Proo F: Economic Inequality and Its Socioeconomic Impact

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World Development Vol. xx, No. x, pp. xxx–xxx, 2002

Ó 2002 Published by Elsevier Science Ltd.
Printed in Great Britain
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PII: S0305-750X(02)00052-9
Economic Inequality and Its Socioeconomic Impact
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3 ERIK THORBECKE and CHUTATONG CHARUMILIND *
54 Cornell University, Ithaca, NY 14853, USA
Summary. — Income inequality is of fundamental interest not only to economists, but also to other
social scientists. A substantial literature in economics and the social sciences has investigated the
relationship between income inequality and economic growth, and a variety of social phenomena.
The links between inequality and economic growth are explored as well as those between inequality
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and such key social variables as political conflict, education, health, and crime. The analysis in this
paper follows a two-step process. First, a review of the empirical evidence relating inequality to
growth and to each of the above social variables is undertaken. Second, the various causal
mechanisms that have been proposed in the social science literature to explain those links are
surveyed. Ó 2002 Published by Elsevier Science Ltd.
Key words — inequality, income distribution, growth, education, health
1. INTRODUCTION
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gested to explain how inequality affects growth.
Section 4 discusses the relationship between
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18 Income inequality is of fundamental interest income inequality and democracy, social con- 53
19 not only to economists, but also to other social flict, and political instability––again, through 54
20 scientists. A substantial literature in economics an empirical and theoretical lens. Sections 5 55
21 and social sciences has investigated the rela- and 6 analyze the effect of income inequality on 56
22 tionship between income inequality and eco- education and health respectively. Finally, 57
23 nomic growth, and a variety of social Section 7 scrutinizes the relationship between 58
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24 phenomena. There are several channels income inequality and crime. 59

25 through which economic inequality influences
26 these phenomena. In this paper, we attempt to
27 crossdisciplinary boundaries––from economics
2. WORLDWIDE AND
28 to such fields as political science, sociology,
WITHIN-COUNTRIES DISTRIBUTIONS
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29 psychology, criminology, and public health. We

OF INCOME
30 explore the links between inequality and eco-
31 nomic growth, as well as between inequality
(a) Worldwide income distribution
32 and such key social variables as political con-
33 flict, education, health, and crime. The analysis
A first relevant issue relates to the extent of 64
34 in this paper follows a two-step process. First, a
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inequality among different countries and geo- 65

35 comprehensive review of the empirical evidence
graphical regions of the world––particularly 66
36 relating inequality to growth and to each of the
between developed and developing countries. 67
37 above social variables is undertaken. Second,
Table 1 presents the income distribution across 68
38 we survey and attempt to synthesize the various
countries and regions in 1999 with GNP mea- 69
39 causal hypotheses and mechanisms that have
sured at purchasing power parity (PPP). The 70
40 been proposed in the social science literature
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first noteworthy observation is the large in- 71

41 (particularly by economists) to explain the ob-
equality between the advanced industrialized 72
42 served relationships between inequality and
world (the United States, Japan, and Western 73
43 those socioeconomic variables.
Europe) and the rest of the world. The former 74
44 The paper is structured as follows. Section 2
received 49.55% of the world’s income with 75
45 reviews the evidence on the extent and form of
only 12.81% of the world’s population. Thus, 76
46 inequality in the worldwide distribution of in-
approximately one-half of global income went 77
47 come as well as within countries. Section 3
to the richest one-eighth of the global popula- 78
48 presents the empirical evidence relating income
49 inequality and economic growth and the vari-
50 ous causal mechanisms that have been sug- * Final revision accepted: 22 April 2002.
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Table 1. World income distribution in 1999

Country Population % of World GNP at PPP % of World GNP per capita at PPP
(millions) population (billions of dollars) GNP (thousands of dollars)
US 273 4.57 8,350.1 21.52 30.6
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Japan 127 2.13 3,042.9 7.84 24.0
Western Europe 365 6.11 7,834.2 20.19 21.5
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Low and middle income countries
East Asia and 1,837 30.74 6,423.8 16.55 3.5
Pacific
Europe and 475 7.95 2,654.1 6.84 5.6
Central Asia
Latin America and 509 8.52 3,197.1 8.24 6.3
Caribbean
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Middle East and 291 4.87 1,337.5 3.45 4.6
North Africa
South Asia 1,329 22.24 2,695.0 6.94 2.0
Sub-Saharan 642 10.74 929.3 2.39 1.4
Africa
Low and middle 5,084 85.09 17,323.9 44.64 3.4

income
High income
World
891
5,975
14.91
100.00
Source: World Bank (2001), World Development Report. D
21,763.4
38.804.9
56.68
100.00
24.4
6.5
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79 tion. Sub-Saharan Africa has the lowest GNP (iii) ‘‘True’’ world inequality
80 per capita (US$1400), compared with a GNP This third indicator treats every individual 109
81 per capita in the US of US$30,600. the same, regardless of the country, and ranks 110
82 We turn next to a dynamic analysis of the each individual from the poorest to the richest. 111
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83 changes in inequality in the worldwide income In other words, this measurement ignores 112
84 distribution. We begin by looking at different country boundaries, but includes within-coun- 113
85 world income inequality indicators; according try inequality and is therefore a much more 114
86 to Milanovic (2001), there are three such con- accurate reflection of the true (actual) global 115
87 cepts that need to be discussed: distribution of income. The data for this indi- 116
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cator come from national household surveys. 117

(i) Unweighted ‘‘inter-national’’ inequality We can now present the changes in the world 118
89 The unweighted inter-national inequality income inequality according to each of the 119
90 uses GDP per capita from national accounts as three indicators as follows: 120
91 the source of data. This indicator disregards
92 country size and within-country inequality. It ––Unweighted inter-national inequality in- 121
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93 compares representative individuals across creased during 1950–98. The Gini coefficient 122
94 countries in the world, and attempts to see if steadily rises from about 0.45 in 1978 to 123
95 countries are converging in terms of their in- about 0.53 in 1998 (see Milanovic (2001) 124
96 come levels. The mathematical form of this Figure 4, p. 21). This indicates a divergence 125
97 indicator and other indicators discussed next in economic performance between the poor 126
98 are given in the Appendix A. and the rich countries. Indeed, for 1950–98, 127
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rich countries grew faster than poor coun- 128

(ii) Population weighted inter-national tries; some of the latter, for example, were 129
inequality plagued by slow and/or declining growth 130
101 Similar to the first concept, this indicator rates in the 1980s (Latin America and Afri- 131
102 uses data on GDP per capita from national can countries). 132
103 accounts. In this instance, however, countries ––Weighted inter-national inequality fell 133
104 are weighted by their population size. As in the over 1965–98. The Gini coefficient drops 134
105 first measurement above, it is assumed that from 55.6 to 50.1 over this period (see Mila- 135
106 within-country income distribution is perfectly novic (2001) Figure 7, p. 30). Together with 136
107 equal. the previous result from the first inequality 137
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ECONOMIC INEQUALITY 3
138 measure, this reveals that the changes in world income received by the richest 10% of the 166
139 world population shares of the poor and world population relative to that received by 167
140 the rich countries push the weighted inter- the poorest 10% increased from 52:1 in 1988 to 168
141 national inequality down. The drop in the 64:1 in 1993 (the ratio between the average in- 169
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142 Gini coefficient for this indicator is driven come of the world top 5% to that of the bottom 170
143 among other things, by China’s remarkable 5% rose even more from 78 to 1 in 1988 to 114 171
144 pace of economic growth. Accounting for to 1 in 1993). 172
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145 0.22 in world population share, the ratio of A dramatic illustration of worldwide income 173
146 China’s GDP per capita to that of the world inequality is that the top 10% of the US pop- 174
147 increased from 0.14 in 1965 to 0.56 in 1998. ulation receives an aggregate income equal to 175
148 ––As shown in Table 2, the true world in- the income of the poorest 43% of people in the 176
149 come distribution (by far the best indicator world, or differently stated, total income of the 177
150 of world income inequality) based on house- richest 25 million Americans is equal to the 178
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151 hold surveys of 91 different countries, shows total income accruing to almost two billion 179
152 an increase in inequality (as measured by the people (Milanovic, 1999). 180
153 Gini index) from 62.8 in 1988 to 66.0 in In sum, the level of world income inequality 181
154 1993. The most important force driving this is high, and there has been a steady increase in 182
155 income inequality is the increasing disparity world income inequality. There is no strong 183
156 between countries’ mean incomes rather evidence supporting any trend towards greater 184
157 than within-countries’ inequality. The evi- income equality across countries. 185
158
159
160
dence also suggests that inequality measures
within countries are relatively stable over
time.
D (b) Within-country income inequality
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The degree of income inequality varies sig- 187
161 One of the main reasons for the rise in true nificantly from one country to another. Gini 188
162 world inequality during 1988–93 is the widen- coefficients of intracountry income distribu- 189
163 ing income gap between the rich and the poor tions range between 0.2 and 0.63 (World De- 190
164 countries, which is picked up by the first mea- velopment Report, 2001). The Slovak Republic, 191
165 surement. As shown in Table 3, the ratio of the
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Belarus, Austria and the Scandinavian coun- 192

tries have the most equal income distributions, 193
Table 2. World income inequality in 1988 and 1993 with Gini coefficients ranging between 0.20 and 194
Gini index Gini index 0.25. At the opposite end, Sierra Leone, South 195
in 1988 in 1993 Africa, Brazil, Guatemala and Paraguay dis- 196
play the highest Gini coefficients between 0.60 197
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Within-country inequality 1.3 1.3

