Desperately Seeking Kuznets

Kevin Albertson

What goes up …

In 1955, the economist Simon Kuznets[1] put forward the hypothesis that, as an economy develops, market forces first increase, then decrease inequality – or at the least, that is what many suppose his hypothesis to be.

Kuznets’ analysis considered data from the USA, the UK and Germany, and he concluded that there were two drivers of increasing inequality – the concentration of savings in the upper income brackets (in other words, the wealthy can afford to save, and therefore invest more than the vulnerable) – and the disparity in incomes between urban and rural workers. However, Kuznets argued, as an economy develops inequality will eventually decrease. This postulated inverted “U” shape became known as the Kuznets Curve.

 photo Kuznets_zpsbdsqjobs.jpg

Other economists have similarly argued a Kuznets’ style effect in pollution[2], a so-called Environmental Kuznets Curve. This hypothesis suggests poor nations have no alternative but to increase, for example, green-house gas emissions as they industrialise. However, as they become more wealthy, nations can afford to “invest” in a cleaner environment; therefore emissions will stabilise and decline.

Kuznets’ original analysis appears to justify the speculation of Adam Smith[3] who argued:

They [the rich] are led by an invisible hand to make nearly the same distribution of the necessaries of life, which would have been made, had the earth been divided into equal portions among all its inhabitants

and the monetarist economist Milton Freidman[4] who speculated:

the free market system distributes the fruits of economic progress among all people

What goes down …

Others beg to differ from this optimistic point of view. Winston Churchill, for example, wryly commented[5]

The inherent vice of capitalism is the unequal sharing of blessings

Mind you, that not mean we should dispense with capitalism; as he also noted:

the inherent virtue of socialism is the equal sharing of miseries.

Recent evidence is rather on the side of the naysayers. Rather than an inverted “U” shape, in the English speaking world at any rate, there is evidence that inequality first declined then increased over the last century. (Those readers of a New Zealand persuasion might like to speculate what happened in 1999 which might have disrupted this trend).

 photo Ushape_zpscsk0u4k9.jpgSource: Max Roser (2015) – Income Inequality. Published online at OurWorldInData.org.

Similarly, while there is some evidence nations are relatively less focussed on heavy industry as they become more affluent, however on a world scale affluent nations cause more pollutants to be emitted (per capita) than poorer nations[6], there is no significant evidence of an Environmental Kuznets Curve. In general developed nations are relatively successful in out-outsourcing their carbon footprint (that is, relocating polluting industries to less well developed nations): this is, of course, not the same as reducing their carbon footprint.

The externalities of growth

It would seem that economic growth is no panacea to the problems the free-market produces. This is because pollution and inequality are what economists would call negative externalities; unwanted side-effects of otherwise desirable activity. Simple economic theory shows, where a market produces externalities, that market fails to be efficient and may even become unsustainable.

In the same way that global pollutants can build to a point where the world eco-system is endangered because there is no corrective mechanism inherent in the market, so inequality can increase to the point where the world economy is endangered. This is the point we have reached, according to analysis by economists at organisations such as the OECD, the IMF and the World Bank. In short, economic sustainability and growth is jeopardised as inequality increases. The UK economy, for example, grew at an average annual rate of 3% in the three decades ending 1978, compared with only 2·6% per year in the three decades ending 2008. Average annual growth since 2008 has been even less impressive.

From economy to political economy

We come, however, to praise Kuznets, not to bury him. The unforeseen increase in inequality does not disprove his hypothesis, merely the interpretation that some commentators put on it. Kuznets did not suggest it was solely economic forces which reduced inequality, but rather political-economic forces. For example, as nations prosper, workers unionise, and demand that government acts to reduce the externalities (including inequality) which arise from capitalist industrialisation. In democratic nations, voters may likewise pressure their representatives to ensure the benefits of growth do not accrue disproportionally to the economically powerful.

It may well be that the events of the 1980s, the decade which saw inequality reverse its decline and begin once again to increase, were triggered not by economics, but rather by political change. At this time many Western nations adopted policies based on what is sometimes called the Washington Consensus (sometimes also known as monetarism or neo-liberalism). It should be noted that, in their original form, many of the policy prescriptions of the Washington Consensus made good economic sense. Over time, however, those policy prescriptions tended to emphasise limiting the power of democratic governments.

As Western governments sought to limit their own powers (and, to limit the power of trades unions), so the democratic check on the increase in inequality became undermined; the drivers of the downwards part of Kuznets’ postulated curve were removed and inequality once again began to increase. Conversely, those nations which tended rather to emphasise the social-democratic role of government were less likely to see an increase in inequality. It is worth noting that many of these nations began the 20th century with even more unequal distributions than the UK.

 photo Lshape_zpsemwb9gvj.jpgSource: Max Roser (2015) – Income Inequality. Published online at OurWorldInData.org.

In sum

Increasing inequality, like environmental degradation, is an unfortunate side effect of economic growth. This does not mean we have to put a stop to growth. However, economic growth, on its own, is not the answer to the problems it creates. If our economy is to deliver sustainable prosperity, we must find the political will to address these side-effects, as many nations did prior to the adoption of neo-liberal policies in the 1980s.

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1  Kuznets, S. (1955) Growth and Income Inequality, The American Economic Review, 45(1), 1-28

2  Grossman, G.M., and Krueger, A.B. (1991) Environmental impacts of a North American free trade agreement (No. w3914). National Bureau of Economic Research

3  Smith, A. (1759) The Theory of Moral Sentiments, 6th ed. (1790), London: A. Millar. Available at http://www.econlib.org/library/Smith/smMSCover.html

4  Friedman, M. and Friedman, R. (1980) Free to choose: A personal statement, Harcourt Brace Jovanovich

5  Churchill, W. (22 October 1945) Demobilisation, speech in the House of Commons. Available at http://hansard.millbanksystems.com/commons/1945/oct/22/demobilisation#column_1703

6  Peters, G.P., Minx, J.C., Weber, C.L., & Edenhofer, O. (2011). Growth in emission transfers via international trade from 1990 to 2008, Proceedings of the National Academy of Sciences, 108(21), 8903-8908.

A version of this blog previous appeared on the MetroPolis website.

Please note that blog posts do not necessarily represent the views of other authors on the blog or of the Manchester Metropolitan University

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