Ebook Growth and Inequality: Evidence from Transitional Economies
The relationship between income inequality and economic growth has received much attention in the economic literature. The impact of economic development on income inequality, however, remains ambiguous. Even if found to be significant in the univariate regressions of income inequality on economic development, the parameter estimate on aggregate income, a proxy for the level of development, loses its strength and can even reverse sign when other explanatory factors or country-specific dummies are introduced (Deininger and Squire, 1998).
However, a common trait of the previous studies linking income inequality and economic growth is that they concentrated primarily on what happens to income distribution during the process of development, that is of rising per capita income. In contrast, the countries of Eastern Europe (EE) and the former Soviet Union (FSU) witnessed a sharp contraction in output during the initial stage of the transition. Another pronounced feature of the transition has been a marked increase in income inequality, though, not at a uniform rate across the region. In many transitional economies inequality has reached a level comparable to that seen in highly unequal countries of Asia and Latin America.
These developments in transitional countries pose many intriguing questions. What is the role of economic decline (and recovery) in the changing income distribution? What specific factors lie behind a noticeable increase in income inequality over the transition? How well do the same factors explain the changes in inequality across different counties?
We aim at suggesting answers to these questions in this paper using a unique panel of inequality estimates constructed for 24 transitional countries of EE and the FSU and embracing the period from 1989 to 1998. The fact that the combined population of these countries exceeds 400 million people makes the understanding of the factors driving the changes in income distribution go far beyond a purely research interest. Although it is often argued that policy makers should be more concerned about absolute poverty than income inequality, there are several reasons why one may (or should) care about the latter as well. At a given rate of economic growth, more unequal distribution of income would be associated with a lower rate of poverty reduction, assuming, of course, that the poor participate fully in sharing the gains from growth. Moreover, as suggested in a great many studies (e.g., Alesina and Rodrik, 1994; Birdsall et al., 1995; Deininger and Squire, 1998; Persson and Tabellini, 1994; Sylwester, 2000; Easterly, 2001), an unequal income distribution might itself be detrimental to long-run economic growth for a variety of reasons. The most common arguments for high income inequality to deter growth are that an unequal distribution of income creates pressure for re-distributional policies, and hence distorts incentives for working and investing; that it leads to abuse of power by the elite and to sociopolitical instability and, thus, harms the investment environment; and that, in the presence of imperfect capital markets, it reduces opportunities for accumulating human capital (such as education and health) and physical assets. From a social welfare point of view, it has also been argued that both utilitarian and non utilitarian views of welfare suggest that income inequality reduces aggregate well-being. The above considerations seem to leave no doubt that inequality indeed matters, and in our paper we investigate which factors underlie the trends in inequality observed in transitional economies.
There is a growing amount of research which attempts to explain the rise in income inequality during the transition. Many existing studies try to figure out the possible factors behind the changes in the distribution of income using either theoretical models of transition (Aghion and Commander, 1999; Ferreira, 1999; Milanovic, 1999), or a Gini decomposition analysis (by income component or recipient) applied to a single country or a set of countries (Garner and Terrell, 1998; Milanovic, 1999; Yemtsov, 2001). Yet a third approach employs cross-country regressions to examine why income inequality is different across countries at a given point in time (the World Bank, 2000).
This paper represents the first attempt to study an inter-temporal relationship between income inequality and economic development for a broad set of transitional economies using panel data analysis. The focus of the empirical analysis is therefore to identify factors underlying changes in income inequality over time within countries rather than to explain differences in inequality levels across countries. Up to now a lack of compatible time series data with sufficient area coverage ruled out the possibility of doing this, and we undertake the task using the assembled panel of inequality estimates comparable over time and across countries. We use panel data estimation methods to control for unobservable country-specific effects that result in a missing-variable bias in cross-sectional studies.
The striking economic decline at the start of the transition might be one explanation of rising inequality. This decline was associated with dramatic and heterogeneous shocks to real incomes, a collapse in government revenues and the real value of social transfers, and other developments in social and economic conditions. However, even if significant in explaining inequality, the general level of economic development per se does not essentially explain many of the changes in the distribution of income. There have been profound region-specific economic and political changes during the transition that could have had a strong impact on inequality. Therefore, in this paper we are not constrained to investigate the relationship between income inequality and per capita GDP only, but go a step further and try to identify more specific determinants of changes in income distribution.
The remainder of the paper is structured as follows. In Section II we present some evidence on the evolution of income inequality and economic growth during the transition. Section III discusses potential determinants of rising inequality in transitional countries with a reference to existing literature. Section IV describes the data used in the empirical analysis. Section V is devoted to model specification and description of the estimation technique. Section VI describes regression results. In Section VII we examine the robustness of results. Section VIII offers a conclusion and presents some policy implications of our findings.
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