Have you ever wondered how inequality levels are measured?

To measure the level of inequality, economists use tools to analyze this level of inequality.

Commonly, Lorenz Curve and the “Inverted-U” Kuznets Curve is used.

Lorenz Curve

Is a tool that compares income distribution to help economists whether income is distributed
equally or unequally.

The graph plots percentiles of the population on the horizontal axis according to income or
wealth and plots cumulative income or wealth on the vertical axis. The numbers of income
recipients are plotted on the horizontal axis, not in absolute terms but in cumulative
percentages, since it focuses on the distribution pattern, not the actual amounts. The same
goes with the vertical access. Both axes are at the same length.

At every point on that diagonal, the percentage of income received is exactly equal to the
percentage of income recipients

The Lorenz curve shows the actual quantitative relationship between the percentage of income
recipients and the percentage of the total income they did in fact receive during, say, a given
year.

The more the Lorenz line curves away from the diagonal (line of perfect equality), the greater
the degree of inequality represented. This happens because no country exhibits either perfect
equality or perfect inequality in its distribution of income. the greater the bend and the closer to
the bottom horizontal axis the Lorenz curve will be.

Why Use the Lorenz Curve?

It shows both situations (perfect equality and inequality) on the same graph so we can compare
them.

Close to the straight line = More equality.

Far from the straight line = More inequality.

Dualistic Development and Shifting Lorenz Curves: Some Stylized Typologies:

Gary Fields used Lorenz curves to analyze 3 limiting cases of dualistic development:

1.) The modern-sector enlargement growth typology, in which the two-sector economy
develops by enlarging the size of its modern sector while maintaining constant wages in
both sectors. This is the case depicted by the Lewis model— or the Dual Sector model,
that explains the growth of a developing economy in terms of a labor transition between
 two sectors, the subsistence or traditional agricultural sector and the capitalist or modern
industrial sector. It corresponds roughly to the historical growth pattern of Western
developed nations and, to some extent, the pattern in East Asian economies such as
China, South Korea, and Taiwan.

Key term: the modern sector grows and absorbs more workers from the traditional sector. This
is called modern-sector enlargement.

Sector:
a. Traditional
b. Modern

2.) The modern-sector enrichment growth typology, in which the economy grows but
such growth is limited to a fixed number of people in the modern sector, with both the
numbers of workers and their wages held constant in the traditional sector. This roughly
describes the experience of many Latin American and African economies.

Keynote: only urban areas improve.

3.) The traditional-sector enrichment growth typology, in which all of the benefits of
growth are divided among traditional-sector workers, with little or no growth occurring in
the modern sector. This process roughly describes the experiences of countries whose
policies focused on achieving substantial reductions in absolute poverty even at very low
incomes and with relatively low growth rates such as Sri Lanka, and the state of Kerala
in southwestern India.

Keynote: economic growth happens mainly in the traditional sector, improving incomes and
living standards for people in this group. Examples of such growth could be:

● Introducing better farming methods.

● Supporting rural development programs.
● Providing access to education or health services in rural areas.

Using these three special cases and Lorenz curves, Fields demonstrated the validity of the
following propositions (reversing the order just presented):

Using Lorenz Curve, the distribution of income of the following cases are shown:

1.) In the traditional-sector enrichment typology, growth results in higher income, a more
equal relative distribution of income, and less poverty. Traditional Sector enrichment
growth causes the Lorenz curve to shift uniformly upward and closer toward the line of
equality.
Why is there a reduction of inequality?
● As the traditional sector becomes more productive, incomes for poor, rural workers rise.
● This closes the income gap between the traditional and modern sectors.
● More people benefit from growth, leading to greater equality in the economy.

2.) In the modern-sector enrichment growth typology, growth results in higher incomes,
a less equal relative distribution of income, and no change in poverty. Modern-sector
enrichment growth causes the Lorenz curve to shift downward and farther from the line
of equality.

Inequality happens:
● Since growth is limited to a small, wealthy group in the modern sector, the income gap
between the modern and traditional sectors increases.
● Inequality worsens because the rich get richer, but the poor remain poor.
3. Finally, in the case of Lewis-type modern-sector enlargement growth, absolute incomes
rise and absolute poverty is reduced, but the Lorenz curves will always cross, indicating that we
cannot make any unambiguous statement about changes in relative inequality: It may improve
or worsen. Fields shows that if, in fact, this style of growth experience is predominant, inequality
is likely first to worsen in the early stages of development and then to improve.

As this enlargement happens, income inequality can follow three phases depending on how the
transition unfolds:

Phase 1: Rising Inequality (Early Growth)

● At first, only a small number of people move to the modern sector and enjoy higher
wages.
● Most people stay in the low-income traditional sector, so the gap between the rich and
poor widens.

Phase 2: Peak Inequality

● Over time, more people transition to the modern sector, but inequality is still high
because the income gap between the two sectors remains large.

Phase 3: Falling Inequality (Later Growth)

● Eventually, most people work in the modern sector, and the economy becomes more
uniform.
● Wages in the traditional sector may also rise due to fewer workers being left behind.
● As a result, the gap between rich and poor shrinks.
The Lorenz curve shifts during this process:

● In Phase 1, the curve bows further away from the line of equality (more inequality).
● In Phase 3, the curve moves closer to the line of equality (less inequality).

