Income Distribution in Less Developed Countries

R. M. Sundrum

• Publisher: Routledge
• Year: 2003
• Print ISBN: 9781138417076
• eBook ISBN: 9781134896172
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

This is a major book in a key area of development economics. It gives a comprehensive survey of the link between income distribution and the growth of national income, bringing out major patterns and trends, and concluding that there is still considerable scope for growth with equity in LDCs.

Chapter one

Introduction

1.1 The growing interest in income distribution

Economics began its scientific career as an enquiry into the wealth of nations. And ever since, the study of the national income, how it differs between countries and how it grows over time, has remained the main concern of economists.

The British classical economists, who laid the scientific foundations of a new approach to the subject, were interested in the national income of countries from the point of view of the welfare of the entire population of these countries; hence, their measure of the economic progress of a country was its per capita income. This was a momentous shift of emphasis from previous writers on political economy, especially those of the Mercantilist school, who were more interested in the power of the state and its rulers.

The classical writers were also interested in how the national income was distributed among different sections of the population, but they distinguished these sections according to their ownership of the various factors of production: land, labour, and capital, that is, the ‘functional’ distribution of income. As Ricardo (Sraffa edition 1972, vol. 8, pp. 277–8) claimed in a well-known statement: ‘Political economy … should rather be called an enquiry into the laws which determine the division of the produce of industry among the classes who concur in its formation.’

The main reason underlying this interest in the functional distribution of income was that the classical economists believed that this distribution was closely intertwined with the process of growth itself. Ricardo analysed this interaction with characteristic boldness, working from a few basic assumptions to derive grand theorems about change over long periods of time, so that his work on the subject has come to be known as the ‘magnificent dynamics’.

However, in recent times there has been growing interest in the way the national income of countries is distributed among individuals and households in those countries, that is, the ‘personal’ distribution of income. This growing interest has given rise to a large literature on this topic. The main object of this book is to give a comprehensive review of these studies.

But first we consider the reasons why interest in the personal distribution of income has grown only in recent times. One reason is that in earlier times individuals may have accepted their economic status as a given fact of their lives and thus have been resigned to it. But in our century large groups of people, sometimes indeed entire nations, have become dissatisfied with their present economic status. At the same time they have become increasingly aware that this status can be modified to their advantage, especially by influencing the policies of their governments, and therefore react to their real or imagined grievances by pressing for such actions. These pressures in turn have led to various government interventions with the working of the economic system. The result has been that whereas in the nineteenth century the triumph of classical political economy ushered in a long period of economic growth under free market forces among the Western nations, the time has now come that the governments of these very nations are actively intervening with market forces primarily for distributional reasons. In fact, it is even true to say that the very success of free markets in promoting the overall growth of the national product in these countries has led to the present concern with distributional issues and with various policy interventions to deal with them. Hirsch (1977) has eloquently argued that it is under such a ‘distributional compulsion’ that the developed market economies (hereafter DMEs) have been moving towards a ‘reluctant collectivism’.

There has also been a growing interest in the distribution of income in the less developed countries (hereafter LDCs), though for an entirely different reason. The most striking feature of the LDCs is the large proportion, amounting in some cases to more than half, of the population living in absolute poverty on any reasonable definition. In the early postwar literature on development, such widespread poverty was considered essentially a reflection of the low level of national income relative to population, so that the solution was seen almost entirely in terms of overall economic growth. But since the mid-1960s doubts have begun to set in as to whether economic growth could be accelerated beyond the annual rate of around 5 per cent that many LDCs were experiencing, itself a sharp break from the stagnation of prewar years, and whether, even if these rates could be accelerated, the resulting growth of national income alone could solve the problem of widespread poverty in these countries (Fields 1980: Chap. 7). As an alternative, development economists have begun to look to improvements in the distribution of the national income among persons and households as a more promising way of relieving poverty. In fact, development itself is viewed by some writers primarily in terms of securing a more equal distribution of income, a point of view most forcefully stated by Seers (1969):

The questions to ask about a country’s development are therefore: What has been happening to poverty? What has been happening to unemployment? What has been happening to inequality? If all three of these have declined from high levels, then beyond doubt, this has been a period of development for the country concerned.