Between-country inequality 55.1 57.8
and 0.65. The US income distribution is rela- 198
Overlap 6.4 6.8 tively less even than in most Western European 199
Total world inequality 62.8 66.0 countries, i.e., a Gini of 0.41 (see Table 4). 200
Number of countries in the 91 91 Another measure of economic inequality is 201
sample the ratio of the richest 10% to that of the 202
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Source: Milanovic (1999). poorest 10%. This ratio varies from about 5.5 203
Table 3. Cumulative percentage of persons and income Table 4. Significant differences income inequality within
Cumulative countries
Cumulative percentage of
percentage of World world income Countries Gini Ratio of richest
population (%)
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coefficient 10% to poorest

1988 1993 10%
Bottom 10 0.9 0.8 Belgium, Denmark, 0.25 5.3–5.7
Bottom 20 2.3 2 Norway, Sweden (1992)
Bottom 50 9.6 8.5 UK (1991) 0.36 10.5
Bottom 75 25.9 22.3 US (1997) 0.41 16.9
Bottom 85 41 37.1 Brazil, Guatemala, Para- 0.60 42.5–48.7
Top 10 46.9 50.8 guay, South Africa (1997)
Top 5 31.2 33.7 Sierra Leone (1989) 0.63 87.2
Top 1 9.3 9.5
Source: World Bank (2001), World Development Re-
Source: Milanovic (1999). port.
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Table 5. Inequality comparisons of selected middle-in- tant determinant of economic growth (less in- 237
come countries equality is conducive to higher growth). The 238
Measure Poland Malaysia Venezuela Brazil South empirical and theoretical evidence on the effects 239
Africa of income inequality on growth are investigated 240
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GNP per 3,960 3,400 3,670 4,420 3,160 in this section. 241
capita The outline of this section is as follows. In 242
(US$1999) the empirical section, we start by examining the 243
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Gini index 32.9 48.5 48.8 60.0 59.3 conventional wisdom regarding the effect of 244
% Share of 7.7 4.5 3.7 2.5 2.9 income inequality on economic growth. Until 245
income of recently, conventional wisdom claimed that 246
poorest
20%
inequality was growth-enhancing. Due to the 247
% Share of 3.0 1.8 1.3 0.9 1.1 increased availability of micro-level household 248
income of survey data, however, the recent literature has 249
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poorest re-examined the interactions between inequality 250
10% and growth. Figure 1 depicts the channels 251
Source: World Bank (2001), World Development Re- through which income inequality can affect 252
port. growth. 253
The various channels depicted in Figure 1 are 254
analyzed in detail in the subsequent Section 255
204 in Scandinavia to 87 in Sierra Leone. The UK 3(c). Very briefly, Panel A in Figure 1 reflects 256
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(10.5), the US (17), and Brazil (45) occupy in-
termediate positions within the above range
(see Table 4).
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the classical view that prevailed until recently.
A higher presumed marginal propensity to save
among the rich than among the poor implies
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208 It is interesting to observe that some middle- that a higher degree of initial income inequality 260
209 income countries with relatively similar GNP will yield higher aggregate savings, capital ac- 261
210 per capita (Poland, Malaysia, Venezuela, Bra- cumulation and growth. In contrast, Panel B 262
211 zil, and South Africa), are characterized by very summarizes the mechanisms that have been 263
212 different degrees of inequality. Table 5 reveals proposed in the recent literature in linking 264
213 that the Gini coefficients of Brazil and South higher initial income inequality with lower 265
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214 Africa are much higher than those of Poland growth and conversely. There are four main 266
215 and Malaysia, as are the other indicators in- channels (paths): (i) through the impact of in- 267
216 cluded in that table. come inequality on encouraging (unproductive) 268
rent-seeking activities that reduce the security 269
of property rights; (ii) through social tensions 270
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3. INCOME INEQUALITY AND and political instability that increase uncer- 271
ECONOMIC GROWTH tainty and discourage investment; (iii) high in- 272
equality is likely to be reflected in a relatively 273
(a) Overview poor median, representative voter who will seek 274
redistribution through taxation that, in turn, 275
220 Most of the economic literature on the rela- will bring about further distortions in the 276
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221 tionship between income inequality and eco- economy; and conversely in (iv) a more equal 277
222 nomic growth has its origin in the path- initial income distribution implies a greater in- 278
223 breaking work of Kuznets (1955). In his ‘‘income share accruing to the middle class that is 279
224 verted-U’’ hypothesis, Kuznets suggested that likely to reduce fertility and population growth. 280
225 economic growth (i.e. a rise in average per Galor (2000) made an attempt to reconcile 281
226 capita income) can initially lead to a rise and these conflicting approaches (see Panel C). The 282
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227 then fall in income inequality within a country. essence of his ‘‘unified model’’ is that the clas- 283
228 Since then, however, much evidence has been sical approach holds at low income levels but 284
229 accumulated against this hypothesis. For in- not at later stages of development. 285
230 stance, using a large-scale crosscountry and
231 time-series data set, Deininger and Squire (b) The effect of income inequality on economic
232 (1996) find no confirmation of the inverted-U growth: empirical evidence
233 Kuznets curve, but rather a significant rela-
234 tionship between initial income inequality and Until recently, the conventional wisdom was 288
235 subsequent growth. Hence, they find that the that inequality is growth-enhancing. The main 289
236 initial level of income inequality is an impor- reason for this was that the presumption that 290
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Figure 1. The channels through which inequality affects growth.

