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UNIT 1

INEQUALITY AND
DEVELOPMENT: CONCEPTS
AND MEASUREMENT

Structure

1.0 Objectives
1 .I Introduction
1.2 Growth, Development and Inequality
1.2.1

Economic Growth

1.2.2 Development
1.2.3 Income lnequalities

1.3
1.4

Inverted-U Hypothesis,
lnequalities - Empirical Findings
1.4. I

lnequalities Across Countries

1.4.2 lnequalities within a Country - India

1.5

Measurement of Inequality
1.5.1

Lorenz Curve

1.5.2 Gini Coefficient

1.6
1.7

Let Us Sum UP
Key Words

1.8 Some Useful BooksIReferences


1.9 AnswersIHints to Check Your Progress Exercises

1.0 OBJECTIVES
After going through this Unit, you should be in a position to:
identify the factors leading to inequalities in income;
explain the link between inequality and development;
a

explain the concept of inverted - U hypothesis; and


measure income inequalities.

1.1 INTRODUCTION
Economic growth has been an important motivator for individuals and policy makers
to debate and initiate policies that would lead to an increase in aggregate national
wealth. We find that economists, policy makers, social scientists and politicians are
driven by the idea of high economic growth fo; countries. Multilateral agencies like
the World Bank and the International Monetary Fund are talking of a fast rate of
economic growth so that people can improve their living standards and make full use
of their capabilities. However, it is observed that in spite of economic growth,
development .of all components of the economy is not taking place. We must start by
understanding the terms like 'growth' and 'development'. These terms are often used
interchangeably, though social scientists have
,
. given different meanings to the two
terms.

S~cietyand Economic
Dwe'Opment:
Hard

Inequality refers to disparities in distribution in income and economic assets of


individuals or households. In an aggregative context it may refer to disparities among
nations in per capita income and standard of living. lnequality has existed always
although its nature, extent and causes have been subjected to debate. The role of the
government and government policies in reducing inequality also is a matter of
disagreement amongst economists. We will discuss some of these issues in the
present unit.

1.2 GROWTH,'DEVELOPMENT AND


INEQUALITY
*
To begin with, let us explain certain concepts and find the difference between them.

1.2.1 Economic Growth


Economic growth implies that the output of goods and services in an economy has
been expanding. This would also entail an increase in the income levels in an
economy. The two concepts of 'national income' and 'per capita income' are used to
analyse the growth levels of various economies. Thus the Chinese economy, which
has been growing at about 10 percent per annum for several years, is performing
better than the Indian economy, which is growing at the rate of about 6 percent per
year. It means that the rate at which an economy is producing goods and services
would determine the level of growth of that economy. There are several theories of
economic growth to explain why some economies grow faster than others.
Economists such as Lientiff, Harrod and Domar have developed theoretical models
to define factors that would lead to stable growth in an economy. These theories
explain that there is a close link between technological change and the capacity to
invest by individuals or governments.

/
L . .

Growth in productive
potential
..........".....I

............ 7

Increase in
stock of factor $
inputs
?

Sburce: C. Pass et al. (1 997)


Fig. 1.1: Determinants of Economic Growth

Fig. 1.1 presents the determinants of economic growth. Economic growth can
materialize, as you know from 'MEC-004: Economics of Growth and Development'.
through two basic means, viz., use of higher quantity of inputs and technological
progress. According to some economists growth process based .on inefficient use of