Thus we see that interest in income distribution has grown in both the developed countries (hereafter DCs) and in the LDCs, though for different reasons. In the DCs, the interest was due to the rapid growth of national income leading to the present state of affluence; by contrast, in the LDCs it was due to the failure to achieve rapid economic growth.

The subject divides naturally into three parts: the quantitative data and their statistical analysis; the economic analysis of the broad patterns of income distribution; and the implications for policies that governments have followed or might follow to improve it. These are described in the following sections, and discussed more fully in later chapters.

1.2 The statistical approach

The first division of the subject is the statistical approach, discussed in Part I of this book. It is primarily concerned with the statistical properties of income distribution, and deals with issues of measurement and the derivation of various quantitative relationships. The central questions addressed are: How is total income distributed among individuals and households? Are there any mathematical patterns which best describe the distribution of incomes? How unequal is this distribution? How can such inequality be measured? What determines the extent of such inequality? In particular, are there any statistical relationships between the degree of inequality and other characteristics of societies taken as a whole? How does income inequality differ between countries? How does it vary over time? What determines differences in income inequality between countries?

An increasing amount of data has now been collected from a number of countries to provide answers to these questions. The nature of these data is discussed in Chapter two. They consist typically of the incomes or consumption expenditures of a sample of individuals or households, presented in statistical frequency distributions, showing the number of individuals or households in various income classes. The data are generally presented for the population as a whole; sometimes the individuals or households are also classified in other ways, but only according to a limited number of demographic or geographic groups such as regions of the country, urban or rural location, age, sex and education of individuals, and size of households. The choice of the data that are collected has been deeply influenced by the statistical approach to the subject. These data often fall short of what are required to answer some of the main questions of interest. Therefore some methods have to be developed to analyse these data to answer these questions at least approximately.

A particularly serious problem is that the concepts, definitions, survey procedures, and statistical reliability of data vary greatly from country to country, so that the data from different countries of different periods are not strictly comparable with one another. Another serious problem is that most of the data refer to the distribution of incomes received by individuals or households during a short period, such as a year or even a few months; hence, they do not throw sufficient light on the economic conditions of people in different economic and social classes, such as would be provided by data on lifetime incomes. While some countries have collected income distribution data for a number of years, few countries have long time series of such data.

The next step in the statistical approach is to summarize these data so that distributions of income in different countries or regions and at different times may be compared with one another. This is usually done by calculating an index of inequality or poverty. A large number of such measures have been proposed in the literature. The methods of their construction and their statistical properties are discussed in Chapter three. The typical procedure followed in constructing measures of inequality is to compare an actual distribution of income with the egalitarian distribution from various points of view. The various measures fall into two major categories, one consisting of measures of dispersion of individual or household incomes without reference to any underlying social welfare function, and the other of measures based on an explicit assumption of such a function. Another aspect of income distribution, distinct from the degree of inequality, is the extent of poverty. The chapter also discusses various measures of poverty which have been proposed. These deal with various aspects of the population living below a specified poverty line. In spite of considerable theoretical differences among these measures of inequality and of poverty, they tend to be highly correlated in practice. The chapter also discusses some aspects of income distribution not covered by measures of inequality or of poverty, and the ways they may be measured.

Although the data from different countries are not strictly comparable, the cross-section data reveal some broad patterns which are discussed in Chapter four. Generally speaking, the distribution of income is more equal in the DCs than in the LDCs, and within the LDCs, it tends to be more equal in Asian countries than in African and Latin American countries. Attempts to explain these variations have relied heavily on the relationship between income inequality and the level of average incomes in different countries. The leading hypothesis in the literature is the so-called Kuznets’s law that income inequality rises with per capita income up to a point, and declines thereafter. However, this hypothesis is subject to some serious limitations which are pointed out in the chapter: the statistical relationship between income inequality and income level is not very strong, and even if there is such a relationship, it cannot be taken as indicating a causal connection between the two variables. Therefore a number of other factors are discussed which also influence income inequality in different countries. There is also a discussion of the inter-country variation in the extent of poverty, and the extent to which it is related to variations in income levels and income inequality.

