Income inequality and economic growth in developing countries:

Income inequality and economic growth in developing countries: an empirical Since the 1950', income inequality and its impact on the economy

has frequently been studied by many authors.

Even though numerous studies have considered

many aspects of this impacts, there are still many

questions that remain. One of the lingering questions

involves the nature of the relationship between

income inequality and economic growth. Studies

indicate conflicting conclusions about this relationship.

This paper attempts to use income inequality data

from several developing countries and shed new light

on it. Based on panel data estimation over the 1966-

1991 time period, the empircal evidence shows that

countries with higher income inequality do not grow at

a slower rate than developing countries with a more

equal income distributionINTRODUCTION

Over the last half century, an intriguing topic among

economists and policy makers has been the possible

impact of income inequality on the economy, especially

on the rate of economic growth. Understanding the

relationship between these two very important economic

variables is important, because higher income inequality

is more often found in less developed countries.

If there is a clearer understanding about this relation,

specific economic policies could be adopted in less

countries in the appropriate manner to deal with

income inequality and to stimulate economic growth.

This paper does not provide definitive or conclusive

answer on the relationship between income inequality

and economic growth; rather an attempt to provide

additional empirical evidence in the search for the

focus on income inequality and economic growth

began in the 1950's when Simon Kuznets (1955)

presented his idea of an inverted U relationship

between per capita GNP and inequality in the

distribution of income. Based upon income

distribution data available at that time, Kuznets

suggested that as per capita income rose in lesser

developed countries, income inequality also rose,

reached a maximum, and then declined as income

levels rose further. Kuznets developed this theory

by studying data estimating income distribution in a

few rich and a few poor countries and by studying

trends in distribution in a few European countries

over time (Perkins et al, 129). His findings were

later described as an "inverted-U hypothesis."

Following this ground breaking theory, many

countries tolerated rising income inequality

arguing that income would become more equally

distributed with advanced development, as

Kuznets observed. Thus, developing countries

facing high income inequality need not to be

concerned with such rising inequality. If, however,

income inequality does not reverse itself with

advanced development, it is important to understand

the possible effects of income inequality on the

economy. Whatever may be the theoretical

justification of the Kuznets hypothesis, the

empirical validity of this phenomenon still remains

questionable at best.

A prominent case study displaying a possible relationship

between income inequality and economic growth is

that of South Korea and the Philippines. As discussed

by Benabou (1996), South Korea and the Philippines

looked similar in the early 1960's as indicated by many

macroeconomic factors, including GDP per capita,

populations, urbanization, and primary and secondary

school enrollment. They differed, however, in their

distribution of income. In 1965, South Korea's Gini

coefficient was 34.3 while the Philippines' Gini

coefficient was 51.3. During the next thirty years,

South Korea averaged 6% growth annually while the

Philippines stagnated at 2%. South Korea's output

level increased fivefold while the Philippines output

level barely doubled (Aghion et al, 1999). This result

by no means proved a negative relationship between

income inequality and economic growth, but it did

invigorate the interest in the relationshipIt is important

to understand the relationship between income distribution

and economic growth for a number of reasons. Many of the

nations experiencing high rates of income inequality are the

least developed countries and developing countries. It has

been argued sometimes that income inequality and the

accumulation of wealth in a small proportion of the population

would result in higher growth in the future. From such a 'trickle

down' theory, the mass poor are told to simply wait and they

will receive transfers of the accumulated wealth through

redistribution later on.

redistribution of wealth eventually puts everyone in

a better

position then they were before and therefore, initial

income inequality it acceptable (Clark 1995). However,

there could also be a negative impact of inequality on

growth as argued by others. If a country experiences

high income inequality, there is a great pressure from

the poor masses to redistribute the wealth accumulation.

The high taxes levied to redistribute the wealth lower

the rate of return on private assets, which r

estrict capital accumulation and slows growth

(Clark 1995). These theoretical claims were

supported by Alesina and Rodrik (1991) and Person s

and Tabellini (1990) through cross country growth

analysis. The purpose of this paper is to provide

additional empirical evidence of the relationship

between income inequality and an economy's

rate of growth in such developing countries.

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