resources, particularly exhaustible raw materials, is not sustainable in the long run.
Thus an economy should thrive for technological progress.
Labour can influence growth by its quantity and quality. At the macro level, labour
supply can increase due to demographic reasons such as population growth and
higher work participation, or through longer working hours. Labour quality, on the
other hand, can be enhanced by increasing capital investment per labour and by
imparting skill in labour. Similarly, technical advances and innovation can further
enhance overall productivity in an economy. Schumpeter attached a high degree of
significance to innovation in facilitating growth. He argued that in modem capitalist
societies, innovations and technological advances are basic to rapid development and
growth.
The inter-relationships between various factors and processes, however, determine
the pattern and pace of growth in an economy. You may have observed that some
countries have reached high levels of productive capacity, which enhances their
potential to produce goods and services.
There have been attempts to theorize the growth process which can explain the way
societies develop. In 1960s, W.W. Rostow developed a 'stages-of-growth model' of
development with five categories, viz., the traditional society, the pre-conditions for
take-off into self sustaining growth, the take-off, the drive to maturity and the age of
high mass consumption. Developed countries were considered to be in the stage of
self sustaining growth and beyond. The developing countries were considered to be
either traditional societies or working towards pre-take off stage. In order to take off,
these countries needed sufficient investment which could take place only with the
help of domestic and foreign savings. This was further elaborated in the HarrodDomar growth model according to which national savings, and the capital-output
ratio together determine the growth in national income.
Therefore, higher the savings, the higher the rate of GDP growth. Robert Solow,
however, in his growth model argued that economies with similar rates of savings,
depreciation and growth in labour force and productivity will converge to similar
income levels. The growth model developed by Solow yields diminishing returns to
capital and labour. The neoclassical growth models could not explain the differential
growth rates and pattern of growth in underdeveloped countries even when they had
high levels of capital infusion. In practice we observe that the gap between rich and
poor countries is widening. The endogenous growth theory, by emphasizing on
human resource development, has been able to explain the divergence in growth
rates across countries (see MEC-004 for details on growth theories).

1.2.2

Development

The concept of 'development' has wider connotation than the concept of 'growth'.
Economic development refers to the process of economic and social transformation
that takes place in a country or in some parts of the country. Factors like literacy,
levels of income of the population, inequality, and healthcare facilities are taken into
consideration while talking about development. In Block 5 of this course we will
analyze issues related to human resource development in detail.
Economic growth signifies the quantitative dimensions while economic development
refers to qualitative aspects of progress being made. There are several factors which
can improve quality of life. The most important ones are: improvements in literacy
and skill formation, accessibility to basic needs such as food, drinking water, health,
and housing facilities, and availability of infrastructure such as roads, electricity and
communication. Some economists have emphasised both the productive capacity
and the distributional aspects prevalent in an economy. It is, often argued that
economic growth might benefit some groups more and faster thus leading to
divisions in societies. Steep inequality in an economy may stifle the development
process of an economy.

Inequali@ and
Concepts and Measurement

Society and Economic


Deve'opment:
Hard

It is worth mentioninuh-at gmyth can take place without development. It has been
observed that policies of economic growth pursued in the past have not led to
equitable development across countries. Within countries also there have been
pockets of prosperity surrounded by poverty and illiteracy. Three-fourths of the
world's population lives in developing countries. In most of these countries, growth
is confined to small areas, particularly urban centers and some industrial areas. They
most often have a wealthy minority with vast levels of inequality amongst the poor
majority. These inequalities are visible in terms of deprivations of various kinds and
a very low quality of life. It can be said that growth can take place in the absence of
development due to faulty distributional policies.
It is accepted by policy makers that development should be multi-dimensional. It
should lead to eradication of poverty, reduction of inequalities and dismantling of
oppressive social structures. Amartya Sen considers 'capability to function' as an ,
important dimension of development which should imply enhancing the lives people
lead and freedoms they enjoy.

1.2.3 Income Inequalities


Total national income divided by the number of persons in a country gives the per
capita income, which is an average figure of the total income of a country. This
measure does not tell us about how the income is distributed amongst people. It is
generally accepted that increase in productive capacity increases the wealth of a
country. This wealth may not be equitably accessible to the entire population. Hence,
an increase in national income or per capita income does not tell us the real condition
of an average person in society. In other words, policies geared toward economic
growth should enable efficient use of factor inputs so as to increase productivity and 1
supply of goods and services in the economy. At the same time, there is a need to
follow policies that lead to increase in effective demand which will further stimulate
investment. The pattern of demand determines the pattern and magnitude of goods
and services produced in the economy.
\

The pattern of distribution of income in an economy informs us of the likely pattern


of consumption.'Hence, the study of consumption pattern is linked to the study of
incomes and savings. Long term trends in income influence the expenditure pattern.
Extreme inequality in incomes leads to a shift in'the investment behaviour in an
economy. It is interesting to find out how luxury hotels, expensive hospitals and
housing and other such investments have been increasing globally over the years
while investments in primary health care, low cost hotels and housing have been
neglected.
Income inequalities are also further accentuated by other social deprivations that low
income earners experience. They have low level of skills and end up getting
employment in low productivity jobs with low wages. This reduces their chances of
skill up-gradation thereby keeping them in low wage jobs. Low income means bad
housing, negligible health care and bad nutrition. This is then the vicious circle in
which the poor are compelled to live.