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6 WORLD DEVELOPMENT
291 the rich have a higher marginal propensity to run growth, and the magnitude of the effect is 347
292 save than the poor. Greater inequality would that a one standard deviation decrease in in- 348
293 therefore result in greater aggregate savings and equality raises the annual growth rate of GDP 349
294 investment, and hence would lead to rapid per capita by 0.5–0.8% points. On the other 350
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295 capital accumulation and growth. hand, Barro (1999) using a three-stage least 351
296 Most of the early empirical literature based squares estimator which treats the country- 352
297 on household micro-data supports this con- specific terms as random, finds that the effect of 353
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298 ventional wisdom on the positive relationship inequality on growth is negative in poor coun- 354
299 between inequality and personal saving (e.g., tries (GDP per capita below or around US$ 355
300 Houthakker, 1961; Kelly & Williamson, 1968). 2000 at 1985 prices), but is positive in rich 356
301 On the other hand, based on crosscountry ag- countries (GDP per capita above US$ 2000 at 357
302 gregate data, evidence on the effect of inequal- 1985 prices). Banerjee and Duflo (2000), how- 358
303 ity on aggregate saving is more mixed. Cook ever, find that a country’s rate of economic 359
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304 (1995), using data from 49 less developed growth follows an inverted U-shaped function 360
305 countries (LDCs) found that inequality has a of lagged inequality. 361
306 positive effect. But, recent empirical work by Why is the conventional wisdom regarding 362
307 Schmidt-Hebbel and Serven (2000) using both the positive effect of inequality on growth 363
308 cross-section and panel data, provides no con- contradicted by the recent empirical evidence? 364
309 clusive evidence that income inequality fosters Is there other empirical evidence for such an 365
310 high aggregate savings. Smith (2001), using the association besides the saving behavior of 366
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Deininger and Squire (1996) data set, examines
empirically two hypotheses––subsistence con-
sumption and credit market imperfections––of
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households? The following empirical evidence
regarding this effect incorporates political in-
stability, voting behavior, and uncertainty over
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314 specific channels for inequality to affect private property rights. 370
315 saving rates. He found that there is econometric Alesina and Rodrik (1993, 1994) and Persson 371
316 evidence that even at low average per capita and Guido (1994) estimate a negative, reduced- 372
317 income (where the average is below the sub- form effect of income inequality on investment 373
318 sistence level but where at least some individ- and growth rates through the political process. 374
319 uals are above the subsistence level), income Alesina and Rodrik (1996), using a Gini coef- 375
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320 inequality is associated with higher aggregate ficient of income and land distribution to 376
321 savings––a finding at variance with the modern measure income and wealth distribution, en- 377
322 view. Perhaps a more relevant finding is that dogenize economic and political variables in a 378
323 inequality only affects private saving rates in two-equation system and test it on a sample of 379
324 countries with low levels of financial market 71 countries. Their results suggest a negative 380
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325 development. This means that ‘‘when (poor) effect of inequality on political stability, as well 381
326 individuals cannot borrow against future in- as a negative effect of political instability on 382
327 come, the initial distribution of income affects investment. They also argue that these results 383
328 physical and human capital accumulation and coincide with the experience of the East Asian 384
329 economic growth.’’ ‘‘miracle’’ countries, which have had relatively 385
330 There are also definitional issues that cloud more political stability and much less inequality 386
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331 the distinction between consumption and sav- compared to that of Latin American countries 387
332 ings. This is particularly true at low income at similar income levels. 388
333 levels where many forms of apparent con- Using crosscountry data, Svensson (1998) 389
334 sumption such as food, health and education finds that after controlling for the quality of 390
335 make the worker more productive and should property rights, the measures of political in- 391
336 therefore be considered more appropriately as stability employed in his regressions have no 392
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337 forms of savings-cum-investment. direct effect on private investment. Keefer and 393
338 In fact, most of the recent empirical evidence Knack (2000), using the five indicators pro- 394
339 regarding the effect of inequality on growth posed by the International Country Risk Guide 395
340 contradicts the conventional wisdom. Benabou for measuring the extent of property rights: (i) 396
341 (1996a,b) summarizes the main results from 23 expropriation risk, (ii) risk of repudiation of 397
342 recent studies on the effects of inequality on contracts by government, (iii) rule of law, (iv) 398
343 growth based on cross-sectional ordinary least quality of the bureaucracy, and (v) corruption 399
344 squares (OLS) covering a variety of countries in government, as well as Gini coefficients for 400
345 and periods in time. He concludes that initial income and land inequality from the Deinin- 401
346 inequality is negatively correlated with long- ger–Squire data set also find that the relation- 402
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403 ship between inequality and growth diminishes The Stone–Geary representative household’s 456
404 considerably after controlling for the security utility function takes the form: 457
405 of property rights.
406 Perotti (1996) finds that a greater income uðcÞ ¼ ððc c0 Þð1hÞ 1Þ=ð1 hÞ
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407 share of the middle class has a strong negative
408 effect on fertility, and this, in turn, has a sig- where c is the consumption level, h > 0 (the 459
409 nificant and positive impact on growth. Rodrik elasticity of consumption equals the 460
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410 (1998) argues that domestic social conflicts constant h), and c0 P 0 represents the con- 461
411 caused a growth collapse in many countries stant subsistence level of consumption. The 462
412 after the mid-1970s. His econometric results intertemporal elasticity of substitution in this 463
413 show that countries which experienced the utility function is zero when consumption is 464
414 sharpest drop in growth were those with ‘‘di- below the subsistence level, and is positive and 465
415 vided’’ societies and with weak institutions of increasing when it exceeds subsistence. It 466
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416 conflict management. The extent to which so- therefore implies that the poor cannot afford to 467
417 cieties were divided was measured by various save because consumption smoothing cannot 468
418 indicators of inequality, and ethnic fragmenta- occur until subsistence is met. 469
419 tion; the degree of conflict management was Like the subsistence-level argument, the life 470
420 proxied by indicators of the quality of govern- cycle hypothesis claims that income inequality 471
421 mental institutions, rule of law, democratic positively affects private saving rates. In this 472
422 rights, and social safety nets. model, bequests from the previous generation 473
(c) The effect of income inequality on economic

growth: causal mechanisms
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enable the current generation to save. In this
regard, saving is concentrated among relatively
few richer households who are accumulating
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savings in order to pass on their bequests to 477
425 The central question remains: what are the their sons and daughters for dynastic motives. 478
426 mechanisms through which income inequality Galor (2000) also argues that for a country in 479
427 affects economic growth? We now turn to ex- an early stage of development, inequality would 480
428 amine the economic theories and hypotheses promote growth because physical capital is 481
429 that have been suggested regarding the effect of scarce at this stage and its accumulation re- 482
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430 income inequality on economic growth. As quires saving. An increased share of the rich in 483
431 Figure 1 reveals clearly a number of different the population would then result in higher 484
432 causal mechanisms and paths have been pro- saving and rapid growth. On the other hand, at 485
433 posed. We start by analyzing the direct channel a later stage of development, the increased 486
434 through which income inequality affects growth availability of physical capital raises the return 487
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435 via saving. We then discuss the indirect chan- on investment in human capital. But, with 488
436 nels through which income inequality affects credit market imperfections, the poor––who do 489
437 growth via redistribution of income, social not have the ability to provide collateral––may 490
438 conflict and political instability. find their access to capital curtailed (Galor & 491
Zeira, 1993; Aghion & Bolton, 1996). The poor 492
(i) The direct channel via savings will therefore find it difficult to invest in human 493
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440 In standard growth theories, higher saving capital. Income inequality would then result in 494
441 rates promote investment and economic growth a poverty trap and lower growth. The credit- 495
442 either temporarily in the transition to a new constrained human capital accumulation hy- 496
443 steady state (Solow model) or permanently pothesis which is discussed in detail in Section 4 497
444 (endogenous growth models). Therefore, the (the effect of income inequality on education) is 498
445 first task is to explain the relationship between based on the notion that under imperfect in- 499
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446 income inequality and saving and more par- formation, moral hazard arises because a bor- 500
447 ticularly the savings behavior of the rich and rower knows more about the investment 501
448 the poor. opportunity than a lender. That is, a lender 502
449 Kaldor (1956) argues that more inequality absorbs all the risk after entering into a con- 503
450 favors capital accumulation because the rich tract; from a borrower’s side, a larger middle 504
451 have a higher marginal propensity to save than class mitigates the moral hazard problem be- 505
452 the poor, thereby resulting in rapid economic cause it increases the number of potential in- 506
453 growth. The following hypotheses explain such vestors who are able to offer collateral. From 507
454 behavior: subsistence consumption level, and the creditor’s side, a larger middle class enlarges 508
455 lifecycle-saving hypothesis including bequests. the pool of loanable funds. Thus, it reduces the 509
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510 constraint on the credit market and therefore The first argument is that a highly unequal 565
511 facilitates lending to the poor. distribution of income and wealth causes social 566
tension and increases political instability. This, 567
(ii) The indirect channels via redistribution of in turn, raises the risk of the government re- 568
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income, social conflict, political instability, and pudiating contracts, and threatening the secu- 569
democracy rity of property rights, thereby discouraging 570
515 How does income redistribution affect eco- capital accumulation. Moreover, when the gap 571
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516 nomic growth? In the classical approach dis- between rich and poor widens, the latter pre- 572
517 cussed above, income inequality was found to sumably have a greater temptation to engage in 573
518 affect overall household savings positively. rent-seeking or predatory activities at the ex- 574
519 Hence, a redistribution of income from the rich pense of the former. This increases the number 575
520 to the poor would lower aggregate savings, of people who engage in illegal activities that 576
521 which would in turn reduce investment and pose a threat to property rights thereby lower- 577
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522 economic growth. ing economic growth (Benhabib & Rustichini, 578
523 We turn next to a more realistic model which 1991; Fay, 1993). Poor countries may therefore 579
524 incorporates imperfect credit markets. Though fall into a vicious cycle of lower investment and 580
525 the poor and the rich are assumed to possess reduced growth because they are more likely to 581
526 identical preferences, their savings and invest- be politically unstable (Alesina & Perotti, 582
527 ment behavior may differ because they face 1996). On the contrary, political stability, 583
528 different institutional constraints such as credit which is enhanced by the presence of a wealthy 584
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530
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markets. In this model, redistribution from rich
to poor would stimulate growth (Agion &
Bolton, 1997; Aghion & Howitt, 1998) for the
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middle class has a positive effect on growth.
The second argument looks at the fiscal
channel which links income inequality and
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532 following reasons: large sunk costs preclude the economic growth. Persson and Guido (1994) 588
533 poor from investing in education, and entre- construct a median-voter model where the po- 589
534 preneurial projects; moral hazard occurs be- litical process and economic growth are en- 590
535 cause the more the poor must borrow to dogenized. This channel is based on the effects 591
536 undertake investment projects, the more they of inequality on the demand for fiscal redistri- 592
537 must share their returns with creditors. Incen- bution (Alesina & Rodrik, 1994; Bertola, 1993; 593
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538 tives to supply the necessary effort to ensure a Persson & Guido, 1994), implying an inverse 594
539 high return from the investment are therefore relation between inequality and investment in 595
540 low. In this framework, redistribution toward physical capital. The demand for fiscal redis- 596
541 borrowers would result in a favorable incentive tribution financed by distortionary taxation is 597
542 effect and consequently a positive effect on higher in more unequal societies because the 598
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543 growth. level of government expenditure and taxation 599

