Decomposing inequality change from the perspective of reranking and income growth between income groups

This paper proposes a decomposition of the change in inequality from the perspective of income groups. For every dichotomisation of the income distribution into poorer and richer parts, the decomposition allows to detect the change in the relative income gap between the two parts and the reranking between poorer and richer individuals. This decomposition approach is particularly suitable when analysts split the population between the individuals initially below the poverty line and those above the poverty line, since the decomposition allows to capture the effects of reranking and disproportional growth in income between poor and non-poor individuals and to compare these effects with those detected for the entire population. An application to Italian income data illustrates the proposed decomposition.     

Income inequality and economic growth in an open economy

Income inequality has a strong impact on fiscal policy when majority voting enables those individuals with less-than-average income to decide on tax rates. This study analyzes the impact on economic growth of income inequality in an open economy where tax revenues are partially used for international transfers. In any case, income inequality is harmful for growth. In an economic union, positive effects of international integration raise the growth rate as long as net transfers do not grow proportionally. In a political union, unionwide voting makes distributive politics depending on the union's median voter. In this case, additional output growth on aggregate level is a necessary, but not sufficient condition for a majority of voters to accept union membership.     

Growing income inequality due to biased technological change

Inequality is rising in many countries. This paper presents a growth model in which technological change increases the income share of reproducible factors at the expense of non-reproducible ones. Agents are heterogeneous in wealth. Preferences imply that the saving rate increases with wealth. Consequently, assets (reproducible factor) are less equally distributed than raw labor (non-reproducible factor). This implies that technological change raises the share of the less equally distributed factor, increasing inequality along permanent growth path. When reproducible factors and the state of know-how are low, to adopt new technologies is not profitable, learning-by-doing and technological change ceases, arising stagnation.     

The effect of growth volatility on income inequality

This paper assesses the long-run effect of growth volatility on income inequality using a comprehensive panel of annual U.S. state-level data during the 1945 to 2004 period. Using the pooled mean group (PMG) estimator, we find evidence supporting the hypothesis that larger growth volatility positively and significantly associates with higher income inequality. Our key finding is robust to alternative lag structures, conditioning variables, inequality measures, volatility indicators, time periods, and panel estimators. Our key finding does change for asymmetric effects, where larger growth volatility positively and significantly associates with higher income inequality only for positive economic growth. The volatility effect proves positive, but insignificant, for negative economic growth.     

The permanent income hypothesis in an underdeveloped economy

After a concise but critical survey of several tests of the permanent income hypothesis (PIH), the authors advance their own test for India using annual data from 1919–1960. It employs Friedman's technique for calculating the permanent value of a variable. Two different specifications of the model are tested, using different values of the consumer's ‘horizon.’ In almost all cases it is found that the marginal propensity to consume out of transitory income is very similar to the marginal propensity to consume out of permanent income. The authors conclude that even a looser variant of the PIH is not valid for India. However, no valid generalization with respect to the appropriate planning horizon can be made, for the PIH was almost equally invalid with a horizon of one, two and two-and-a-half years. The authors briefly discuss the policy implications of their results for the savings efforts in underdeveloped countries.     

The corporate income tax in an open economy

The paper begins with a brief review of the distortion literature, stressing its relation to the general equilibrium consequences of the corporate income tax. The consequences for international trade of the distortions associated with the tax are then examined, and among other things it is found that trade could reduce welfare. Finally, the implications of trade for the incidence question are examined, and it is shown that whether labor or capital bears the burden of the tax depends entirely on whether the tax is imposed in the labor-intensive or the capital-intensive industry.     

The effects of economic growth on income inequality in the US

The paper analyzes the relation between growth and income inequality in the US during the post-war years (1953–2008). We show that the income of the top income groups is more sensitive to growth, defined broadly as current growth and changes in expectations of future growth, compared to the income of the lower income groups. We provide evidence that this increased sensitivity arises for two reasons: (a) the top income groups receive a large portion of their income from wealth, which is more sensitive to growth than labor income and (b) the top income groups receive a large portion of their labor income in the form of pay-for-performance (equity compensation), which is also sensitive to growth. Consequently, we conclude that growth and income inequality are positively associated.     