Check Your Progress 1


1)

Explain the difference between growth and development.

2)

Why is economic growth essential? Does a rise in national income imply


increased well-being of every person in the economy?

1.3 INVERTED-U HYPOTHESIS


It was argued by Simon Kuznets (1955) that a country's industrialization process in
the initial phases could lead to higher income inequalities. The process gets reversed
as the level of industrialization goes up. Kuznets gave empirical examples from
developed countries to prove his argument. He hypothesized that the relationship
between the level of economic development and income inequality takes the form of
an inverted U-curve. This hypothesis is commonly referred to as the inverted-U
hypothesis and the curve is called the Kuznets' curve. In particular, Kuznets
postulated that the i~itersectoralshifts which occur in,the early stages of economic
development accentuate inequality. However, after reaching certain threshold level
of development, inequality attains its peak and then declines in later stages.
The Kuznets curve is based on empirical findings. Usually Gini coeff~cient
(explained in Section 1.6) is taken as the measure of inequality. When Gini
coefficie~itis plotted against a quadratic function of per capita income we obtain the
Kuzets curve. In Fig. 1.1 we show a hypothettical Kuznets' curve. The possible
reason behind Kuznets curve is that in early stages of development, when investment
in physical capital is the main engine of economic growth, inequality spurs growth
by directing resources towards those who save and invest the most. In more mature
economies, on the other hand, human capital accumulation takes the place of
physical capital accumulation as the main source of growth. Moreover, inequality
impedes growth by hurting education because poor people cannot fully finance their
education.
The Kuznets' curve is extended to other areas including environment. The
environmental Kuznets curve is a hypothesized relationship between various
indicators of environmental degradation and income per capita. In the early stages of
economic growth there is an increase in environmental degradation and pollution, but
beyond some level of income per capita (which will vary for different indicators) the
trend reverses. Consequently, at high-income levels economic growth leads to
environmental imprc~vementand there is decline in the level of environmental
degradation. This implies that the e~ivironmental impact on an indicator is an
inverted U-shaped function of income per capita. Typically the logarithm of the
indicator is modeled as a quadratic function of the logarithm of income.

I
I

Many studies have shown the implications of inverted-U hypothesis. First, high
income inequality may increase absolute poverty which may, in turn, adversely
affect the quality of health, education, nutrition, etc. resulting in poor quality of
human capital. Second, rising inequality in favor of a small minority of the
population may heighten social and political tension and threaten a country's longrun development prospects. With the interaction of economic and political forces,
policy makers may not formulate correct policies to enable long term income
redistribution.

Inequalityand
Concept, and Measurement

Society and Economic


Development: Some Hard Facts

Per capita income


Fig. 1.2: Inverted-U Hypothesis

1.4 INEQUALITIES -'EMPIRICAL FINDINGS


Let us look into some empirical findings on inequality across countries and in India.

1.4.1

Inequalities Across Countries

The level of inequalities across countries is not only high but also increasing rapidly.
It is said that disparities between poor nations and rich nations have increased in the
past two decades. During the 1980s and 1990s, growth in developing countries has
been highly volatile. There was a slow down in growth rates in the 1980s in almost
all the developing countries. Real per capita GDP in most of the developing countries
declined by 0.2% in 1990 and 1991 and there was a slight increase in subsequent
years. The East Asian countries did witness continuous growth in the 1980s but due
to the financial crisis of the 1990s, economic growth in these countries plummeted.
For several developing countries, the 1980s was a lost decade for development. 'In
fact, during the 1980s and early 1990s, the income gap between rich and poor nations
widened at the fastest pace in more than three decades. The impact of this widening
gap is striking' [Todaro and Smith, 20051. The income levels of the richest 20% of
the world's population was 30 times larger than the poorest 20% in 1960. This
income gap had widened to 70 times by 1997 as given in Table I. I .
Table 1.1: Global Income Disparity
( 1960-2000)

