Inequality and development

The Kuznets curve

Inequality of income and wealth tends to increase as economies begin to experience economic development. However, beyond a theoretical point inequality will begin to fall as the income and wealth gap between households starts to close.

According to the Kuznets curve, after American economist, Simon Kuznets, inequality in an economy will increase as it raises its level of development, say from a to b in the graph.

The Kuznets curve

At ‘very low’ levels of development, the majority of the population have little income, and inequality is relatively low.

As an economy develops, a few can gain high rewards, widening the income gap. This seems to be a function of the early development of market systems.

As markets develop opportunities arise for those with capital or who can provide entrepreneurship. Rapid gains in income are possible for this group. However, at the other end of the spectrum, wages are suppressed as a result of an influx of cheap labour.

video on the Kuznets curve

However, with further development a ‘middle class’ emerges, and inequality falls (from its peak at c to d). Higher income also means higher taxes and a larger public sector, where more is spent on public and merit goods, and on social welfare.

Education becomes more evenly distributed and knowledge spreads across all sectors of the economy. Employment opportunities increase, increased labour market participation occurs, wages rise, and inequalities begin to diminish.

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