E297C
Ethics of Development in a Global Environment
Rights of Economic Equality Workshop
Professor Bruce Lusignan
NOTE: GRADUATING SENIOR
Economic Growth and Inequality:
Motivations for Redistributive Policies in Brazil
Guilherme Sousa
SUID 4754347
Sousa 1
1. Introduction
Many economists have conducted studies on the potential relationships between
economic growth and inequality, in efforts to define solid connections and perhaps
develop some kind of cause and effect relationship. This trend in the study of
development economics was largely driven by the hypothesis of negative effect of growth
on the poor. More recently, the increasing globalization of markets has produced
plentiful negative publicity. Many believe in the idea that this global trend has left a
large portion of the world population behind. Economic Nobel Laureate Joseph Stiglitz
begins his book Globalization and Its Discontents by acknowledging the various positive
aspects associated with globalization, such as international trade, access to knowledge
and foreign aid. Nonetheless, he goes on to claim:
But to many in the developing world, globalization has not brought the
promised economic benefits. A growing divide between the haves and
the have-nots has left increasing numbers in the Third World in dire
poverty, living on less than a dollar a day. Despite repeated promises
of poverty reduction made over the last decade of the twentieth century,
the actual number of people living in poverty has actually increased by
almost 100 million. This occurred at the same time that total world
income actually increased by an average of 2.5 percent annually
(Stiglitz, 5).
This type of rhetoric begs a host of questions: Is the economic growth being
achieved around the world today not benefiting the poor? Further, could it be making
matters worse for the already less fortunate portion of the world population? What
economic, political and social policies should be undertaken in order to improve the
current scenario of inequality? Is the answer to create wealth, redistribute existing
wealth, or a combination of the two?
The first approach is to analyze the theoretical and empirical developments made
thus far, and attempt to extrapolate some direction in the analysis of this complex set of
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questions. Addressing the effects of growth on inequality will eventually lead the
analysis into the opposite causal direction. The last step will be the application of the
studies on growth and distribution to a specific case, namely the extreme scenario of
inequality found in Brazil. The analysis of the various studies conducted on the
interconnections between growth and inequality will shed some light on the Brazilian
situation. Particularly, they ought to motivate a drive for sustained growth accompanied
by sound redistributive government measures.
2. Inequality and Growth
2.1 The Effect of Growth on Inequality
In 1955, Kuznets made the first effort to identify a relationship between growth
and inequality. Due to the limited amount of data available at the time, Kuznets studied
small samples of developing (India, Sri Lanka and Puerto Rico) and developed (United
States and United Kingdom) countries, and utilized a ratio of the income share of the
20% richest to that of the 60% poorest as a measure of inequality. From this early study
he extracted the idea that developing countries demonstrate a higher degree of inequality
than developed nations. In 1963, Kuznets refined his research, obtaining data for
eighteen countries and further strengthening his previous findings. He went on to
propose the inverted-U hypothesis, in which he claims inequality rises in the early stages
of development (measured by income per capita) but eventually falls as more individuals
are able to reap the benefits of growth.
Various studies were conducted to test Kuznets’ inverted-U hypothesis. In
particular, many scholars used the cross-sectional method in an attempt to overcome the
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lack of country-specific inequality data spanning the time necessary to complete Kuznets’
U path. Paukert (1973) compared averages of the Gini coefficient for bins of countries
organized by GDP level. The average Gini coefficient traced the inverted-U curve as it
progressed from low income bins to high income bins. Nonetheless, Paukert’s data
featured significant variation within bins, making the results somewhat unreliable.
Further, Ahluwalia (1976) conducted a cross-sectional regression on a group of sixty
countries, which also supported the U-hypothesis. Still, data limitations and statistical
bias rendered these results doubtful. For instance, cross-sectional studies assume all
countries have the same income-inequality relationship. Such notion can be easily
objected when considering the different historical paths or the diverging government
policies amongst nations.