Year

Ratio of Income Shares


(Richest 20 per cent to the Poorest 20 per cent)

Source: Todaro and Smijh (2005)


Various international agencies particularly the United Nations and the World Bank
have developed various criteria for classifying countries according to their level of
development. Some of the countries in each category are given below:

High income group

OECD countries, US, UK, Italy, Japan, Germany,


Sweden, Belgium, Denmark

Other high income countries:

United Arab Emirates, Kuwait, Brunei, Qatar,


Cyprus, Slovenia, Singapore, Barbados

Upper income group

Venezuela, Uruguay, Chile, Malaysia, Brazil,


Costa Rica, Turkey, Poland, Saudi Arabia, Oman,

Lower middle income group:

Sri Lanka, Maldives, Guatemala, Guyana,


Colombia, Namibia, Swaziland, Thailand

Low income group

India, Pakistan, Bangladesh, Bhutan, Nepal, Chad,


Indonesia, Cambodia, Afghanistan, Vietnam

Inequality and Development:


Concepts and Measurement

Table 1.2: Income Poverty by Region, Selected Years, 1987-1998


Number of persons living on less than $llday
(in Million)

Region

I East Asia & Pacific 1


Excluding China

1
1 1 14.1 1
I 1.1
41 7.5

Europe and Central


Asia

1
83.5 1
18.3 1

43 1.9

7.1

1
55.1 1

1
65.1 1

265.1

278.3

76.0

78.2

73.8

Latin America & the


Caribbean
Middle East & North
Africa

1
92.0 1

452.4

9.3

5.7

70.8

5.0

5.0

5.5

South Asia

474.4

495.1

505.1

53 1.7

522.0

Sub-Saharan Africa

217.2

242.3

273.3

289.0

290.9

1 183.2

1276.4

1304.3

1 190.6

1 198.9

879.8

915.9

95 5.9

980.5

985.7

Total
Excluding China

1 Percentage of Population Living on less than $1 Per day


Region

1987

23.9

1993

1990

18.5

15.9

I
1998

1996
14.9

25.2

27.6

26.6

East Asia & Pacific

1 Excluding China

10.0

"

15.3
11.3

Europe and Central


Asia

0.2

1.6

4.0

5.1

5.1

Latin America & the


Caribbean

15.3

16.8

15.3

15.6

15.6

p
p
p
p

4.3

2.4

44.9

44.0

Sub-Saharan Afiica

46.6

Total

28.3

Middle East &North


Africa

I South Asia
1

1.9

1.9

42.4

42.3

47.7

49.7

48.5

29.0

28.1

Excluding China
28.5
28.1
27.7
Source: World Development Report 200012001

24.5
27.0

40.0

46.3
24.0

26.2

Society and Economic


Deve'Opment: 'One

Hard Facts

The international poverty line is determined based on income of $1 a day. Based on


that as shown in the above table, nearly a quarter of the global population is living
below $1 a day income level. It is also observed that the estimated number of poor
people remained unchanged and in several instances increased over the period shown
in Table 1.2. The number of people living in absolute poverty in the Sub-Saharan
countries has increased over the period. This is also reflected in the high level of
deprivations globally (Table 1.3).

