2 1680 DEVELOPMENT BRIEF Number 35 The World Bank May 1994 transfers, measured as a share of a S o c i alI a n d p u blI i c p o l i cy country's GDP. These two factors are the products of political deci- c h o I ces I m p o rta n t fO r sions, both current and past (for example, a country might have a income equality large state sector because of a strong past influence of socialist In an augmented Kuznets hypothesis, two kinds of fac- parties). These public policy factors tors determine the distribution of income in the short run raise a key question: To what extent do social choice factors statistically _ he famous Kuznets inverted obviously a variable that changes explain cross-country income U-curve hypothesis (Simon slowly, and, for the same reasons, so inequality? Kuznets 1955) states that at is the inherited regional inequality. Once the "given" elements are very low levels of income, income accounted for, there is still sizable inequality must also be low, as discretion regarding income in- practically everybody lives at or Income distribution equality. Income distribution is close to subsistence level. There is viewed also as the product of social no room for increased inequality is viewed also as choices mediated through elections, because, with the small size of over- lobbying, societal preferences, or all output, increased inequality the product of historical developments. So, some would push many people below the o countries may have a greater pro- subsistence level. As the process of social choices portion of state sector workers be- growth begins, income inequality cause socialist or Communist increases. People migrate from the The public policy factors are (1) the parties were historically traditional agricultural sector, percentage of workers employed in stronger, or the population may where incomes are low, to the mod- the state and the parastatal sector, prefer to eradicate poverty and ern industrial sector, where the and (2) the size of government redistribute income through trans- (expected) wage is higher and wage differentiation is greater. . In proposing an "augmented" Factors explaining the difference in inequality Kuznets hypothesis, a World Bank compare researcher argues that the size dis- d with inequality in OECD countries tribution of income is determined (Gini points) by two kinds of factors in the short Latin America run: by those "given"-from the Due to Socialist Africa Asia and the Caribbean point of view of policymakers or Social choice -13.0 +11.0 +3.0 +8.1 society as a whole-and by those State sector -15.8 +2.3 +2.0 +0.4 resulting from social (or public Size of transfers +2.8 +8.7 +8.1 +7.7 policy) choice.* The "givens" are The Asia dummy n.a. n.a. -7.1 n.a. the level of income and the regional "Given" factors +4.4 +7.3 +5.9 +8.1 heterogeneity of a country. Neither Regional inequality +0.3 +1.5 +0.8 +2.6 of these factors can be influenced Income level +4.1 +5.8 +5.1 +5.5 Unexplained +2.2 +2.8 +0.9 +1.8 strongly in the short run. The level Actual difference -6.4 +21.2 +9.8 +18.0 of development (level of income) is n.a. Not applicable. 'For more details, see Branko Milanovic, 'Determinants of Note: A negative sign indicates that a given element reduces inequality Cross-Country Income Inequalitv" World Bank Policv Re- search Working Paper 1246, January 1994. m the region compared with inequality in OECD countries. fers, or the middle classes-which occupations and still more the Social choice variables reduce decisively determine the size of higher clerical, the professional and inequality transfers in developed democra- administrative are paid less than in The social choice variables (social cies-may have experienced down- the West relative to the bulk of transfers and state sector employ- ward mobility and may regard manual workers." ment), jointly with the "given" transfers as an insurance proposi- Still another reason why a high variables, were included in the tion (lest they become poor), as level of state involvement in the standard formulation of the argued by Lindert (1989 and 1991). economy may lead to lower in- Kuznets hypothesis. In all formula- In any case, variables such as the equality: "if decisionmaking is tions of the regressions, the social size of the state sector and the size perceived to be largely decentral- choice variables show a statistically, of transfers will be determined ized, individual advances are attrib- significant negative impact on in- through the interaction of social uted to chance, or possibly merit (or equality. forces or by the political economy demerit). When decisiornaking is In a sample of 80 countries in the of the country. known to be centralized, such 1980s, the social choice variables Consider the influence of two advances will be attributed to favor- reduce inequality by some 13 Gini "social choice" elements in more itism ... [Centralized systems] will points. At a low level of income, the detail. The large size of the state strain to be more egalitarian not just role of social choice variables is sector tends to reduce inequality because they want to, but also be- almost negligible. As income rises, because of its more compressed cause they have to: centralization of their importance increases. It could wage distribution compared with be argued that, at a low level of that in the private sector. More income, social choice has no effect bureaucratic structures, in which because everyone is poor and there earnings are determined largely by As average incomes is nothing to redistribute. But at seniority and academic credentials, low levels of income, inequality is have been shown to pay those at rise, people place relatively high, so social choice the top relatively less and to pay g variables could, a priori, play a those at the bottom relatively more. greater emphasis significant role. Why they do not do Bishop, Formby, and Thistle (1991) n equality so can only be conjectured now. find that wage distribution in the f The Bank researcher's hypothesis U.S. government is consistently is that society's preferences change more egalitarian than that in manu- decisionmaking largely deprives during the process of development facturing, services, or agriculture them of tolerance for inequality that and that, as average incomes rise, (all of which are entirely private). is available to more decentralized people place greater emphasis on Meron (1991) obtains the same systems" (Hirschman 1973). equality. Their preference for sociaL result for France. Socialist countries Government transfers tend to equality is therefore income-elastic, further confirm the leveling tenden- reduce inequality, though the reduc- The implication of this result: the cies of state-owned enterprises, tion in inequality achieved by a given validity of the original Kuznets because the majority of workers amount of government transfers will hypothesis diminishes as society (outside agriculture) were or are vary. If most transfers are captured develops. The level of inequality employed in the state sector. Wage by those who pay taxes (out of which that a society charts throughout its distribution, adjusted for the the transfers are financed), the reduc- development diverges systemati- heterogeneity of the country, tends tion in inequality may be small (the cally from the level predicted by the to be more equal in socialism than theory of the middle-class capture of Kuznets curve. This is so because in capitalism. Thus Phelps-Brown benefits argued by Le Grand 1982 inequality in richer societies (1988) writes that lower inequality and Sawyer 1982). But generalLy the decreases not only due to economic in Soviet-type economies "arises larger the transfers, the greater the factors but also because societies mainly from a slower rise of reduction in inequaLity will be, even if choose less inequality. income above the median, that is, additional increases in transfers broadly: the more skilled manual lower inequality by less and less. Dezslopmsent Brirfs are issued by the World Bank to inform the media, business, academic, and government policy communities about development policy analyses and results from the Bank's research activities. They are drawn from the work of individual Bank researchers and do not necessarily represent the views of the World Bank and its member countries-and should not therefore be attributed to the World Bank or its affiliates. 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