544 Benabou (1996a,b) argues that income in- results from a voting process in which income is 600
545 equality affects economic growth through its the main determinant of a voter’s preferences. 601
546 impact on income redistribution and political In particular, in an unequal society, the poor 602
547 power. In this section, we explore the existing see large gains from high taxation on the rich. 603
548 literature on how income inequality affects Therefore, the poorer the median voter in re- 604
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549 economic growth through the socio-political lation to the voter with average income, the 605
550 process. In other words, the following ques- higher the equilibrium tax rate. This, in turn, 606
551 tions are addressed: does income inequality leads to an inefficient tax system, distorts eco- 607
552 affect social conflict, political instability, and nomic decisions, discourages investment and 608
553 democracy? And, do social conflict, political therefore growth. 609
554 instability, and democracy in turn affect eco- Barro (1999) argues that it is possible that the 610
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555 nomic growth? The political economy literature predicted negative effect of inequality on 611
556 brings out insightful indirect relationships be- growth can arise even if there are no transfers 612
557 tween inequality and economic growth. in equilibrium. This is because the rich may 613
558 There are three lines of argument which link prevent redistributive policies through lobbying 614
559 inequality and growth in the context of political and buying of votes of legislators. But then a 615
560 economy: i.e., through domestic social conflict; higher level of economic inequality would re- 616
561 demand for fiscal redistribution; and democ- quire more of these activities to prevent redis- 617
562 racy. We will explain these arguments in detail tribution of income through the political 618
563 in Section 3 (the effect of income inequality on process. The lobbying activities would consume 619
564 political conflict, and stability). resources and promote official corruption. 620
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621 Since these effects would be adverse for eco- (a) The effect of income inequality on political
622 nomic performance, inequality can have a conflict, democracy, and stability: empirical
623 negative effect on growth through the political evidence
624 process even if no redistribution of income oc-
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625 curs in the equilibrium (Barro, 1999, pp. 6–7). According to Alesina and Perotti (1994), 675
626 The last argument relates the effect of income there are two related definitions of democracy, 676
627 inequality on economic growth through a pro- and two ways to measure political instability. 677
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628 cess of democratization. Bourguignon and The two definitions of a democracy are, re- 678
629 Verdier (2000) construct a model to analyze the spectively, ‘‘a nation with regular, free, com- 679
630 dynamics of inequality, democratization, and petitive (multiparty) elections’’; and that 680
631 economic growth. In their model, income in- democracy can be measured by ‘‘the degree of 681
632 equality is associated with democratic institu- civil and economic liberties available to the 682
633 tions, and education is the growth engine and a population.’’ In turn, the two measurements of 683
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634 determinant of political participation. They political instability employ (i) socio-political 684
635 argue that because an increase in income in- events such as frequencies of riots, political 685
636 equality can intensify the threat of revolution, demonstrations against the government and 686
637 political elites strategically decide to promote assassinations, and the death rate during po- 687
638 an educated middle class to minimize the risk of litical movements; and (ii) the frequency of 688
639 revolution. Promoting an educated middle class government collapse. 689
640 would result in rapid human capital accumu- A body of empirical evidence has emerged to 690
641
642
643
lation, and in turn accelerate economic growth.
The economy may therefore shift to a new path
of self-sustained growth and democratization
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examine the causal linkage between income
inequality, democracy, and political violence.
Nagel (1974), drawing on the psychological
691
692
693
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644 because of the positive education externality. theory of social comparison, 1 postulates an 694
645 They also acknowledge that the omission of inverted-U shaped relationship between in- 695
646 physical capital accumulation is the limitation equality and political stability; when the level of 696
647 of the model. Given the constraint on an inequality is relatively low, an increase in in- 697
648 economy’s resources, the effect of democrati- equality intensifies social discontent and hence 698
649 zation on growth might be negative if the cost political instability under the ruling re- 699
EC
650 of increasing human capital accumulation is gime––however, when the gap between the rich 700
651 greater than the benefit of reducing the rate of and the poor becomes substantial, the poor 701
652 physical capital accumulation. begin to lose the framework for social com- 702
parisons. The likelihood of revolution therefore 703
diminishes at a high level of income inequality. 704
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At the intermediate level, political instability 705