Table 1.3: Human Health and Education Deprivation in the Developing World,
2001
Nature of human deprivation

People deprived

Lack of access to health services

766 million [I9951

Lack of access to safe water

968 million [I9981

Lack of access to sanitation

2.4 billion [I9981

Children dying before age 5 from preventable causes

1 1 million [I 9981

Underweight children under age 5

163 million [I 9981

People living with HIV/AIDS

34 million [2000]

Illiterate adults

854 million [2000]

Children not in school

325 million [2000]

Source: UNDP, Human Development Report, 200 1

1.4.2 Inequalities within a Country - India


,India is a good example of growth with inequalities. With an average growth rate of
5% and above of GDP, the level of deprivation in terms of nutrition, healthcare and
education is extremely high at more than 50% of the total population not being able
to access reasonable levels of education and healthcare. lndia has pockets of
advanced and modem industry and agriculture. These coexist with large areas of
unorganized industrial sector and subsistence agriculture. lndia has the largest
number of people living on less than $ 1 a day. Persistence of regional disparities in
the country has been highlighted in various studies. Indicators like the proportion of
population below the poverty line, the extent of malnourishment, illiteracy, lack of
healthcarepoint towards high level of inequality in the country. States like Uttar
Pradesh, Bihar, Orissa have not advanced at the same rate as Maharashtra, West
Bengal and the southern states. In all the regions in lndia there are vast differences in
income and living standards.

Table 1.4: Poverty Line in India


(Rupees per capita per mwth)
Year

Rural

Urban

1993-94

21 1.30

274.88

1999-00

327.56

454.1

Source: Planning Commission

Inequality and Development:


Concepts and Measurement

Table 1.5: Poverty Ratio at the State level-Selected States


(per cent)
Rural

1 Andhra Pradesh

1993-93

15.9

Urban
1999-00

11.2

1993-94

38.3

1999-00

26.61

Aruqachal Pradesh

45.0

40.0

7.7

7.5

Assam

45.0

40.0

7.7

7.5

I Bihar

58.2

44.3

34.5

32.9

Gujarat

22.2

13.2

27.9

15.6

Haryana

28.0

8.3

16.4

10.0

Himachal Pradesh

30.3

7.9

9.2

4.6

Jammu & Kashmir

30.3

4.0

9.2

2.0

Karnataka

29.9

17.4

40.1

20.3

I Kerala
1 Madhya Pradesh
I Maharashha

1
1

40.6
37.9

1
1

1
1

37.1
23.7

48.4
35.2

1
'1

38.4
26.8

Meghalaya

45.0

40.0

7.7

7.5

Nagaland

45.0

40.0

7.7

7.5

Rajasthan

26.5

13.7

30.5

19.8

Tamil Nadu

32.5

20.6

39.8

22.1

Uttar Pradesh

42.3

31.2

35.4

1 West Bengal
1 Delhi

40.8

1.9

31.97

2.4

149

16.0

9.4

0.4

37.3

All 1ndh

1
/

1
1

23.6
P ,

9.

Income distribution c a n p studied by analyain&functional income distribution and


the personal income d~stritpion.Functional .distribution of income tells us the
distribution of 'ncome .amozgst factors of production while personal income
distribution re'ers to the level of income distribution amongst individuals or
households. The level of per capita income and the rate of change of personal
incomes provide indications about the level of income inequality in an economy.
Similarly, the average personal income level provides a crude indication of average
welfare, while the level and range of per capita income provides equally crude
indication of speed and direction of change in that welfare. There are different
measurements to study income inequalities in an economic system. Two of the
commonly used measurements are Lorenz Curve and Gini Coefficient.

f.

Society and Economic


Development: Some Hard Facts

1.5.1 Lorenz Cuwe


Lorenz curve is used to study the distribution of personal incomes of a set of
population. The level of the inequality in the distribution of income levels can be
measured by drawing a Lorenz curve. This method was developed by Max 0. Lorenz
in 1905 for showing the distribution of income amongst people. The Lorenz curve is
a graph based on the cumulative distribution of income and shows shows the
proportion of the distribution of income amongst households. The percentage of
households is plotted on the x-axis, the percentage of income on the y-axis (see Fig.
1.1). Thus Lorenz curve is a function of the cumulative proportion of ordered
individuals mapped onto the corresponding cl~mulativeproportion of their income.
The Lorenz curve can also be used to show distribution of assets like land to indicate
the prevailing social inequality.
If all individuals are of the same size, the Lorenz curve is a straight diagonal line (the
line AED in Fig. 1 .I). This line is called the line of equality. If there is any inequality
in size, then the Lorenz curve falls below the line of equality. The total amount of
inequality can be judged by the area AEDF; the larger the area, greater is the
inequality.
percentage of income

