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Fridays Academy: Economic Growth and Inequality

Ignacio Hernandez's picture

From Raj Nallari and Breda Griffith's lecture notes. This week we finish the analysis of the relationship between economic growth and poverty. 

 

Economic Growth and Inequality

Is a less equal distribution of income good or bad for a country’s development? There are different opinions about the best pattern of distribution in terms of growth generation—about whether, for example, the Gini index should be closer to 25 percent (as in Sweden) or to 40 percent (as in the United States) and whether optimal distribution patterns change as income changes. An excessively equal income distribution can be bad for economic efficiency. Take, for example, the experience of communist countries, where deliberately low inequality (with no private profits and minimal differences in wages and salaries) deprived people of the incentives needed for their active participation in economic activities—for diligent work and vigorous entrepreneurship. Among the consequences of attempted equalization of incomes were poor discipline and low initiative among workers, poor quality and limited selection of goods and services, slow technical progress, and eventually, slower economic growth leading to more poverty. But moving beyond this extreme, some studies suggest that countries with more equal distribution of certain assets (public goods, land, etc) tend to grow faster (see graph below).

 

For instance, Deninger and Squire (1997), using a comprehensive and improved dataset, found that inequality generally tended to favor economic growth across countries. Their findings also suggest that inequality across assets has more of an impact than income inequality, although the two are closely related. Turning to policy recommendations, they indicate that redistributive policies, in particular those that improve the poor’s access to credit, can help boost growth. Government’s have, of course tried redistributive policies in the past – for example, through land redistribution, through employment programs, through subsidies, or through access to credit, to public goods, to infrastructure, to health, or to education – but with varying degrees of success.  A large agenda for further, deeper research exists in this area, directly related to the impact of public spending on equality.

 

Countries with more equal land distributions tend to grow faster

 


land2

Source: World Bank

 

Conclusion

 

Sustained economic growth is the most critical factor in alleviating poverty. This finding is firmly supported by the evidence. In this vein, it has also been found that the poor are not generally left behind in the growth process, and that they generally share in the gains that result. That said, there are differences in the response rate of poverty to growth across countries. The initial level of income inequality and the changes in inequality over time play an important role here, as does the composition of economic growth itself (especially whether it is concentrated in areas where the poor play a large role). The link between economic growth, poverty and inequality has, therefore, occupied a large part of the development literature in recent years and has led to a focus on what is termed ‘pro-poor growth’. ‘Pro-poor’ growth is defined in turn as the type of growth process that is most effective in raising the incomes of the poor. Thus assessing whether growth is pro-poor requires information on distributional changes in income and the extent to which this has impacted the welfare of the poor. 

 

Next week we will start looking at Policies and Growth, in particular Macroeconomic Policies. We will start with Fiscal policy and the Poor.

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