reaches its peak. 706
4. INCOME INEQUALITY, SOCIAL Edward N. Muller is one of the main con- 707
CONFLICT, AND POLITICAL tributors in this area. In his 1985 paper, using a 708
INSTABILITY crosscountry data set spanning two decades 709
(1958–67 and 1968–77), he found a strong 710
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656 As mentioned in the previous section, income positive effect of the total income share of the 711
657 inequality is regarded as the crucial factor top 20% of households on the death rate from 712
658 leading to social conflict, and political insta- political violence. He also found that political 713
659 bility. High inequality could lead to a lower violence follows a nonmonotonic, inverted-U 714
660 level of democracy, high rent-seeking policies, function of regime repressiveness, which is 715
661 and a higher probability of revolution. An measured by political and civil rights indices. In 716
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662 economy could fall into a vicious cycle because his 1988 paper (Muller, 1988a,b), he found in- 717
663 the breakdown of social cohesion brought verse causal relationships between political de- 718
664 about by income inequality could threaten mocracy and income inequality in both 719
665 democratic institutions. In this section, we ex- directions. 720
666 plore further the existing economic, sociologi- Simpson (1990), using a 62 crosscountry 721
667 cal, and political science literature analyzing the dataset for 1965–75, finds that political de- 722
668 relationship between income inequality, democracy (measured by political democracy in- 723
669 mocracy, and political violence––first by pre- dex (PDI)) and education enrollment levels 724
670 senting the empirical evidence before turning to have an inverted-U relationship with income 725
671 a review of the causal hypotheses. inequality. Acemoglu and Robinson (2000) 726
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10 WORLD DEVELOPMENT
727 document the historical evidence in Europe redistribution. Therefore, democratization 781
728 that the threat of revolution leads to the ex- leads to a direct reduction in inequality via in- 782
729 tension of the franchise (i.e. voting rights). For come redistribution or an indirect reduction via 783
730 instance, taking an example of Britain (where education expansion. On the other hand, as 784
F
731 the franchise was gradually extended to various mentioned before, income inequality can lead 785
732 parts of the population in 1832, 1867, and to social revolution and instability of demo- 786
733 1884––and finally for woman in 1928), the cratic institutions. There may be however, cir- 787
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734 years preceding the electoral reforms were cumstances under which an authoritarian 788
735 characterized by unprecedented political unrest regime may have no choice but to implement 789
736 and social disorder. In their model, Acemoglu policies that reduce income inequality and 790
737 and Robinson (2000) show that the extension poverty in its own self-interest. Indonesia is a 791
738 of the franchise as a commitment device to the good example; under Suharto, the survival of 792
739 redistribution of the power of political elites the regime hinged on reducing inequality, par- 793
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740 comes from the threat of revolution, and social ticularly between the relatively better off center 794
741 pressure due to an increase in inequality. (Java) and the poorer periphery (the outer Is- 795
742 Looking at the political participation channel lands). Poverty alleviation was also crucial in 796
743 through which voters can express their prefer- discouraging a revival of radicalism among the 797
744 ences for income redistribution, Milanovic rural population. 798
745 (2000), using 79 observations drawn from There are two main hypotheses on the effects 799
746 household budget surveys from 24 democracies of income inequality on political violence: (i) 800
747
748
749
to test the median voter theorem, also found
that countries with greater inequality of factor
income redistribute more to the poor.
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the relative deprivation hypothesis, and (ii) the
resource mobilization hypothesis (Muller,
1985). The relative deprivation hypothesis ar-
801
802
803
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750 Does income inequality increase the risk of gues that there exists a direct relationship be- 804
751 large-scale political violence, and civil war? An tween various kinds of deprivation-induced 805
752 effort to explain this question would require discontent and collective political violence. 806
753 considering a large number of factors besides Discontent is not, however, generated from 807
754 income inequality such as the heterogeneity of inequality per se but rather from the gap be- 808
755 language, ethnic origins and religion, geogra- tween an individual’s expected and achieved 809
EC
756 phy, national history, and levels of education. well-being. This hypothesis is difficult to test 810
757 Collier (2000) and Collier and Hoeffler (1998) empirically because it requires qualitative data. 811
758 analyze the pattern of conflict using a large new Once this information is gathered, the use of 812
759 dataset on civil wars during 1965–99. They polarization measures may be appropriate. In 813
760 found that inequality and a lack of democracy contrast, the resource mobilization hypothesis 814
RR
761 had no systematic effect on risk of a civil war, argues that the central explanatory variable is 815
762 which was classified in their analysis as an in- the organization of discontent, i.e., the extent 816
763 ternal conflict with at least 1000 battle-related to which dissident groups are able to acquire 817
764 deaths. On the other hand, countries which control of the resources necessary to develop 818
765 have a substantial share of their income (GDP) strong and effective organizations for obtaining 819
766 coming from the export of primary commodi- collective goods. The land maldistribution hy- 820
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767 ties, as well as those characterized by geo- pothesis developed from this approach is based 821
768 graphical dispersion and dominant ethnic or on the assumption that discontent resulting 822
769 religious groups, were found to be more prone from a highly concentrated distribution of land 823
770 to conflict. and/or lack of land ownership in agrarian so- 824
cieties is an important direct cause of mass 825
(b) The effect of income inequality on political political violence. Gamson (1975), Oberschall 826
UN
conflict, and stability: causal mechanisms (1973), and Tilly (1978) reject this reasoning, 827
claiming that inequality and discontent are 828
773 As mentioned earlier, analyzing the effect of present in almost every society; thus, the most 829
774 income distribution on democratic institutions direct and influential explanatory factor must 830
775 is complicated by their two-way causation. If not be discontent per se but rather the organi- 831
776 there is a large gap between the rich and the zation of discontent. 832
777 poor in a democracy, the median (representa- Muller and Seligson (1987) argue that theo- 833
778 tive) voter will have an increased incentive to ries emphasizing land maldistribution as a 834
779 support heavily progressive taxes or land re- fundamental precondition of insurgency and 835
780 form policies due to greater opportunities for revolution are misspecified, claiming that these 836
WD 1307 No. of Pages 20, DTD = 4.3.1
837 theories attribute direct causal significance to importance of education for economic growth 890
838 an inequality variable that plays only a rela- is well known. In addition to its impact on 891
839 tively small and indirect part in the generation earning power, schooling is seen as a social 892
840 of mass political violence. Instead, Muller and equalizer. Before analyzing the relationship 893
F
841 Seligson (1987) point to inequality in the dis- between these two variables, the distribution of 894
842 tribution of income rather than land as the education across countries is reviewed. Thomas 895
843 more important and direct cause of variation in et al. (2000) estimated Gini coefficients of ed- 896
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844 rates of political violence across countries. ucation attainment for 85 countries and found 897
845 Collier (2000, pp. 3–4) argues that inequality significant differences in the distribution of ed- 898
846 does not lead to civil wars. Civil wars occur ucation across countries over 1960–90. More- 899
847 where rebel organizations are financially viable. over, they found that education inequality as 900
848 In his paper, he states that measured by ‘‘education Gini’’ is negatively 901
correlated with the average years of schooling 902
PR
In the economist’s view of conflict, grievance will turn in a country. This implies that countries with 903
out to be neither a cause of conflict, nor an accidental higher levels of educational attainment are 904
by-product of it. Rather, in a sense grievance is delib- most likely to achieve equality in education 905
erately generated by rebel organizations. . . The eco-
nomic theory of conflict argues that the motivation
than those with lower levels of attainment. 906
of conflict is unimportant; what matters is whether Over 1960–90, Gini coefficients of education 907
the organization can sustain itself financially. It is this, have fallen, indicating rising educational 908
rather than any objective grounds for grievance which equality in most countries––but large differ- 909
determine whether a country will experience civil war.
D
ences still persist. Over this period, Korea
achieved the most rapid decline in the educa-
tion Gini coefficient, which fell from 0.55 to
910
911
912
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5. INCOME INEQUALITY AND 0.22. Afghanistan and Mali had the least eq- 913
EDUCATION uitable distributions in the 1990s, with educa- 914
tion Gini coefficients of 0.90, while the US 915
860 Wide income disparities tend to coexist with and Poland revealed the most equal distribu- 916
861 underinvestment in human capital, that trans- tions of educational attainments with Gini co- 917
862 lates into lower long-run economic growth. The efficients of 0.1. 918
EC
863 empirical evidence suggests that there is a high

864 correlation between income and educational (a) The effect of income inequality on education:
865 levels, as well as between income and educa- empirical evidence
866 tional inequalities. The issue that needs to be
867 investigated is how these variables affect, in
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Income and education distribution variables 921

868 turn, economic growth. are almost perfectly correlated. To put it dif- 922
869 Thomas, Wang, and Fan (2000) approach ferently, illiterate people and the poor are 923
870 this question by reinterpreting income as years synonymous. Empirically, there are four types 924
871 of schooling. The justification for this is that a of education variables used in explaining the 925
872 lack of education leads directly to lower in- income distribution: 926
873 comes, and thus lower aggregate savings and
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874 investment. Conversely, education raises in-

875 comes and promotes growth because it helps to (1) A flow variable of education such as enrollments at
different levels of education, (2) a stock variable of ed-
876 unleash the productive potential of the poor. ucation such as the mean or median years of schooling
877 An overly skewed distribution of education of the labor force, (3) the rate of return on education
878 tends to have a negative impact on per capita at different levels of education, and (4) the dispersion
879 income in most countries (Lopez, Vinod, & of educational attainment (Park, 1996, p. 52).
UN
880 Yan, 1998). A greater equity in the distribution

881 of educational opportunities enables the poor A large body of empirical research has been 933
882 to capture a larger share of the benefits of conducted on the effect of education on income 934
883 economic growth, and in turn contributes to inequality. For example, Knight and Sabot 935
884 higher growth rates. In contrast, large-scale (1983) observe that there are two effects of ed- 936
885 exclusion from educational opportunities re- ucational expansion on income inequality: the 937
886 sults in lower economic growth and persistent composition effect, raising the earnings of those 938
887 income inequality. who are more educated, tends to increase in- 939
888 In this section, we focus on the relationship come inequality, and the wage compression 940
889 between income inequality and education. The effect, which follows the expansion of the edu- 941
WD 1307 No. of Pages 20, DTD = 4.3.1
942 cated labor supply relative to demand, tends to situation where the nature of technological 996
943 decrease income inequality. Using a cross-sec- change and the globalization trend are mani- 997
944 tion data from 59 countries, Park’s (1996) fested by a rapidly increasing relative demand 998
945 econometric results show that a higher level of for technologically skilled workers. If the de- 999
F
946 educational attainment in the labor force has mand for unskilled labor is contracting, or 1000
947 an equalizing effect on income distribution. The growing at a slower rate than the demand for 1001
948 larger the dispersion of schooling among the skilled labor, then wage inequalities will in- 1002
OO
949 labor force, the greater the income inequality. crease. The gap between rich and poor will then 1003
950 Using the dataset of Deininger and Squire start to widen. Income inequality will continue 1004
951 (1996) and the ‘‘world income inequality data- to grow until the supply of new college gradu- 1005
952 set’’ (WIID), Checchi (2000) finds that average ates depresses the return on schooling. More- 1006
953 years of education have a strong negative effect over, as mentioned earlier, if there is a large 1007
954 on income inequality. disparity in the educational opportunities be- 1008
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955 Less empirical research has been done on the tween the rich and the poor, the benefits of 1009
956 reverse effect of income (or wealth) inequality economic growth are mainly captured by edu- 1010
957 on education. Deininger and Squire (1998) cated workers. This, in turn, exacerbates in- 1011
958 show that initial inequality in landholdings can come inequality. 1012
959 help predict both income growth and changes The main reason for underinvestment in ed- 1013
960 in income inequality. Land inequality also re- ucation is that credit markets are imperfect. 1014
961 duces average years of education in their re- The poor possessing little or no collateral, in 1015
962
963
964
gressions. They explain this evidence by
referring to liquidity constraints on educational
access. Using US data from the panel study of
D
the setting of a developing country, are practi-
cally sealed off from the formal credit market.
Poor households are constrained for cash and,
1016
1017
1018
TE
965 income dynamics (PSID) for 1970–90, Mayer as they are unable to borrow, have a hard time 1019
966 (2000) finds that a one standard deviation in- sending their children to school or keeping their 1020
967 crease in income inequality as measured by the children in school. These stylized conditions 1021
968 Gini coefficient results in a 10% decline in high lead to a vicious cycle where initial inequality 1022
969 school graduation, and a one standard devia- and poverty result in underinvestment in edu- 1023
970 tion increase in inequality results in a 40% in- cation among the poor which further exacer- 1024
EC
971 crease in college graduation. But, Acemoglu bate inequality. 1025

