Science recently published a theme issue on income inequality in the developing world (free access, with registration). It includes contributions from, among others, Thomas Piketty, Martin Ravallion and Angus Deaton.
The main idea from Piketty’s bestseller, Capital, is that inequality has been rising since the 19th century because yields on wealth are higher than those on income. This trend was only interrupted by the 2 world wars. Piketty’s thesis rests on historical data from the US and Europe. This theme issue looks whether the conclusions are valid for developing countries as well.
Has the strong economic growth in developing countries since 2000 resulted in falling levels of inequality? And what has been the effect on poverty? The main findings from the article of Ravallion:
Inequality has fallen between 1981 and 2010. However, the period between 2005 and 2010 shows an increase. The variance over time is mainly attributable to inequality between countries. Again, most recent data indicate that the component between countries has fallen, whereas the component within countries has risen.
- Economic growth has lead to increasing inequality between countries, but to falling inequality within countries (although the latter trend has weakened in recent years).
- The effect of economic growth on poverty depends on the initial level of inequality. The higher that level, the lower the share of economic growth that flows to the poor and the lower the poverty reduction resulting from that growth.
- Even if inequality has not been rising overall, there are still worries about high levels on inequality in developing countries:
- capital tends to have diminishing returns, implying it’s more ‘useful’ when more equally spread;
- high inequality means that many poor, talented people cannot reach their full potential;
- high inequality tends to erode democracy, as a small group of people may hijack the democratic process and turn ‘inclusive institutions’ into ‘extractive ones’ (see Acemoglu’s and Anderson’s work);
- low inequality and a strong middle class tend to create a more diversified and robust economy, as a result of a stronger focus on consumption goods and support for pro-growth policies.
- Three cautionary remarks on the data:
- The data, using the Gini or related MLD indicators, represent relative inequality. This means that inequality is the same whether incomes are 1$ and 2$ or 1000$ and 2000$. This implies that even with constant relative inequality, the absolute differences in income and wealth can grow much larger.
- Data on inequality in developing countries are notoriously unreliable. The main data sources are the national accounts (household consumption item) and household surveys. In the latter, the rich either don’t participate or tend to under-report their income and wealth.
- Developing countries are a mixed bag. Countries with rising inequality from a low base (India, China), countries with rising inequalities from a high base (South Africa, with Gini = 0.7!!!) and countries with decreasing inequality (most countries in Latin America).
- Falling inequality is not something which happens ‘automatically’ as countries grow rich, as was postulated by Simon Kuznets. It’s the result of pro-equity policies, such as investments in health and education (Bolsa Familia in Brazil) and job creation.