The process of modern-sector enlargement growth suggests a possible mechanism that could
give rise to Kuznets’s “inverted-U” hypothesis, so we turn to this question next.

Kuznets’s Inverted-U Hypothesis

Simon Kuznets suggested that in the early stages of economic growth, the distribution of
income will tend to worsen; only at later stages it will improve.

Suggesting that inequality follows an inverted U-shape, because a longitudinal (time-series) plot
of changes in the distribution of income—as measured

This graph reflects the relationship between a country’s income per capita and its equality of
income distribution.

graph:

● The x-axis is the level of economic development (time or GDP per capita).
● The y-axis is the level of income inequality.
● The line looks like an upside-down "U", showing how inequality rises first, then falls.
Explanations as to why inequality might worsen during the early stages of economic growth
before eventually improving are numerous. They almost always relate to the nature of structural
change. Early growth may, in accordance with the Lewis model, be concentrated in the modern
industrial sector, where employment is limited but wages and productivity are high.

As just noted, the Kuznets curve could be generated by a steady process of modern-sector
enlargement growth as a country develops from a traditional to a modern economy.

Alternatively, returns to education may first rise as the emerging modern sector demands skills
and then fall as the supply of educated workers increases and the supply of unskilled workers
falls.

Kuznets did not specify the mechanism by which his inverted-U hypothesis was supposed to
occur; it could in principle be consistent with a sequential process of economic development.

But as shown earlier, traditional- and modern-sector enrichment would tend to pull inequality in
opposing directions, so the net change in inequality is ambiguous, and the validity of the
Kuznets curve is an empirical question.

a few development economists would argue that the Kuznets sequence of increasing and then
declining inequality is inevitable. There are now enough case studies and specific examples of
countries such as Taiwan, South Korea, Costa Rica, and Sri Lanka to demonstrate that higher
income levels can be accompanied by falling and not rising inequality. It all depends on the
nature of the development process.

Evidence on the Inverted-U Hypothesis

This data shows data collected from 16 countries on the percentage shares in total national
income going to different percentile groups.

The figures recorded give a first approximation of the magnitude of income inequality in
developing countries. For example, we see that in Zambia, the poorest 20% (first quintile) of the
population receives only 3.6% of the income, while the highest 10% and 20% (fifth quintile)
receive 38.9% and 55.2%, respectively. By contrast, in a relatively equal developed country like
Japan, the poorest 20% receives a much higher 10.6% of the income, while the richest 10% and
20% get only 21.7% and 35.7%, respectively. The income distribution of the United States, a
relatively less equal developed country, is given for comparison.

Consider now the relationship, if any, between levels of per capita income and degree of
inequality. Are higher incomes associated with greater or lesser inequality, or can no definitive
statement be made?
provides data on income distribution in relation to per capita GNI for a sampling of countries,
arranged from lowest to highest in terms of per capita income.

per capita incomes are not necessarily related to inequality.

Income vs. Inequality Relationship:

● Per capita income does not consistently correlate with inequality.

● Poor countries can have both low inequality (e.g., Ethiopia) or high inequality (e.g.,
Mozambique).
● Middle-income countries include both high-inequality regions (e.g., Latin America) and
low-inequality ones (e.g., Egypt, Indonesia).
● High-income countries often have lower inequality but with considerable variation, and
inequality has been rising recently in some of them.

Which comes to this question:

Could the Kuznets curve that is seen in the data be a mere statistical fluke resulting from the
fact that for extraneous historical reasons, most Latin American countries just happened to have
both a middle level of income and a high level of inequality? And could a combination of both
cross-sectional and longitudinal (time-series) data help resolve the question?

Gary Fields and George Jakubson examined this question.

plots a combination of data from the 35 countries in Fields and Jakubson’s data set, t, where
reliable estimates of the Gini coefficient have been available for various developing countries at
different points in time. The inverted-U relationship, tracing the triangles, is computer-generated
parabola that best fits the data under standard statistical criteria.
Latin America’s Influence on the Kuznets Curve:

● The "Latin America effect" suggests that Latin America’s historical circumstances
(middle incomes and high inequality) strongly influence the perceived inverted-U shape
of the Kuznets curve.
● When Latin American countries are statistically controlled, the inverted-U pattern tends
to disappear.

So the question is, what happens over time?

Longitudinal (Time-Series) Findings:

● Countries show diverse trends:

● Brazil exhibits an inverted-U.
● Hong Kong and Singapore follow a U-shaped pattern.
● Many Asian countries show no consistent pattern.
● Combining such mixed trends can misleadingly produce an overall inverted-U.

As a result of this work, the dominating influence of the “Latin America effect” has been strongly
supported. In fact, for many countries, there is no particular tendency for inequality to change in
the process of economic development.

Inequality tends to remain stable in most countries unless there are major disruptions or strong
policies, such as:

● Land reforms in Japan, Taiwan, and South Korea, which were driven by external forces
(e.g., U.S. occupation).

But inequality can be gradually reduced through well-implemented policies to promote pro-poor
growth over time.