972 and Pischke (2000) analyzed the behavior of
973 college enrollments across US states, and do
974 not find any evidence to support the notion that A household’s demand for education is not, however,
only a function of household income and household
975 enrollments increase more in states where wage
RR
access to borrowing. It is also a function of expected

976 inequality and returns to schooling rises more returns to the family from schooling, in the form of
977 substantially. higher future income for educated children (Birdsall,
1999).
(b) The effect of income inequality on education:
causal mechanisms Thus ceteris paribus, as the investment rate of 1032
return to education rises, parents would have 1033
CO
980 The theories underlying the effect of income stronger incentives to send their children to 1034
981 inequality on education can be derived from school, and thus have a greater demand for 1035
982 research on the costs and benefits of education. quality education. Their willingness to pay for 1036
983 There are two main mechanisms underlying their children’s education would rise, thereby 1037
984 these theories: the price mechanism in the labor resulting in a higher level of educational at- 1038
985 market, and the social comparison mechanism. tainment in the population. 1039
UN
986 According to the first mechanism, the equilib- On the supply side of skilled labor education 1040
987 rium wage rate is derived directly from the may act as a signal because of imperfect in- 1041
988 demand for and the supply of labor. The sec- formation (Spence, 1974). That is, a greater 1042
989 ond mechanism works through the interper- share of highly educated workers within a co- 1043
990 sonal comparisons between the rich and poor, hort may signal to the employers that those 1044
991 and is characterized by two additional theories: with less education have lower ability, and 1045
992 relative deprivation, and role models. hence the latter’s earnings may be reduced ac- 1046
993 The relationship between education and in- cordingly. This may also lead to larger earnings 1047
994 come equality is linked to the economic returns inequalities between high and low education 1048
995 associated with education. Consider the present workers. 1049
WD 1307 No. of Pages 20, DTD = 4.3.1
1050 The nature of the political process may also change might have positive externalities for 1103
1051 affect the relationship between education and poorer children, making them act more like the 1104
1052 income inequality. rich. But an increase in inequality can also 1105
make the poor even poorer, which could in- 1106
F
When the distribution of income is highly unequal, the crease the number of negative role models. If 1107
provision of subsidized basic education to a large seg- children are more influenced by this negative 1108
ment of the school-age population implies a relatively rather than positive phenomenon, increasing 1109
OO
large tax burden on the rich. High income families are inequality could lower their welfare. 1110
likely to resist. One result can be the underfunding of
education––and the decline in quality described
above. A second result can be the channeling of public
subsidies to higher-education institutions where the 6. INCOME INEQUALITY AND HEALTH
children of wealthier families are more likely to be
the beneficiaries (Birdsall, 1999, p. 20).
PR
A large body of empirical evidence (Preston, 1112
1063 Inequality may affect voters’ willingness to 1975; Pritchett & Summers, 1996; Adler, Boyce, 1113
1064 support redistributive policies which could af- Chesney, Folkman, & Syme, 1993) supports 1114
1065 fect the tax rate (Perotti, 1996; Alesina & Ro- that, other things being equal, the level of in- 1115
1066 drik, 1994). Likewise, high levels of inequality come has positive effect on health. The mecha- 1116
1067 may encourage the rich to enroll their children nism of this association is straightforward. 1117
1068 in private schools, making them less interested Income directly affects health because it influ- 1118
1069 in supporting public schools.
The general consensus among social scientists, econo- D

ences individuals’ consumption of commodities
that affect their health or cause malnutrition.
Recently, however, there has been great interest
in understanding the relationship between in-
1119
1120
1121
1122
TE
mists and policy makers is that inequality is socially
costly (Acemoglu, 2001, p. 5). come inequality and health per se among 1123
economists, sociologists, and other researchers. 1124
1073 We now turn to the theories of social com- Some studies have examined the effects of in- 1125
1074 parison: relative deprivation, and role models come inequality on individuals’ health differ- 1126
1075 (As Mayer, 2000, pp. 6–7). ences, health at the societal level, and 1127
EC
crosscountry (or crossstate) variations in health. 1128