(percentage of pupulation)

Fig. 1.3: Lorenz Curve

1.5.2 Gini Coefficient


The Gini coefficient (also called the Gini ratio) gives a summary figure for Lorenz
curve. If we consider the lower traingle (ABD) in Fig. 1.1, the Gini coefficient is
given by the following ratio:
G=

area A BDE
area AFDE

The Gini coefficient was developed to measure the degree of concentration


(inequality) of a variable in a distribution of its elements. The Gini coefficient ranges
between 0 and 1. It assumes a value of zero where all individuals are equal and there
is perfect equality in society. On the other hand, it takes the theoretical maximum of
1 where in an infinite population the income level of every individual except one is
zero. The concept of Gini coefficient provides relatively more precise estimates of
inequality of incomes in a unit of population.
Gini coefficient is used to measure income distribution across states, countries and
rural and urban areas. If the Gini coeff~cientis rising along with increase in GDP, it
denotes that income inequality is increasing. Gini coefficient also denotes the
changes in income levels over a period of time thus indicating income trends as they
emerge over a time frame. The measurement based on Gini coefficient suffers due to

variations in sample size, size of countries and non monetary benefits received by
some sets of population which cannot be easily quantified.

Check Your Progress 2


1)

Explain the inverted-U hypothesis.

...............................................................................................

'

2)

Explain the concept of Lorenz curve. How do you obtain Gini coefficient from
it?

3)

Write short notes on the following:


i)

Inequalities across countries

ii)

Inequality in India

1.6 LET LTS SUM LIP


In this unit, we have been introduced to the concept of growth and development.
We have also analysed the limitations of GNP as an indicator of growth. Growth has
bee11explained as an indicator of the level of national income or the output produced
in a country. Development denotes a wider expression, which covers other indicators
like access to education, healthcare and other quality of life.
We have also covered the concept of inverted U Hypotheses as developed by
Kuznets. Information about inequalities across countries has been provided in the
unit. Regional variation and inequalities within India have also been covered. We
have also been introduce to the measurement of inequalities with the help of
concepts like Lorenz Curve and Gini Coefficient. It has been explained in the lesson
that there are persisting income inequalities in developed and the developing
countries. As a case study, it has been explained that there are regional variation in
economic growth of various states in India. Therefore, the level of poverty is also
regionally varied.

1.7 KEY WORDS


Development

It is a wider concept which also looks at the changes


in the quality of life of the people as a result of
changes in national income.

Inequality and
Concepts and Measurement

Society and Economic


Development: Some Hard Facts

Inequality

. -

It represents a situation where income is not


distributed equally amongst people.

Kuznets' curve

It represent a hypothesishich argues that in the


initial phase of economic growth, inequalities will rise
and decline subsequently.

Gini Coeff~cient

It is given by a pure number ranging between 0 to I . A


greater value of Gini coefficient implies higher
inequality.

1.8 SOME USEFUL BOOKSJREFERENCES


Kapila, Uma, 2003, Indian Economy Since Independence Academic Foundation,
New Delhi.
Kindelberger, ~ h a r l e sP. and Bruce Herrick (eds.), 1977, Economic Development
McGraw Hill.
Kumets, S., 1955. Economic Growth and Income Inequality, American Economic
Review, vol. 49.
Mukherjee, S., 2005, Modern Economic Theory, New Age International, New Delhi.
Panayotou, T., 1997, DemystifLing the Environmental Kuznets Curve: Turning a
Black Box into a Policy Tool, Environment and Development Economics, vol. 2.
Pass, C. et al, 1997, Business and Macroeconomics, International Business Press.
Todaro, Michael and Stephen Smith, 2005, Economic Development, Pearson
Education, London.

1.9 ANSWERSIHINTS TO CHECK YOUR


PROGRESS EXERCISES
Check Your Progress 1
1)

See Section 1.2 and answer.

2)

See Section 1.2 and answer.

Check Your Progress 2

1)

See Section 1.3 and answer.

2)

See Section 1.5 and answer.

3)

See Section 1.4 and answer.