Five workers in a carpentry workshop, South Africa. | © shutterstock.com
In the realm of economic development, the intricate relationship between economic growth and income inequality has long been a topic of significant interest and debate. We delve into this in our recent paper that illuminates the often-overlooked impact of short-term fluctuations in economic growth on inequality in developing countries. Drawing from a comprehensive analysis of data from 71 developing nations over the period 1981–2014, our study provides valuable insights into how both positive and negative economic conditions impact the dynamics of inequality.
Defining 'Good' and 'Bad' Times
We used two criteria to assess whether a country experienced 'good' or 'bad' economic times in a specific year: first, whether its GDP per capita growth rate was positive or negative, and second, we compared this growth rate to the country's average GDP per capita growth rate between 1981 and 2014. By considering both factors, we were able to determine the economic conditions of each year. The results of this study are particularly pertinent in the context of the global discourse on reducing economic 'scarring' from the COVID-19 pandemic.
Unveiling the Findings
The empirical analysis, utilizing data from the World Bank's PovcalNet database, offers insights into the intricate relationship between economic growth and income inequality. Our findings reveal a clear pattern: during 'good' times, inequality, as measured by the Gini index, tends to decrease, while 'bad' times lead to an increase in inequality.
During periods of economic prosperity, the income or consumption share of the bottom 50 percent of households rises, concomitant with a decline in the share of the top 10 percent. However, when economic conditions sour, the income or consumption share of the bottom 50 percent dwindles, while the top 10 percent enjoys a larger share of the pie. The reductions in inequality witnessed during 'good times' are largely undone during 'bad times.'
Unpacking the Unemployment Channel
Our study uses mediation analysis to unveil the causal effect of 'good' and 'bad' economic times on inequality through the lens of unemployment, with a particular emphasis on youth unemployment. The results underscore the quantitative importance of this channel, especially during 'good times, where it explains 41.3 percent of the effect on inequality in developing countries and 51.1 percent in a sub-sample of 28 emerging market economies.
The connection between 'bad' times and inequality via the unemployment channel is slightly lower, at around 28.4 percent in developing countries. However, it is worth noting that a robust statistical causal relationship between 'bad' times and inequality through the unemployment channel couldn't be established for emerging market economies.
Policy Implications
The research offers key implications for policymakers in developing countries, particularly in the context of post-pandemic recovery and beyond. The findings underscore the pivotal role of job quality and labor market policies in reducing inequality. Structural reforms are needed to address factors exacerbating income disparities, including the prevalence of informal or self-employment, the absence of robust employment protection or unemployment benefits, and limited labor mobility.
Furthermore, the study emphasizes the critical importance of focusing on youth unemployment as a key driver of reducing inequality during ‘good’ times. Policies geared towards enhancing the employability of young workers and safeguarding them from the impacts of economic downturns are crucial.
In Conclusion
Our study presents compelling new evidence regarding the relationship between economic fluctuations and inequality in developing countries. B y examining the influence of 'good' and 'bad' economic times on inequality through the unemployment channel, this research underscores the significance of implementing policies that not only promote economic growth but also ensure equitable distribution of resources and opportunities. Such proactive measures can help mitigate the adverse effects of economic downturns, safeguarding vulnerable populations and fostering a more inclusive and resilient society, particularly for youth people.
Join the Conversation