Some scholars have tried to account for the regional differences by introducing
country-specific dummy variables in their analysis. For example, a dummy variable
could symbolize the fact that Latin American countries have historically been the most
inequitable in the world. Deininger and Squire (1996) used this approach and found
results that invalidated Kuznets’ U-curve. In other words, country specific factors were
found to be creating the U-curve, as opposed to general trends in the time dynamics of
inequality. Moreover, the relationship between income levels and inequality was found
to be extremely weak. The most useful result from this study was that overall economic
growth led to growth in the income of the poorest quintile in 85 of 91 cases. Thus,
Deininger and Squire found that even when inequality had increased, its negative effect
on the poor had been outweighed by the positive effect of growth.
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These results have been further reaffirmed. Dollar and Kray (2000) from the
World Bank and Gallup, Radelet and Warner (1998) from Harvard University confirmed
the absence of a direct causal relationship between growth and increased inequality. In a
yet more recent study, Pfeffermann (2000) discredits Kuznets’ U-hypothesis, and also
claims that “the poverty-growth relationship did not change in the 1990s [new economy]”
(2000). Addressing some of the worries of Stiglitz regarding globalization, Pfeffermann
claims international trade equally benefits the poor and the rest. Similarly, economic
downturns, inflation targeting policies, rule of law and fiscal discipline are outlined as
factors that either benefit the poor more than the rest or in similar fashion. Pfeffermann’s
analysis seems quite generic, perhaps failing in the same manner as cross-sectional
studies do. The general findings that have found more substantial support can be
summarized as: (1) The U-hypothesis has been refuted by recent studies; and (2) Growth
per se does not increase inequality, and evidence shows it decreases poverty.
If it is indeed true that growth does not work against equality, a look in the
opposite causal direction becomes sensible. If growth is generally believed to be propoor, and is naturally beneficial from a development economics standpoint, how should
governments go about spurring it? Can reduced inequality improve the conditions for
economic growth? This direction of thought in the growth-inequality relationship has
also been extensively explored, yielding applicable results.
2.2 The Effect of Inequality on Growth
Having established the notions of growth as a pro-poor phenomenon that does not
have a significant correlation with the level of inequality, the association between growth
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and development is now reaffirmed. However, the relationship between growth and
inequality has not been completely invalidated, as there exists another causal direction.
Indeed, many studies have been conducted on the potential effects of initial inequality
and subsequent economic growth. Pioneering this discussion were Galor and Zeira
(1993), whose study drew the conclusion that “the distributions of wealth and income
affect output and investment in the short run and the pattern of adjustment to exogenous
shocks” (51). The idea underlying this negative impact on investment and output stems
from capital markets imperfections. Galor and Zeira considered the case of credit
markets where enforcing repayment is not a costless measure. This leads to higher
lending rates to poorer individuals, who in turn are not able to attain the minimum level
of investment necessary for productive activities. With a large portion of the potentially
productive population excluded from the credit markets and thus unable to invest, output
falls below its potential. Furthermore, Banerjee and Newman (1993) analyzed the
inability of the poor to provide collateral assets, such as land, to obtain loans. This
condition excludes them from the credit market in similar fashion.
Motivated by the findings of Galor and Zeira, Persson and Tabellini (1994) and
Alesina and Rodrik (1994) proposed a negative correlation between ex ante inequality
and subsequent growth rates. Their regression coefficients, as well as Benabou’s (1996)
cross-country empirical data, supported this hypothesis. Further, Deininger and Squire
were able to make an important distinction between two types of inequality. Their study
conveyed a weak correlation between income inequality and growth. On the other hand,
asset inequality as measured by the Gini coefficient of land was found to have a strong
negative correlation with growth. In other words, the greater the ex ante inequality of
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land distribution within a country, the slower growth rates it will experience. This
finding is consistent with the aforementioned systematic exclusion of the poorer
population from the credit markets, which can be explained by their inability to provide
collateral assets to creditors. This inability to access credit reduces investment, which in
turn reduces aggregate output.