Relative deprivation theory holds that high levels of
In this section, we will explore the existing evi- 1129
inequality make the poor feel worse off, thereby in- dence regarding the effect of income inequality 1130
creasing their alienation and stress (Jencks & Mayer, on the average level of health in the population. 1131
1990). One version of this hypothesis is that children We will also investigate the mechanisms of such 1132
RR
feel deprived when they cannot have the same material an association by drawing on existing theories 1133
possessions as other children in their school or neigh- in economics, psychology, and political science. 1134
borhood. Another version is that relative deprivation
can also make poorer parents feel stressed and alien-
ated, lowering their expectations for their children or (a) The effect of income inequality on health:
reducing the quality of their parenting (McLoyd, empirical evidence
1990). The role model hypothesis hold that children
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model their behavior on the behavior of those around Preston (1975) attempts to characterize the 1137
them. Role models can either be positive or nega-
tive. . . If children are more influenced by negative
crosscountry relationship between life-expec- 1138
than positive role models, increasing inequality could tancy and income per head. The concavity of 1139
thus reduce the frequency of behavior that parents this relationship among the poorest countries 1140
usually promote. means that increases in average income are 1141
strongly associated with increases in life ex- 1142
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1093 The role model hypothesis argues that chil- pectancy; however, the relationship grows 1143
1094 dren model their behavior on the behavior of weaker as income per head rises. There is no 1144
1095 those around them. Role models can either be strong relationship between these two variables 1145
1096 positive or negative. Most of the literature as- in richer countries. Preston therefore argues 1146
1097 sumes, however, that attending a school where that the level of income strongly affects health 1147
1098 the majority of children want to go to college in low-income countries, but weakly affects 1148
1099 increases a child’s own chances of going to health in rich countries. His analysis suggests 1149
1100 college. Thus, if increased inequality made that the health of individuals in a society de- 1150
1101 some households richer, and if this changed pends on the degree of income inequality in 1151
1102 their children’s behavior for the better, the that society. This negative effect of income in- 1152
WD 1307 No. of Pages 20, DTD = 4.3.1
1153 equality on health becomes more important in Gravelle, Wildman, and Sutton (2000), using 1209
1154 a richer society. income inequality data for 75 countries from 1210
1155 Empirical evidence suggests that there is high the Deininger and Squire (1996) and World 1211
1156 correlation between income inequality and Tables for 1980–82 and 1989–90, found that the 1212
F
1157 health indicators (e.g., morbidity, mortality) estimated relationship between income in- 1213
1158 across countries, and within countries and equality and life expectancy is dependent on the 1214
1159 communities (Wilkinson, 1996; Kaplan, Pamuk, dataset used, the functional form estimated and 1215
OO
1160 Lynch, Cohen, & Belfour, 1996; Kennedy et al. the way in which the epidemiological transition 1216
1161 1996; Lynch, Kaplan, & Pamuk, 1998). Ken- is specified. The association is insignificant in 1217
1162 nedy et al. (1996) and Kaplan et al. (1996) have all of their models. They argue that these results 1218
1163 also suggested that income inequality predicts do not disprove the relationship between in- 1219
1164 excess mortality within individual countries af- come inequality and health, but aggregate level 1220
1165 ter controlling for the level of income. Kennedy studies are incapable of distinguishing between 1221
PR
1166 et al. (1996) result shows that, at the state level, the direct effect of income inequality on indi- 1222
1167 income inequality in the US was strongly cor- vidual health and nonlinearity in the individual 1223
1168 related with total mortality rates even after health–income relationship. There are serious 1224
1169 controlling for median income, poverty rates, methodological difficulties in using aggregate 1225
1170 smoking prevalence, and race. Kawachi, Levine, cross-sections as means of testing hypotheses 1226
1171 Miller, Lasch, and Amick (1994) carried out an about the effect of income inequality on indi- 1227
1172 analysis of income inequality in the US and its viduals’ health. 1228
1173
1174
1175
relation to social capital, as defined by levels of
civic trust and density of associational mem-
bership. Their data on social capital were ob-
D(b) The effect of income inequality on health:
causal mechanisms
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1176 tained from 39 states in a survey conducted by
1177 the National Opinions Research Center between We have learned from the empirical evidence 1231
1178 1986 and 1990. Their result suggests that: a low that income has a positive and direct effect on 1232
1179 level of civic trust was highly correlated with the health. This empirical evidence is supported by 1233
1180 degree of income inequality in each state, and the absolute income hypothesis. There is a two- 1234
1181 density of associational life, as gauged by the per way causality between these two variables: low 1235
EC
1182 capita membership in such organizations as income leads to poor nutrition, and poor health 1236
1183 church groups and sports clubs sports groups reduces earnings potential. A different pathway 1237
1184 was correlated with income inequality. In turn, between incomes and health has been proposed 1238
1185 both the degree of civic distrust and density of by Wilkinson (1996). He argues that income 1239
1186 associational life were strongly correlated with inequality per se has a negative effect on health. 1240
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1187 overall mortality. He also argues that individuals who live in a 1241
1188 Judge, Mulligan, and Benzeval (1998, see more unequal society have a higher probability 1242
1189 Table 1, pp. 570–571) summarize 12 studies of death. This is the so-called relative income 1243
1190 examining the relationship between measures of hypothesis. In spite of the evidence presented 1244
1191 income inequality and average levels of popu- above, however, Deaton (2001) finds that while 1245
1192 lation health across developing and developed income inequality is important, there is no 1246
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1193 countries. Ten out of 12 studies in their sum- conclusive evidence that it poses a direct risk to 1247
1194 mary found some evidence of an association individual health because of the following 1248
1195 between income inequality and average levels mechanisms: (1) a nonlinearity between income 1249
1196 of population health. Using selected health in- level and health, (2) redistribution of income 1250
1197 dicators derived from the World Bank data (life through public goods and the ‘‘urban bias,’’ (3) 1251
1198 expectancy and infant mortality), as well as psychosocial stress, and (4) relative depriva- 1252
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1199 income distribution indicators from Atkinson, tion. These mechanisms are discussed in detail 1253
1200 Rainwater, and Smeeding (1995), they found below. 1254
1201 that income inequality was not a significant First, we have learned from the absolute in- 1255
1202 determinant of average population health in come hypothesis that poverty is what drives 1256
1203 rich industrialized countries. They did remain mortality. As a result, income has a much 1257
1204 convinced, though, that at the individual level, bigger effect on health at lower rather than 1258
1205 low incomes are associated with poor health higher levels of income. Deaton (2001) argues 1259
1206 and that the overall shape of the income dis- that the nonlinear nature of this income effect 1260
1207 tribution might be expected to influence aver- may explain why income is less important to 1261
1208 age national health. health in rich countries. 1262
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1263 Second, ‘‘income inequality may make it effects of income inequality on property crime 1313
1264 more difficult for people to agree on the pro- should be distinguished from those on violent 1314
1265 vision of public goods such as health, water crime. 1315
1266 supply, waste disposal, education, and police Fleisher’s (1996) econometric results show 1316
F
1267 (Deaton, 2001, p. 22). A highly skewed income that the size of the difference between the av- 1317
1268 redistribution may reduce the provision of erage income of the second lowest quartile and 1318
1269 public goods and therefore worsen health. that of the highest quartile of households tends 1319
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1270 Moreover, differential access to resources and to increase city arrest and court-appearance 1320
1271 services, and unequal treatment between the rates. But, the coefficient became statistically 1321
1272 rich and the poor may result in less effective insignificant when the regressions were run for 1322
1273 preventive health care (e.g., childhood vacci- high-income communities alone. Ehrlich (1973) 1323
1274 nations), and more costly disease control (e.g., uses an income distribution variable to capture 1324
1275 tuberculosis treatments). the opportunity costs of crime and finds it to 1325
PR
1276 Third, Wilkinson (2000) argues that psycho- have a positive and statistically significant effect 1326
1277 social stress (level of depression, isolation, in- on crime. That is, individuals at the lower end 1327
1278 security, and anxiety) is another pathway of the income distribution will be more prone 1328
1279 through which inequality affects health. to commit a crime because the cost in terms of 1329
1280 ‘‘Equality is seen as a precondition for the ex- legal income forgone is quite low. Similar to 1330
1281 istence of stress-reducing networks of friend- Fleisher’s (1996) results, Ehrlich found that a 1331
1282 ships, while inequality and relative deprivation measure of income inequality––the percentage 1332
1283
1284
1285
are seen as compromising individual dignity,
and promoting shame and violence’’ (Deaton,
2001, p. 27).
D
of families below one-half of the median in-
come––was associated with higher crime rates.
This argument does not, however, establish a
1333
1334
1335
TE
1286 Finally, causal link between income inequality and 1336
crime per se, but instead uses inequality as a 1337
The relative deprivation theory of mortality risk has proxy for the opportunity cost of crime. Using 1338
three important implications: (i) within groups, mor- a dataset of crime rates for a large sample of 1339
tality risk is a convex and declining function of in- countries for 1970–94 based on information 1340
come; (ii) conditional on an individual’s relative from the United Nations World Crime Surveys, 1341
EC
income, inequality matters for individual health; and

