In economics, the Kuznets curve () is a hypothesized relationship between income and inequality proposed by economist Simon Kuznets in the 1950s and 1960s, who argued that as an economy develops, market forces first increase and then decrease economic inequality.Kuznets profile at New School for Social Research: "...his discovery of the inverted U-shaped relation between income inequality and economic growth..." The hypothesis remains highly contested among economists, with no consensus regarding its validity.
Explanations
One explanation of such a progression suggests that early in development, investment opportunities for those who have money multiply, while an influx of cheap rural labor to the cities holds down wages. Whereas in mature economies, human capital accrual (an estimate of income that has been achieved but not yet consumed) takes the place of physical capital accrual as the main source of growth; and inequality slows growth by lowering education levels because poorer, disadvantaged people lack finance for their education in imperfect credit-markets.
The Kuznets curve implies that as a nation undergoes industrialization – and especially the mechanization of agriculture – the center of the nation's economy will shift to the cities. As internal migration by farmers looking for better-paying jobs in urban hubs causes a significant rural-urban inequality gap (the owners of firms would be profiting, while laborers from those industries would see their incomes rise at a much slower rate and agricultural workers would possibly see their incomes decrease), rural populations decrease as urban populations increase. Inequality is then expected to decrease when a certain level of average income is reached and the processes of industrialization – democratization and the rise of the welfare state – allow for the benefits from rapid growth, and increase the per-capita income. Kuznets believed that inequality would follow an inverted "U" shape as it rises and then falls again with the increase of income per-capita. Kuznets had two similar explanations for this historical phenomenon: workers migrated from agriculture to industry; and rural workers moved to urban jobs. In both explanations, inequality will decrease after 50% of the shift force switches over to the higher paying sector.Kuznets, Simon. 1955. Economic Growth and Income Inequality. American Economic Review 45 (March): 1–28.
An explanation of the Kuznets curve is the prevention of social unrest and revolutions by the political elites in favor of democratization with economic and political redistribution.
Evidence
With the passage of time, the data no longer reflects a curve, but rather a series of ups and downs or "waves". Inequality has risen in most developed countries since the 1960s, so graphs of inequality over time no longer display a Kuznets curve. Piketty has argued that the decline in inequality over the first half of the 20th century was a once-off effect due to the destruction of large concentrations of wealth by war and economic depression. The curve applies only to a relatively short period in post-World War II Europe and the United States.
The Kuznets curve and development economics
Critics of the Kuznets curve theory argue that its U-shape comes not from progression in the development of individual countries, but rather from historical differences between countries. For instance, many of the middle income countries used in Kuznets' data set were in Latin America, a region with historically high levels of inequality. When controlling for this variable, the U-shape of the curve tends to disappear (e.g. Deininger and Squire, 1998). Regarding the empirical evidence, based on large panels of countries or time series approaches, Fields (2001) considers the Kuznets hypothesis refuted.
The East Asian miracle (EAM) has been used to criticize the validity of the Kuznets curve theory. The rapid economic growth of eight East Asian countries—Japan; the Four Asian Tigers South Korea, Taiwan, Singapore, Hong Kong; Indonesia, Thailand, and Malaysia—between 1965 and 1990, was called the East Asian miracle. The EAM defies the Kuznets curve, which insists growth produces inequality, and that inequality is a necessity for overall growth. Manufacturing and export grew quickly and powerfully. Yet, contrary to Kuznets' historical examples, the EAM saw continual increases in life expectancy and decreasing rates of severe poverty. Scholars have sought to understand how the EAM saw the benefits of rapid economic growth distributed broadly among the population. Joseph Stiglitz explains this by the immediate re-investment of initial benefits into land reform (increasing rural productivity, income, and savings), universal education (providing greater equality and what Stiglitz calls an "intellectual infrastructure" for productivity), and industrial policies that distributed income more equally through high and increasing wages and limited the price increases of commodities. These factors increased the average citizen's ability to consume and invest within the economy, further contributing to economic growth. Stiglitz highlights that the high rates of growth provided the resources to promote equality, which acted as a positive-feedback loop to support the high rates of growth.
