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The Effect Of Income Inequality On Economic Growth

1479 words - 6 pages

1. Introduction and Motivation
Only one century ago we had no airplanes, no computer no cell phones, no internet, no luxurious Bmw`s to show off with. We had only simple versions of cars, trucks, telephone and black and white cameras. Less than one in five homes had running water, flush toilets, a vacuum cleaner or gas or electric heat.
However, in the today`s world of shiny cars, luxurious apartments and houses equipped with appliances a man from the previous century cannot even imagine and with phones and computers that do the thinking instead of us, there is another world, a world that few of us pay attention to. What is striking about it, is that people live like the ones century ago, or ...view middle of the document...


The issue I chose to deal with is quite controversial heaving in mind the different opinions of the economist in terms of the effect of the inequality on the economic growth. There have been plentiful arguments on all sides; that inequality does weaken economic growth, that inequality actually boost growth in the long run, or that they do not have any fundamental effect, or that the relationship is indefinite. However, I am going to concentrate only on the negative effect that income inequality has on the economic growth. I am going to that by going back in time and researching how exactly did the economists approach the subject and what methods did they use in order to reach to this conclusion.

 The Kuznets` Hypotheses

According to Kuznets (1955), excluding government intervention, there are two things that explain income inequality before taxes: the concentration of savings in the wealthy groups of the population and the industrial structure of the income distribution. The former yields inequality in savings which, all other conditions being equal, has a cumulative effect of increasing the proportion of income yielding assets in the hands of the upperincome groups leading to larger income shares of these groups.
The Kuznets`s curve shows graphically that as an economy expands a natural cycle of inequality take place, stimulated by market forces which in the beginning boost inequality and then diminish it after a certain average income is attained. The theory suggest that as a country is going through an industrialization and the wages remain stagnant in rural(agricultural) communities, some people in
urban communities would become better-off. This would result in pulling away workers from rural communities, however the wages of the remaining workers wouldn`t increase with the same pace as those in the urban communities. Basically, the wealthy ones in the cities keep getting richer, while the poor rural workers stay at the previous level of income. Though, this is a typical example of increasing inequality, eventually, when a certain level of average income is reached and the processes of industrialization allow to take advantage of rapid growth rural communities` salaries are raised as well. This shift form inequality to equality is represented in Kuznets` inverted U curve.
However, there are some different suggestions that differs from Kuznets` theory: income inequality must increase before it decreases and income inequality may increase or decrease depending on the type of country and the policies implemented. Along with the studies that consider structural and policy factors including income level or rate of growth, Fields(1988) argues that the extent of inequality in different countries is associated with factors such as education, extent of direct government economic
activity, population growth rate, urbanisation, and importance of the agricultural sector in total production. Furthermore, there are some empirical...

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