Monday, 3 April 2017

Latest research seems to support the Kuznets hypothesis

Simon Kutzets won the Nobel Prize in Economics in 1971 for his work on economic growth, but he made a number of contributions to the discipline. One of these related to the empirical relationship between economic growth and inequality, the so-called Kuznets curve.

Kuznets hypothesised that, at low levels of development, inequality was relatively low. Then, as a country developed, the owners of capital would be the first to benefit because of the greater investment opportunities that the economic growth provided. This would lead to an increase in inequality associated with economic growth. Eventually though, at even greater levels of development the taxes paid by the capitalists would increase, leading to developments such as a welfare state, improved education and healthcare, all of which would improve the incomes of the poor. So, at higher levels of development, inequality would decrease with economic growth. This leads to the Kuznets curve:

The empirical support for the Kuznets hypothesis was drawn from the experience of western developed countries since the Industrial Revolution. However, the relevance of the experiences of western countries to the current development trajectories of developing countries is fairly limited, so the Kuznets hypothesis has been called into question. For instance, in China economic growth has been high for last last few decades, and yet to date inequality has shown little sign of slowing down.

However, in a recent Bloomberg view article Noah Smith recently pointed to two new pieces of research that seem to provide new support for the Kuznets hypothesis. He wrote:
...recent evidence is coming down on the side of Kuznets.
In Latin America, inequality has been falling for over a decade. A recent study by economists Nora Lustig, Luis Felipe López-Calva and Eduardo Ortiz-Juarez found that almost all Latin American countries became more economically equal from 2002-2012...
Only in Honduras did inequality go up during this period...
Lustig and her colleagues found that government transfers and pensions accounted for between 21 and 26 percent of the decline in inequality. That’s important, but it’s far from the whole story. The biggest share of the improvement, by far, was caused by reductions in wage inequality. Lustig's group connected this to increasing levels of education -- in the 1990s, a lot more Latin Americans started going to school. Economic growth has been another reason for increasing wages...
As for China, there are signs that inequality there has peaked as well. A recent study by economists Ravi Kanbur, Yue Wang and Xiaobo Zhang combed through China’s notoriously murky data and found that the Gini coefficient declined to 0.495 in 2014 from 0.533 in 2010.  That's a high level of inequality by international standards, but a trend in the right direction.
The jury may be called back in on the Kuznets hypothesis. It seems it cannot be quite written off yet.

[HT: Marginal Revolution]

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