Cambridge University Lecturer Gabriel Palma recently found no evidence for a 'Kuznets curve' in inequality:
"[T]he statistical evidence for the 'upwards' side of the 'Inverted-U' between inequality and income per capita seems to have vanished, as many low and low-middle income countries now have a distribution of income similar to that of most middle-income countries (other than those of Latin America and Southern Africa). That is, half of Sub-Saharan Africa and many countries in Asian, including India, China and Vietnam, now have an income distribution similar to that found in North Africa, the Caribbean and the second-tier NICs. And this level is also similar to that of half of the first-tier NICs, the Mediterranean EU and the Anglophone OECD (excluding the US). As a result, about 80% of the world population now live in countries with a Gini around 40."
Palma goes on to note that, among middle-income countries, only those in Latin America and Southern Africa live in an inequality league of their own. Instead of a Kuznets curve, he breaks the population into deciles and examines the relationship between their respective incomes and income inequality. Palma then shows that there are two distributional trends taking place in inequality within a country:
"One is 'centrifugal', and takes place at the two tails of the distribution—leading to an increased diversity across countries in the shares appropriated by the top 10 percent and bottom forty percent. The other is 'centripetal', and takes place in the middle—leading to a remarkable uniformity across countries in the share of income going to the half of the population located between deciles 5 to 9."
Therefore, it is the share of the richest 10% of the population that affects the share of the poorest 40% of the population with the middle to upper-middle staying the same across all countries.
In Capital in the Twenty-First Century, Thomas Piketty denies the effectiveness of the Kuznets curve. He points out that in some rich countries, the level of income inequality in the 21st century has exceeded that in the second decades of the 20th century, proposing the explanation that when the rate of return on capital is greater than the rate of economic growth over the long term, the result is the concentration of wealth.
Kuznets's own caveats In a biography about Simon Kuznets's scientific methods, economist Robert Fogel noted Kuznets's own reservations about the "fragility of the data" which underpinned the hypothesis. Fogel notes that most of Kuznets's paper was devoted to explicating the conflicting factors at play. Fogel emphasized Kuznets's opinion that "even if the data turned out to be valid, they pertained to an extremely limited period of time and to exceptional historical experiences." Fogel noted that despite these "repeated warnings", Kuznets's caveats were overlooked, and the Kuznets curve was "raised to the level of law" by other economists.
Inequality and trade liberalization Dobson and Ramlogan's research looked to identify the relationship between inequality and trade liberalization. There have been mixed findings with this idea – some developing countries have experienced greater inequality, less inequality, or no difference at all, due to trade liberalization. Because of this, Dobson and Ramlogan suggest that perhaps trade openness can be related to inequality through a Kuznets curve framework. A trade liberalization-versus-inequality graph measures trade openness along the x-axis and inequality along the y-axis. Dobson and Ramlogan determine trade openness by the ratio of exports and imports (the total trade) and the average tariff rate; inequality is determined by gross primary school enrolment rates, the share of agriculture in total output, the rate of inflation, and cumulative privatization. By studying data from several Latin American countries that have implemented trade liberalization policies in the past 30 years, the Kuznets curve seems to apply to the relationship between trade liberalization and inequality (measured by the GINI coefficient). However, many of these nations saw a shift from low-skill labour production to natural resource intensive activities. This shift would not benefit low-skill workers as much. So although their evidence seems to support the Kuznets theory in relation to trade liberalization, Dobson and Ramlogan assert that policies for redistribution must be simultaneously implemented in order to mitigate the initial increase in inequality.
Environmental Kuznets curve
The environmental Kuznets curve (EKC) is a hypothesized relationship between environmental quality and economic development: various indicators of environmental degradation tend to get worse as modern economic growth occurs until average income reaches a certain point over the course of development.Shafik, Nemat. 1994. Economic development and environmental quality: an econometric analysis. Oxford Economic Papers 46 (October): 757–773
Although subject to continuing debate, there is considerable evidence to support the application of the environmental Kuznets curve for various environmental health indicators, such as water, air pollution and ecological footprint which show the inverted U-shaped curve as per capita income and/or GDP rise. It has been argued that this trend occurs in the level of many of the environmental pollutants, such as sulfur dioxide, nitrogen oxide, lead, DDT, chlorofluorocarbons, sewage, and other chemicals previously released directly into the air or water. For example, between 1970 and 2006, the United States' inflation-adjusted GDP grew by 195%, the number of cars and trucks in the country more than doubled, and the total number of miles driven increased by 178%. However, during that same period certain regulatory changes and technological innovations led to decreases in annual emissions of carbon monoxide from 197 million tons to 89 million, nitrogen oxides emissions from 27 million tons to 19 million, sulfur dioxide emissions from 31 million tons to 15 million, particulate emissions by 80%, and lead emissions by more than 98%.