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INCOME INEQUALITY AND ECONOMIC GROWTH

How income inequality causes economic growth

ARDHI UNIVERSITY SCHOOL OF URBAN AND REGIONAL PLANNING BACHELOR OF ARTS IN ECONOMICS EC 361: CONTEPORARY ISSUES AND ECONOMIC DEVELOPMENT ASSIGNMENT 5221/T.2012, MABELLA, MARIA.M Question : How income inequality causes economic growth? Discuss with empirical evidence. All sciences should be aimed at providing humanity with a better quality of life. According to Adam Smith (1884), no society can be flourishing and happy, of which the far greater part of the members are poor and miserable. During 1970s, in Developed World there was a growing concern with the quality of life and which was manifested in protests against the consequences of Economic Growth such as pollution and depletion of natural resources. In Developing countries the main concern was focused on the relationship between Economic Growth and Income Distribution since many countries that had experienced Growth rates above their historical standards realized that such growth seemed to have negatively affected the income distribution leading to increased income inequality and failure to eliminate, even reduce the level of Poverty (Todaro1994). Income inequality is a state of an economy in which the shares of the total income earned by the rich and poor are highly unequal while Economic Growth is the quantitative increase the goods and services in the economy (United Nation Human Development Report,2007). Economic growth does not take in to the account the standard of living of the society as Economic development does. Different scholars tried to explain how Income Inequality causes Economic Growth as follows: According to Colman and Nixson (1988), the Lewis Model gives the support to the argument the increasing inequality is not only an inevitable effect of Economic Growth, but also a necessary condition for Growth. The basic argument is that Savings are essential to increase productive capacity which leads to higher rates of growth, the reason why income must be redistributed towards the groups that save and invest – the rich- in order to ensure capital accumulation and growth. Therefore, an economy with a high concentration of income by the upper groups is more likely to grow faster than one with a more equitable distribution of income. This is the pro-inequality argument. However, in line with Kuznets (1955) warning, in a Developing Countries context there are no guarantees that the higher income groups will save a significant proportion of their income in their own country .According to Todaro (1994), unlike the historical experience of the now Developed countries, the rich in Developing countries are characterized by spending in Luxury Consumption (usually imported) and saving abroad. This author also challenges the pro inequality argument pointing out that highly unequal distribution of income is manifested in poor health, nutrition, housing and education for the vast majority of the population, which in turn lead to low levels of productivity and thereby to slower growing economy, while the redistribution of income to lower income groups would stimulate demand for home production, since the rich tend to spend more of their additional income on imported goods. Rising demand for local goods provides a greater stimulus to local production, local employment and local investment. Such demand thus creates the conditions for rapid economic growth and a broader popular participation in that growth. In general, income inequality may cause economic growth as tried to be explained above by different scholars. Though, there is no a clear answer to whether the Economic Growth causes Income Inequality or is it the Income Inequality that causes Economic Growth. In the world, different scholars are still debating on the causality of income inequality and economic growth. References: Koske.I, Fournier.J.M and I. Wanner (2012), “Less Income Inequality and More Growth – Are they compatible? part 2. The Distribution of Labor Income”, OECD Economics Department Working Papers, No.925 OECD Publishing. Kuznets. S.(1955) , Economic Growth and Income Inequality: The American Economic Review. V45(p1-28). Todaro M. (1994), Economic Development , 5th edition, Longman Group. Colman.D & Nixson.F. (1988), Economics of Change in Less Developed Countries, 2nd edition, Phillip Allan Publishers Limited, Oxford.