in the periphery may be "washed-out" by the relatively more prominent effects associated with the dominant economic structures found in the center. Thus, policies targeting rural conditions are better understood with models built explicitly for the study of rural areas. Models that account for income and trade flows between the dominant economic centers and their rural periphery, while maintaining the essential focus of the rural areas will be more illuminating regarding the effects of rural development policies. Finally, from the standpoint of policy implementation, there are practical reasons to create models of regions that are delineated by non-economic factors. Regional self-identification arising from natural resource endowments, historical antecedents, local administrative relationships, population homogeneity, and other factors can make models built on the basis of alternative criteria more useful to local policy-makers and the results of local policy analysis more likely to be implemented. The practical effect of using alternative boundaries as the basis for economic modeling, however, presents a number of difficulties. It becomes increasingly important to accurately account for income and trade flows between the rural area under study and nearby economic centers. Similarly, secondary data may not be available for the desired boundaries. Among production costs are payments made to the owners of productive factors (value added). All income accrues to the owners of productive factors. To determine income distribution, it was necessary to specify the share each factor contributed to the net return of productive activities and then determine the share of each productive factor owned by each institution and household income group. IMPLAN reports income in the form of value added. Value added consists of employee compensation, proprietary income, and other property income plus indirect business taxes. This categorization does not allow separation of value added into returns to factors of production. The method used to establish factor shares involved allocating net factor returns first to labor, then to capital and land based on an imputed rate of return (Marcouiller et al. 1996, Leatherman 1995, appendix 2). Institutions provide the transition between productive activity and household income. Institutions serve the functional purpose of providing the organizational scheme for allocating factor income to household income groups. Thus, institutional specification organizes the income generated from production sectors in a fashion that permits observation of distributional patterns associated with development strategies. In this case, the organizational scheme considers how factor income generated by productive activities being targeted by local economic development programs will be distributed. This matrix also distributes factor taxes, the regional in- and out-flow of factor payments, and institutional transfers, providing a more precise accounting of the distribution of income earned from productive activities to household income groups. As local governments in rural areas assume more responsibility for their economic well-being, it becomes beneficial to learn more about the characteristics of private markets at a regional scale. A common objective of local development policy is to enhance opportunities for those in need. To the extent local policy can affect productive activities in targeted economic sectors, such policies will have de-facto distributional consequences that alter the ability to achieve development objectives. To understand the de-facto distributional characteristics of rural development sectors and local development policy, a social accounting matrix analysis was shown to be a useful tool for describing how changes in sectors important to rural areas affect household income groups. Information related to income distribution can not reduce income disparities or local conditions of poverty. However, concern related to distributional impacts encourages the re-examination of assumptions related to local economic development policy, and more careful consideration of the beneficiaries of development assistance. By bringing distributional issues to the policy arena, the community is taking steps toward making rational choices about its economic development. Conclusion The proposition is then examined that unequal income distribution is essential for rapid accumulation and growth because the rich save and invest a greater proportion of their income than the poor. It is shown that, while the rich may indeed save and invest proportionately more than the poor, the same degree of inequality among countries is often associated with different rates of accumulation, or that a given rate of accumulation is compatible with lower or higher inequality. Thus, accelerating growth does not necessarily require a greater concentration of income in the hands of the rich. The relationship between inequality and accumulation is greatly influenced by the extent to which profits are saved and invested. An examination of sources of capital accumulation shows that corporate profits are often the principal source of investment in industry, while the contribution of voluntary household savings to productive investment is relatively small. 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