2.3 Inequality and Growth in Brazil
The divide between the haves and the have-nots mentioned by Stiglitz has been
historically large in Brazil. The plague of inequality is deeply rooted in the country’s
history of slavery and exploitative Portuguese colonization. Furthermore, the country
experienced a significant increase in inequality in the 1980s (see chart below1). As we
begin this new millennium, many questions surround the future of growth and inequality
in Brazil. Recently elected leftist President Luiz Inácio Lula da Silva stepped into office
starring at the hopeful eyes of millions of poor Brazilians. Indeed, the belief in the
possibility of future improvements within the socioeconomic spectrum has received new
life with Lula. The momentum the new President has in his favor provides him with a
unique opportunity to push forward with reforms that have not been able to break through
the status quo in years past.
But what should be the priorities for Lula’s administration? He has taken early
measures targeting the country’s return to economic growth. Namely, Lula managed to
tame market fears regarding his leftist tendencies and a potential debt default by
surrounding himself with a market-savvy economic team that has applied sound
monetary policy, and conveying his determination to carry on with social security and tax
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Real GDP per capita
Real GDP vs Gini coefficient
Gini coefficient
8,000
0.66
7,000
0.64
0.62
6,000
0.60
0.58
4,000
0.56
Gini coefficient
GDP 2002 R$
5,000
3,000
0.54
2,000
0.52
1,000
0.50
0
0.48
80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01
Year
reforms. One result has been the appreciation of the Real against the U.S. dollar (17.5%
in the last three months), following a sharp devaluation during the pre-election period.
Likewise, the country risk (J.P. Morgan EMBI+ Brazil) has declined from a peak of
about 2,400 basis points over U.S. Treasury Bonds (pre-election period, September 2002)
to 863 at yesterday’s (May 29, 2003) close. Inflation, which had experienced upward
pressure due to the devaluation of the Real, is steadily slowing. Although the Central
Bank has been conservative, interest rate cuts are on the horizon. Indeed, that is a clear
goal of the administration, as the economy cannot realistically resume sustained growth
with the current high level of interest rates. In short, the new government is stirring
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Brazil on the right track to future growth. Noteworthy, however, is the fact that
continuing below trend economic conditions throughout the world will surely undermine
the chances of Brazil’s return to growth under Lula.
Notwithstanding the relatively positive outlook of Brazilian growth, the question
remains as to how inequality will be addressed in the short and medium term. The
aforementioned theoretical and empirical studies on the existing relationships between
growth and inequality provide us with some valuable insight into this question. If Lula
were to base his strategy on the Kuznets hypothesis, pursuing growth through sound
monetary and fiscal policies would suffice as a medium for reducing inequality in the
long-run. According to Kuznets, Brazil would most likely be around the maximum of the
inverted U-curve. One would expect that when considering the already extremely high
level of inequality found in Brazil (approximately 0.6 Gini coefficient) by world
standards. This hypothesis would predict that after reaching this maximum level,
inequality would diminish as GDP per capita rose. Kuznets inverted U-curve, however,
has been widely refuted in recent studies. Deininger and Squire (1996), amongst others,
have actually found no significant signs of a causal link between growth and inequality.
In my analysis of GDP per capita growth and Gini coefficient growth in Brazil
over the last two decades, the relationship has also proven to be extremely weak (see
Growth Rates chart below1). The correlation between the growth rates is of magnitude
less than 0.1, i.e., statistically insignificant. Confirming the findings in more depth, my
regression analysis on the Brazilian GDP per capita and Gini coefficient growth rates
since 1980 (see Regression chart below1) again displayed the weak causal effect of
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Real GDP per capita growth
Real GDP per capita vs Gini coefficient Growth Rates
Gini coefficient growth
15.00%
10.00%
5.00%
0.00%
80 81 82 83 84 85 86 87 88 89 90 91 92 93 95 96 97 98 99 00 01
-5.00%
-10.00%
-15.00%
Year
growth on inequality. The scatter plot shows a trend line, i.e., a line of best fit, but it is
clearly visible that there is no linear relationship in the data. The R2 coefficient of 0.0092
is indicative of that fact, and is consistent with earlier findings. This leads us to conclude
that achieving sustained economic growth in Brazil will not effectively address the
problem of inequality.
Furthermore, the studies on the effect of inequality on growth have suggested that
the level of initial inequality is negatively correlated with the level of subsequent growth.