The patterns observed in the cross-section data do not necessarily indicate how the distribution of income changes over time. They can be used for that purpose only on the assumption that all countries follow the same historical path, differing only in the stage they have reached on this path. This is an assumption that cannot be made lightly. It has to be verified against historical time series. The limited data available from a few countries in this form are discussed in Chapter five. They show a considerable diversity of experience about how income inequality changes in the process of economic growth. The data, however, show some interesting regularities concerning inequality of some major components of consumption.

The broad patterns of income distribution are usually much more stable over time than many other economic variables, such as average income levels. But underlying this stability are considerable changes in the fortunes of individuals. The relationship between the fluctuations of individual incomes and the stability of the distribution of income is studied in Chapter six in terms of dynamic probability models of social mobility, which have been discussed more extensively by sociologists than by economists.

The statistical approach has been very useful in organizing the available data on income distribution and exploring some of the relationships between these data and other variables. While this approach is an essential part of the subject, it is not complete by itself. One reason is that by itself, this approach may degenerate into ‘measurement without theory’. Another problem is that this approach tends to concentrate excessively on the degree of inequality in a distribution to the neglect of other important aspects. The statistical approach also attempts to derive some broad empirical generalizations in the subject, but even the most robust statistical or historical generalization cannot be relied upon for making projections or devising policies for the future. Whether these generalizations will hold in the future or not depends on what the underlying conditions were which led to the regularities observed in the past, and whether these conditions will also hold in the future. Therefore both the data to be collected and the methods by which they are analysed must be inspired by a theoretical framework.

1.3 The analytical framework

The main objective of Part II of the book, dealing with the analytical framework, is to understand how various economic and social forces operating in the economy influence the distribution of income in that economy. Hence an appropriate point of departure for this part of the study is the concept of a distribution of income which is not affected by such forces. This is clearly not the egalitarian distribution. Instead, a more relevant point of departure is the random distribution of income, determined only by chance. Such a concept is derived in Chapter seven. While the comparison of actual distributions of income with the egalitarian distribution concentrates on the degree of inequality in the actual distributions, the comparison with the random distribution of income suggests that economic and social forces have both equalizing and disequalizing effects on income distribution.

To study these analytical issues empirically, therefore, we require data related to the operation of these economic and social forces. Unfortunately, there is a severe shortage of such information, because most of the data that are routinely collected have been based mainly on the statistical approach.

In developing theories about income distribution, economists have generally followed the model set by the classical economists. In this model, individual incomes are taken to be given by

where Y_i is the income of the ith individual; L_i, K_i, and A_i are the quantities of labour, capital, and land owned by that individual; and w_i, p_i, and r_i are the rates of wages, profit, and rent received by that individual for supplying these resources. Hence any theory of the distribution of the national income of a country among individuals must explain how the productive resources in the economy are distributed among individuals, and what determines the prices individuals receive for supplying these resources to the production process.

The major theories of income distribution in the literature are briefly reviewed in Chapter eight. These theories have concentrated primarily on the prices, and the respective shares in the national income, of the factors of production. The reason these theories have concentrated only on this aspect of income distribution is that they were mainly interested in explaining the growth of national incomes, and only incidentally with income distribution. Therefore they only considered those aspects of income distribution which they considered useful in explaining the growth of national income. The general approach to the subject has been summarized by Samuelson (1964:637) in his influential textbook as follows:

To understand what determines labour and ...

Table of contents

• Cover
• Title
• Copyright
• Dedication
• Contents
• Tables
• Preface
• 1 Introduction
• Part I The statistical approach
• Part II The analytical framework
• Part III The policy implications
• Bibliography and author index
• Subject index