Finance,income inequality and income redistribution

Using a panel fixed effects model for a large sample of countries covering 1975–2005, we test the hypothesis that income inequality caused by finance (financial development, financial liberalization and banking crises) is related to more income redistribution than inequality caused by other factors. Our results provide evidence in support of this hypothesis. We also find that the impact of inequality on redistribution is conditioned by ethno-linguistic fractionalization. Our findings are robust to the inclusion of several control variables suggested by previous studies.     

The political economy of income comparisons and economic growth

The literature on income inequality has provided various explanations as to how income inequality can affect growth, with the emphasis on ideas such as investments in human capital, issues of occupational choice, or the redistributive policies of governments. Inequality not only has a direct effect on the distribution of consumption in an economy, but it also has a powerful effect on people's subjective sense of well being. This paper takes a novel approach by focusing on the way in which a government's choice of economic policy can be influenced by how individuals perceive themselves relative to other individuals, both within the country and in foreign countries. The chosen policy affects economic growth, with the assumption being that policies that promote growth also tend to result in more switching of individuals between income groups. We show that the government's optimal policy depends on the importance of both inside country and outside country income comparisons, the fraction of national income earned by the different income groups, the potential magnitude of economic growth, the probability of switching between income groups in the presence of growth, and the relative importance of the various income groups. The model predicts that a greater degree of inside country income comparison is bad for growth whereas more outside country comparison is good for growth.     

International trade,technological change and wage inequality in the UK economy

This paper examines the joint impact of international trade and technological change on UK wages across different skill groups. International trade is measured as changes in product prices and technological change as total factor productivity (TFP) growth. We take account of a multi-sector and multi-factor of production economy and use mandated wage methodology in order to create an well-balanced approach in terms of theoretical and empirical cohesion. We use data from the EU KLEMS database and analyse the impact of both product price changes and TFP changes of 11 UK manufacturing sectors on factor rewards of high-, medium- and low-skilled workers. Results show that real wages of skill groups are significantly driven by the sector bias of price change and TFP growth of several sectors of production. Furthermore, we estimate the share of the three different skill groups on added value for each year from 1970 to 2005. The shares indicate structural change in the UK economy. Results show a structural change owing to decreasing shares of low-skilled workers and increasing shares of medium-skilled and high-skilled workers over the years.     

Growth of regional economy and income inequality: county-level evidence from Florida,USA

The purpose of this paper is to find the homogeneous groups and growth factors of Florida's counties through factor analysis and cluster analysis from data sets from 1979 and 2000 and to grasp the relationship between income inequality and growth by cluster using the derived growth factors. The numbers of factors divided through factor analysis were three, and six groups were obtained from cluster analysis.

County-level evidence of this paper indicates that GI_DI and SIN have a strong effect and are statistically significant to the growth rate. Results for income inequality by county and region indicate significant differences between counties, including counties where agriculture accomplishes the primary main function. Therefore, government should adopt the following policies: minimum wage, unemployment insurance, local or state tax policies, income support programmes, and tax reform.     

Foreign direct investment,growth and income inequality in less developed countries

How does foreign direct investment (FDI) affect economic growth in less developed countries (LDCs)? What is its association with changes in the income distribution? This paper empirically examines these issues within a cross section of less developed countries between 1970 and 1989. FDI is positively associated with economic growth within this sample of countries. However, there is no strong association between FDI and changes in income inequality within these same countries and over this same time period. Hence, there is no evidence that FDI is increasing income inequality within this group of LDCs.     

Status-seeking behavior,the evolution of income inequality,and growth

Using an overlapping generations model, this paper investigates the implications of status-seeking behavior, induced by preferences for relative income, for the evolution of income inequality. When average income rises, an individual’s marginal utility of their own income may increase (keeping up with the Joneses, or KUJ), or decrease (running away from the Joneses, or RAJ). It is shown that income inequality is shrinking over time in the KUJ economy, whereas it is expanding in the RAJ economy. We also explore the implications for long-run growth and inequality, in the existence of both KUJ and RAJ agents. I am truly grateful to Koichi Futagami for his encouragement and guidance in writing this paper. I have benefitted from comments by an anonymous referee, Been-Lon Chen, Giacomo Corneo, Akiomi Kitagawa, Kazuo Mino, Kazuhiro Yuki, and seminar participants at Osaka University, the 2006 Japanese Economic Association Autumn Meeting at Osaka City University, the Far Eastern Meeting of Econometric Society 2007 at Taipei, SER Conference 2007 at Singapore, and the European Meeting of Econometric Society 2007 at Budapest. All remaining errors are, of course, my own. The financial support from JSPS Research Fellowships for Young Scientists is greatly acknowledged.     