In particular, the findings of Deininger and Squire (1996) suggest the distribution of land
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Scatter Plot and Trend Line
Real GDP per capita vs Gini coefficient Growth Rates
15%
y = -0.1398x + 0.0003
R2 = 0.0092
10%
5%
0%
-10%
-8%
-6%
-4%
-2%
0%
2%
4%
6%
8%
-5%
-10%
-15%
Real GDP per capita Growth, Gini Growth
Linear (Real GDP per capita Growth, Gini Growth)
– a historically problematic issue in Brazil – is crucial in promoting subsequent economic
growth. This strong negative correlation between initial land inequality and subsequent
growth should underscore the importance of land reform for the Lula administration.
This is an encouraging finding because, having established that growth is pro-poor, it
provides developing countries like Brazil with the basic roadmap to where their
government’s efforts should be targeted. In order to effectively reduce inequality and
promote long-term sustainable growth, Lula should couple growth-oriented measures
with policies that will optimize the distribution of existing wealth.
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3. Conclusion
Lula has taken the right steps thus far in directing the country back to its path of
economic growth. He has shown great commitment to the tax and social security
reforms, which would represent giant steps for Brazil on various levels. First, they would
assure a more efficient and equal distribution of social security benefits and the tax
burden. Second, the passing of these reforms would boost the general external
confidence in the country, which would in turn result in more foreign credit and
investment, higher demand for Brazilian assets and a lower risk premium. Third, more
efficient tax and social security systems would improve the country’s fiscal position and
allow for a reallocation of funds to important under-funded projects.
The issue of land reform in Brazil is even more complex, and its history has been
one of broken promises and unmet expectations. The inequality of land is even more
extreme than that of income (approximately 0.8 land Gini coefficient), which is an
alarming fact in light of the findings of Deininger and Squire (1996). Lula recognizes the
importance of agrarian reform, but it remains to be seen how much he will be able to
achieve during his term. He has indicated his intention to focus on microfinancing and
improving the conditions of family-based agriculture. Furthermore, he has promised to
compete with past governments in the quality – not quantity – of land settlements. In this
regard, it will be crucial to recognize that, in a competitive global environment, the mere
expropriation and redistribution of land is not sufficient in assuring improved welfare.
There needs to be investment that assures an efficient market of inputs, technical training
and an improved rural infrastructure. This should in turn lead to efficient production and
financial return for the stake-holders.
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Notwithstanding the challenges that lie ahead, Lula has demonstrated an
understanding of the necessity of a two-way strategy that encompasses pro-growth and
pro-equity measures. He conveys this understanding in his Plan of Government:
Development with social justice implies a departure from two historical
tendencies of Brazilian society: an excessive external dependency and
an acute concentration of wealth that generates extreme social
exclusion. For this reason, the social dimension must be the axis of
development and not a mere appendix or a supposed natural result of
the economic growth.
Miriam Leitão (Economy columnist, O Globo newspaper) further adds to the
notion of a two-way development strategy, rightly noting that their dimensions should be
simultaneous and complementary:
It does not mean that only after all done – approved reforms, increased
savings, the poor included, the people educated – will we manage to
grow. The country will grow while it performs these tasks. But
without them nothing will be sustainable.
If Lula succeeds in achieving economic growth around his social axis, Brazil may
finally bridge the giant gap between its haves and its have-nots. Only then, will Brazil be
able to grow into the developed world, finally seizing to be the “country of tomorrow”.
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4. Appendix: Workshop Presentation Summary Sheet
Growth and Inequality:
Motivations for Distributive Policies in Brazil
NEWS BRIEF by Guilherme Sousa
But to many in the developing world, globalization has not brought the
promised economic benefits. A growing divide between the haves and
the have-nots has left increasing numbers in the Third World in dire
poverty, living on less than a dollar a day. Despite repeated promises
of poverty reduction made over the last decade of the twentieth century,
the actual number of people living in poverty has actually increased by
almost 100 million. This occurred at the same time that total world
income actually increased by an average of 2.5 percent annually
(Stiglitz, 5).
Questions




Are the poor not reaping any benefits from economic growth?
Could growth be considered anti-poor?
What government policies should be undertaken in order to improve the current
scenario of inequality?
Is the answer to create wealth, redistribute existing wealth, or a combination?
