Inequality and Growth

Question 1

What is the main hypothesis of The Kuznets curve?

Answer 1

In the initial stages of development, inequality will increase, then at the higher stages of development inequality will decrease

Question 2

How does Kuznets define inequality?

Answer 2

Inequality is defined as differences in the shares of the top quintiles in total income and the shares of the lowest quintiles in total income

Question 3

What are the three stages of economic development in the Kuznets curve (1955) ?

Answer 3

• Stage 1: Low per capita income level, low inequality
• Stage 2: Per capita income increases with development, income inequality rises
• Stage 3: Gets to a point where per capita income increases with continued development, income inequality decreases.

Question 4

What is on the X axis of the KC curve?

Answer 4

GDP per capita

Question 5

What are the implications of the KC curve? (3)

Answer 5

1. If the Kuznets curve works then there is a ‘trickle down’ effect.
2. Development is fundamentally an uneven and sequential process. Benefiting some first, leaving other to catch up.
3. Government should concentrate solely on growth!

Question 6

Which two authors found empirical evidence of the Kuznets Curve?

Answer 6

1. Ahluwalia (1976)

2. Barro (2000) updated in Barro (2008)

Question 7

What are the three cautions of the Ahluwalia (1976) empirical evidence?

Answer 7

1. Results can be sensitive to measures of inequality
2. Results can also be sensitive to the functional form used
3. The empirical evidence of the 1970 and 1980s is criticised because they use cross-sectional data (capturing the between country effects not within county effect)

Question 8

What are the key findings of the Barro’s 2008 paper in relation to the Kuznets curve? (3)

Answer 8

1. There is evidence of an inverted-U but the Kuznets curve does not explain most of the variations in inequality across countries and/or over time.
2. Regional Dummies have considerable explanatory power.
3. Turning point is $3050 US2000 dollas

Question 9

What are the 4 links between inequality and growth?

Answer 9

1. Credit Market Imperfections
2. Political economic/Fiscal economy
3. Social Unrest
4. Savings Rate

Question 10

What is the link between inequality and growth due to credit market imperfections?

Answer 10

negative relationship between inequality and growth

Question 11

What is the link between inequality and growth due to the political economy/fiscal economy? (2)

Answer 11

Old view: negative

New view: Positive

Question 12

What is the link between inequality and growth due to social conflict?

Answer 12

Negative

Question 13

What is the link between inequality and growth due to savings rate?

Answer 13

Positive if increasing marginal savings rate

Negative if decreasing marginal savings rate

Question 14

What are the key findings of Barro’s 2008 paper on how inequality effects growth? (3)

Answer 14

1. Income inequality has a negative impact on growth
   - Contrasts to barro’s 2000 paper
2. relationship varies with the level of GDP
   - The negative relationship is evident in poorer countries and turns slightly positive in richer countries
3. We can not pin-point empirically the theory which explains this relationship.

Question 15

What does the Neves and Silva (2014) study present?

Answer 15

It presents evidence on reduced form

Question 16

What are Neves and Silva’s challanges to the earlier studies? (4)

Answer 16

1. Quality of Data: Still the same negative result however adding regional dummies breaks the link
2. Income vs wealth inequality: Still the same negative links but criticise other studies from not focusing on land inequality
3. lack of data comparability across countries over time
4. Panel data vs cross sectional data: presents a non-linear link

Question 17

What is the main findings of the Neves and Silva paper?

Answer 17

A non-linear link between inequality and growth. Link is negative for poor countries and positive for rich countries.
-This link is quiet a robust relationship and is increasingly being accepted in studies.

Question 18

What are Pickety’s (2006) 5 main criticisms of the KC?

Answer 18

1. data available to Kuznets was not good
2. Evidence of other empirical studies that followed cannot be trusted
3. data limiations means we don’t even know if inequality was increasing before 1990s
4. Explanations for the the fall in inequality in the early half of the 20th century were not what KC suggested.
5. Picketty questions Kuznets claim that the rise in inequality in the early half of the 20th Century was due to ‘technological change’

Question 19

Describe the negative relationship between capital market imperfections and inequality & growth? (2)

Answer 19

1. Market are unable to screen low risk borrowers from high risk borrowers
   - High rate of interest, collateral, etc
2. Households without adequate capital will not be able to borrow money from the market
   - Under investment in growth enhancing activities

*The more unequal the distribution, less people with adequate capital, hence less investment.

Question 20

Describe the old view between the negative relationship of political economy/fiscal economy and inequality &growth

Answer 20

• High inequality leads to a time whereby the majoirty do not benefit from economic growth.
• In a democracy, majority voters will demand ‘redistribution’
• If redistribution is done by imposing lump sum taxes of wealth then redistribution can work.
• However if it is done by taxing high incomes it will not work
• It will adversely affect the savings rate and cause capital flight

Question 21

Describe the new view with the positive relation ship between inequality & growth and the political/fiscal economy.

Answer 21

• Rich will influence the political process and will demand lower redistribution.
• Combining this with credit market imperfections we get a positive link.

Question 22

Describe the negative link between social conflict and inequality and growth

Answer 22

Very high inequality may lead to violence/strikes/coups.

This in turn leads to loss of output