A refinement of the relationship between economic growth and income inequality

There is mixed evidence in the literature of a clear relationship between income inequality and economic growth. Most of that work has focused almost exclusively on developed economies. In what we believe to be a first effort, our emphasis is solely on developing economics, which we classify as high-income and low-income developing countries (HIDC and LIDC). We make such distinction on theoretical and empirical grounds. Empirically, the World Bank has classified developing economies in this manner since 1978. The data in our sample are also supportive of such classifications. We provide theoretical scaffolding that uses asymmetric credit constraints as a premise for separating developing economies in such a way. We find strong evidence of a negative relationship between income inequality and economic growth in LIDC to be in stark contrast with a positive inequality–growth relationship for HIDC. Both correlations are statistically significant across multiple econometric specifications. Using international data from 1960 to 2010, this article explores the effect of income inequality on economic growth using dynamic panel technique, such as system generalized method of moments (GMM) that is believed to mitigate endogenous problem. These results are strikingly contrasting to the previous estimation results of Forbes (2000) displaying significant positive correlation between two variables in the short to medium term.     

Poverty decompositions with counterfactual income and inequality dynamics

Traditional poverty accounting decomposes changes in a country's poverty headcount ratio into changes in income and inequality. We argue that this approach is unsatisfactory from the perspective of policy analysis because it compares a country in two points of time without taking the country's initial situation, and hence its potential for poverty reduction, into account. We thus suggest comparing traditional poverty decompositions with a counterfactual situation. This counterfactual indicates what a country starting from its initial situation could be expected to achieve in terms of income, inequality, and, hence, poverty developments. We construct those counterfactuals by modeling income and inequality trends characterized by convergence and a “Kuznets” relationship between inequality and development. Parameters in those relationships are estimated using PovcalNet survey data from 144 countries and we construct our counterfactual poverty predictions for 71 developing countries. While there is overall a tight relationship between actual developments and counterfactuals, we identify several cases, where both deviate from each other and discuss the policy implications. We also check for commonalities in differently performing countries and find that those who fell particularly short of expectations often underwent political transition and state fragility.     

Capitalist systems and income inequality

The paper investigates the relationship between compositional inequality (how the shares of capital and labor income vary along income distribution) and inter-personal income inequality. Using a new methodology and data from 47 countries covering the period 1995–2018, we show that higher compositional inequality is associated with higher inter-personal inequality. This is clearly shown by Latin American countries and India. Nordic countries are exceptional because they combine high compositional inequality with low inter-personal inequality. Their exceptionalism is attenuated when pension income received from largely government-mandated accumulated savings is added to capital income. The analysis shows the theoretical possibility of societies where low compositional inequality may be combined with high income inequality. Currently, China and the United States come closest to that position.     

Educational opportunity and income inequality

Affordable higher education is, and has been, a key element of social policy in the United States with broad bipartisan support. Financial aid has substantially increased the number of people who complete university—generally thought to be a good thing. We show, however, that making education more affordable can increase income inequality. The mechanism that drives our results is a combination of credit constraints and the ‘signaling’ role of education first explored by Spence [Spence, A. Michael, 1973. Job Market Signalling, Quarterly Journal of Economics, 87(3) Aug., 355–374]. When borrowing for education is difficult, lack of a college education could mean that one is either of low ability or of high ability but with low financial resources. When government programs make borrowing or lower tuition more affordable, high-ability persons become educated and leave the uneducated pool, driving down the wage for unskilled workers and raising the skill premium.     

Political regimes and income inequality

We construct a theoretically-motivated model of income inequality. Through a pooled regression on an international panel, we demonstrate that political regime (whether extractive, redistributive, or reinvestment-oriented) correlates with within-country income inequality.     

Technological progress and income inequality

Summary This paper examines the effects of Hicks-neutral, Harrod-neutral, and Solow-neutral technological improvements on the distribution of income in an overlapping generations economy with endogenous labor supply and a bequest motive. Income inequality in this model is generated by a stochastic process representing random variations in intergenerational transfers and pure luck. The comparative dynamics analysis trace the effects of the aforementioned technological changes in each and every period after they occur. These effects depend on the nature of the technological change and on the elasticity of substitution.We thank Carl Davidson, James Foster, and two anonymous referees for their useful comments.