(iii) for groups, mortality risk is independent of group
Fajnzylber, Lederman, and Loayza (1998) 1342
income, but is directly related to the Gini coefficient show that income inequality has a positive ef- 1343
(Deaton, 2001, p. 29). fect on crime rates, both on intentional homi- 1344
cide and robbery. Moreover, they show that the 1345
1295 A reduction in deprivation (through, e.g., level of income per capita is not a significant 1346
RR
1296 land ownership, democratic rights, women’s determinant of national crime rates. 1347
1297 agency) may therefore also lead to improved There are some caveats in the literature, 1348
1298 health in the population contributing to relief however. Using data from all metropolitan 1349
1299 from ill-health. counties and FBI uniform crime reports in 1350
1991, Kelly (2000) finds that income inequality 1351
has no effect on property crime, but has a 1352
CO
7. INCOME INEQUALITY AND CRIME strong and robust impact on violent crime, with 1353
an elasticity above 0.5. In contrast, poverty and 1354
1301 The effect of income inequality on violence at police activity have significant effects on prop- 1355
1302 the macro level (political conflict, and civil war) erty crime, but little on violent crime. Crimes 1356
1303 was discussed in Section 4. We now turn to the against persons as well as property crimes are 1357
1304 effect of income inequality on violence at the correlated with poverty. To distinguish the ef- 1358
UN
1305 micro-level. Income inequality has also been fects of inequality from those of poverty, Kelly 1359
1306 found to affect such behavioral outcomes as includes several measures of deprivation––un- 1360
1307 higher rates of homicide and violent crime employment and poverty rates, percentage of 1361
1308 (Wilkinson, Kawachi, & Kennedy, 1998). the nonwhite population, and percentage of 1362
female-headed families––in the regressions. 1363
(a) The effect of income inequality on crime: Police expenditure per capita is used as a 1364
empirical evidence measure of the deterrent effect of police activ- 1365
ity. Ultimately, the differing effects of inequality 1366
1311 Conventional wisdom maintains that income on property and violent crime are extremely 1367
1312 inequality has a positive effect on crime, but the robust, with similar patterns of significance 1368
WD 1307 No. of Pages 20, DTD = 4.3.1
1369 obtained whether inequality is measured using low. . . because (when low-income individuals) view
1370 income or education, and regardless of the their legitimate lifetime earning prospects dismally
1371 combination of other explanatory variables they may expect to lose relatively little earning poten-
tial by acquiring criminal records; furthermore, if le-
1372 used. Doyle, Ahmed, and Horn (1999) also gitimate earnings are low, the opportunity cost of
F
1373 estimate a model of property crime using panel time actually spent in delinquent activity, or in jail,
1374 data for the US for 1984–93, finding that in- is also low (Fleisher, 1996, p. 120).
1375 come inequality has no independent effect on
OO
1376 crime rates. They did find strong evidence, Income inequality also reduces social capital, 1428
1377 however, that favorable labor market condi- e.g., the degree of trust and mutual support 1429
1378 tions have significant and negative effects on among individuals. Since incarceration entails 1430
1379 both property crime and violent crime. loss of income, individuals with low earnings 1431
potential have a greater incentive to take the 1432
(b) The effect of income inequality on crime: risk of committing burglary, a lower opportu- 1433
PR
causal mechanisms nity cost if caught, and a higher utility if suc- 1434
cessful (Chiu & Madden, 1998). The net benefit 1435
1382 The relationship between income inequality of contemplated crime for an individual against 1436
1383 and crime can be described by three branches of another person can be modeled as proportional 1437
1384 theories: (i) Becker’s (1968) economic theory of to the income difference between them (within a 1438
1385 crime, (ii) Merton’s (1938) strain theory, and community, the average of such incentives over 1439
1386 (iii) Shaw and McKay’s (1942) social disorga- all people is the Gini coefficient of in- 1440
1387
1388
1389
nization theory. Property crime is well ex-
plained by Becker’s economic theory of crime,
while violent crime is explained more by strain
D
come––Deaton, 2001). Moreover, this model
shows how low-income individuals’ incentives
to commit crime increase if the gap between the
1441
1442
1443
TE
1390 and social disorganization theories. rich and the poor is greater. 1444
1391 In the Becker’s economic theory of crime, In sum, the basic assumptions from the 1445
1392 legal wages represent the opportunity cost to above models are that potential criminals act 1446
1393 crime. In his Nobel lecture, Becker (1993, p. rationally, basing their decision to commit a 1447
1394 390) emphasized that crime on an analysis of the costs and benefits 1448
EC
associated with a particular criminal act. There 1449

Rationality implied that some individuals become are two key factors that affect individual career 1450
criminals because of the financial and other rewards choices: the probability that criminals get 1451
from crime compared to legal work, taking account
of the likelihood of apprehension and conviction,
caught, and the relative returns to legitimate 1452
and the severity of punishment. alternatives. Although the individuals are risk 1453
neutral, they will commit a crime whenever its 1454
RR
1400 Becker’s (1968) model was developed further expected net benefits are large enough. In- 1455
1401 by Ehrlich (1973); the latter argued that payoffs creases in relative differential inequality rises 1456
1402 to crime, especially property crime, depend the level of crime because the alternative to 1457
1403 primarily on the ‘‘opportunities provided by crime is less attractive for criminals, and the 1458
1404 potential victims of crime’’ (Ehrlich, 1973, p. potential proceeds from crime are greater. 1459
A rise in inequality may also have a crime- 1460
CO
1405 538) as measured by the median income of

1406 families in a given community. In other words, inducing effect by reducing the individual’s 1461
1407 the level of legal income expected by an indi- moral threshold through a so-called ‘‘envy ef- 1462
1408 vidual includes the income level of potential fect’’. Therefore, a rise in inequality will have a 1463
1409 victims. The higher this level, the higher the positive impact on individuals’ propensity to 1464
1410 incentive to commit crimes, particularly crimes commit a crime. 1465
As Kelly (2000, p. 530) points out, 1466
UN
1411 against property. Thus, for a given median in-

1412 come, income inequality can be an indication of
1413 the differential between the payoffs of legal and Strain theory argues that, when faced with the relative
success of others around them, unsuccessful individu-
1414 illegal activities. als feel frustration with their situation. The greater the
1415 Fleisher (1996) was a pioneer in the study of inequality, the higher this strain, and the greater the
1416 the effects of income on individuals’ decisions inducement for low-status individuals to commit
1417 to commit criminal acts, that crime. Social disorganization theory argues that crime
occurs when the mechanisms of social control are
The principal theoretical reason for believing that low weakened. Factors that weaken a community’s ability
income increases the tendency to commit crime is to regulate its members are poverty, racial heterogene-
that. . . the probable cost of getting caught is relatively ity, residential mobility, and family instability. In this
WD 1307 No. of Pages 20, DTD = 4.3.1
case, inequality is associated with crime because it is (1999), Hartman and Hsiao (1988), Hiday 1490
linked to poverty-areas where high inequality tends (1995), Imrohoroglu, Merlo, and Rupert 1491
to have high poverty rates. (2000), Jackson (1994), Jones (1997), Kennedy 1492
and Kawachi (1997), Kennedy, Kawachi, and 1493
F
8. UNCITED REFERENCES Prothrow-Stith (1997), Kennedy, Kawachi, 1494
Glass, and Prothrow-Stith (1998), Lichbach 1495
1481 Acemoglu and Ventura (2001), Adelman and (1989), London and Robinson (1989), Lynch 1496
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1482 Morris (1973), Bhorat, Leibbrandt, Maziya, (2000), Milanovic and Yitzhaki (2001), Muller 1497
1483 van der Berg, and Woolard (2001), Birdsall, (1989), O’Neill (1995), Partridge (1997), Pyatt 1498
1484 Ross, and Sabot (1997), Blau and Blau (1982), and Thorbecke (1976), Ray (1998), Soobader 1499
1485 Clarke (1995), Daly, Wilson, and Vasdev and LeClere (1999), Sylwester (2000), Wald- 1500
1486 (2001), Deaton (1999a), Deaton (1999b), Dur- mann (1992), Wang, Dixon, Muller, and Se- 1501
1487 lauf (1992), Firebaugh (1999), Gaarder (2001), ligson (1993), Weede (1997) and Wildman 1502
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1488 Glaeser (1999), Gradstein, Milanovic, and Ying (2001). 1503
1489 (2001), Gravelle (1998), Hanushek and Somers
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1505 1. Nagel (1974, p. 454) refers to Festinger’s theory of creases as the difference between his opinion or ability 1508
1506 social comparison which states that ‘‘The tendency to
1507 compare oneself with some other specific person de-
D
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WD 1307 No. of Pages 20, DTD = 4.3.

World Development Vol. xx, No. x, pp. xxx–xxx, 2002

Economic Inequality and Its Socioeconomic Impact

Key words — inequality, income distribution, growth, education, health

24 phenomena. There are several channels income inequality and crime. 59

29 psychology, criminology, and public health. We

inequality among diﬀerent countries and geo- 65

ﬁrst noteworthy observation is the large in- 71

Table 1. World income distribution in 1999

Low and middle 5,084 85.09 17,323.9 44.64 3.4

cator come from national household surveys. 117

rich countries grew faster than poor coun- 128

Belarus, Austria and the Scandinavian coun- 192

Within-country inequality 1.3 1.3

coeﬃcient 10% to poorest

Figure 1. The channels through which inequality aﬀects growth.

(c) The eﬀect of income inequality on economic

543 growth. level of government expenditure and taxation 599

At the intermediate level, political instability 705

863 empirical evidence suggests that there is a high

Income and education distribution variables 921

874 investment. Conversely, education raises in-

880 Yan, 1998). A greater equity in the distribution

971 crease in college graduation. But, Acemoglu bate inequality. 1025

access to borrowing. It is also a function of expected

The general consensus among social scientists, econo- D

crosscountry (or crossstate) variations in health. 1128

income, inequality matters for individual health; and

associated with a particular criminal act. There 1449

1405 538) as measured by the median income of

1411 against property. Thus, for a given median in-

ies, 64, 151–172. growth: the local connection. National Bureau of

United States. Canadian Journal of Criminology Journal, 316, 382–385.

where Gi ¼ Gini coefficient of country i, pi ¼

1863 Spence, M. (1974). Market signaling. Cambridge: Ha-

1876 Waldmann, R. J. (1992). Income distribution and infant

1883 Weede, E. (1997). Income inequality, democracy and X

1884 growth reconsidered. European Journal of Political ðyj yj Þpi pj þ L

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