Findings




Kuznets first predicted the U-curve hypothesis, but it has found no support in
recent studies
The consensus is that growth reduces poverty, and it has no significant causal
relationship with inequality
The other causal direction is more relevant: high level of initial inequality
undermines subsequent growth
This is particularly true when considering land inequality
Brazil under Lula






Immense inequality: 0.60 Gini coefficient, 0.80 land Gini coefficient
Under Kuznets’ hypothesis, we could expect inequality to diminish in the later
stages of growth, but studies have refuted this possibility.
No apparent direct causal link between growth and inequality, supporting recent
studies (correlation < 0.1, R2 = 0.0092)
Growth per se won’t bring equity, but more equity can help sustain growth: there
needs to be a two-way strategy for development
Recently elected leftist President understands this: “the social dimension must be
the axis of development and not a mere appendix or a supposed natural result of the
economic growth.”
Main priorities: (1) Land Reform, (2) Tax and Social Security Reforms, (3) Sound
monetary and fiscal policies, lower interest rates
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


To assure a successful Land Reform: technical training, efficient market of inputs,
improved rural infrastructure, access to credit markets
Lula has promised to focus on microfinancing and improving conditions for familybased agriculture
It remains to be seen if he will live up to his promises and bring Brazil back to
growth around his social axis
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5. Bibliography
Alesina, A., and D. Rodrik (1994). “Distributive Politics and Economic Growth,”
Quarterly Journal of Economics 108, 465-490.
Ahluwalia, M. (1976). “Inequality, Poverty and Development,” Journal of Development
Economics 6, 307-342.
Benabou, R. (1996). “Inequality and Growth,” NBER Macroeconomics Annual, 11-76.
Banerjee, A. V., and A. Newman (1993). “Occupational Choice and the Process of
Development,” Journal of Political Economy 101, 274-298.
Deininger, K., and L. Squire. (1996). Economic Growth and Income Inequality:
Reexamining the Links. Retrieved April 18, 2003, from
http://www.worldbank.org/fandd/english/0397/articles/0140397.htm
Dollar, D., and A. Kray. (2001). “Growth is Good for the Poor.”
World Bank, Washington D.C.
Gallup, J. et al. (1998). “Economic Growth and the Income of the Poor.” Discussion
Paper No. 36, Institute for International Development, CAER II (November),
Cambridge, Mass., Harvard University.
Galor, O., and J. Zeira. (1993). “Income Distribution and Macroeconomics,” American
Economic Review 86, 35-52.
Kuznets, S. (1955). “Economic Growth and Income Inequality,” American
Economic Review 45, 1-28.
Kuznets, S. (1963). “Quantitative Aspects of the Economic Growth of Nations: VIII.
Distribution of Income by Size,” Economic Development and Cultural Change
12, 1-80.
Leitão, M. (2003). Espetáculo.
Retrieved May 20, 2003, from
http://oglobo.globo.com/oglobo/colunas/miriam.htm
Palocci, A. (2002). Programa de Governo 2002.
Retrieved May 2, 2003, from
http://www.lula.org.br/assets/programadegoverno.pdf
Paukert, F. (1973). “Income Distribution at Different Levels of Development: A Survey
of Evidence,” International Labour Review 108, 97-125.
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Persson, T., and G. Tabellini (1994). “Is Inequality Harmful for Growth?,” American
Economic Review 84, 600-621.
Pfeffermann, G. (1995). Capital Markets and Poverty Alleviation.
Retrieved from http://www.ifc.org/economics/speeches/sept95.htm
Pfeffermann, G. (2000). Paths out of Poverty: The Role of Private Enterprise in
Developing Countries. Retrieved on April 25, 2003, from
http://www.ifc.org/economics/speeches/sept95.htm
Ray, D. Development Economics.
Princeton: Princeton University Press, 1998.
Stiglitz, J. Globalization and Its Discontents.
New York: Norton, 2002.
1
Data Sources: GDP: Instituto Brasileiro de Geografia e Estatística (IBGE). Gini coefficient: IBGE and
Deininger Database. No available Gini data for 1994.