Inequality and Growth

Brown University, Providence RI

Investigators

Abstract

This research examines the dynamic evolution of the effect of income distribution on the process of development. It develops unified growth models that encompass the transition between distinct regimes that have characterized the relationship between income inequality and the process of development. The unified modeling of this long transition process is a significant research challenge facing economists interested in the understanding of the role of income inequality in the process of development and in the determination of long-run economic growth. Imposing the constraint that a single model would account for the entire evolution of the relationship between inequality and the process of development is a discipline that would improve the understanding of the underlying phenomena and would generate superior testable predictions and policy implications. The research provides an intertemporal reconciliation between conflicting viewpoints about the effect of inequality on economic growth. It argues that the replacement of physical capital accumulation by human capital accumulation as a prime engine of economic growth has changed the qualitative impact of inequality on the process of development. In early stages of industrialization as physical capital accumulation is a prime source of economic growth, inequality enhances the process of development by channeling resources towards individuals whose marginal propensity to save is higher. In later stages of development, however, as the return to human capital increases due to capital-skill complementarity, human capital becomes the prime engine of economic growth and equality, in the presence of credit constraints, stimulates investment in human capital and promotes economic growth. As wages increase, however, credit constraints become less binding, the adverse effect of inequality on human capital accumulation and growth subsides, and the overall effect of inequality becomes less significant. The research hypothesizes that changes in class structure that have taken place in Europe since the 19th century reflect a deliberate transformation of society orchestrated by the Capitalists. Based on a careful examination of historical evidence, the proposed research will argue that contrary to conventional wisdom, the changes of this class structure could have been an outcome of a cooperative rather than a purely divisive process. The process of capital accumulation has gradually intensified the relative scarcity of labor and has generated an incentive to augment labor via human capital accumulation. Due to the complementarity between physical and human capital in production, the Capitalists were among the prime beneficiaries of the potential accumulation of human capital by the masses. They had therefore the incentive to financially support public education that would sustain their profit rates and would improve their economic well being, The research develops the hypothesis that in land abundant societies with a high degree of polarization education reforms would be delayed, due to the low degree of complementarity between human capital and land. Thus the research argues that, in contrast to a capital abundant society, in a land abundant society the process of development would be slower and polarization would persist longer. Hence, initial differences in land abundance may be the cause of persistence differences in the structure of society, institutions and economic performance across countries.