Inequality and the Growth Process: An Essay on Development Dynamics

The existing literature on income inequality and economic growth can be decomposed broadly into two main strains. One, recently advanced, investigates the impact of the initial inequality on subsequent economic growth. The other, rather older, strain examines the evolution of inequality along with the level of development, especially in dualistic economies, referring in turn to the relationship between growth and inequality. However, neither strain adequately addresses the issue of the dynamic, contemporaneous relationship between growth and inequality. I argue here that this relationship depends both on the growth process and the state of technology. The fundamental growth factors are physical and human-capital, so the growth process could be intensive in either one of these elements or it could be a balanced ratio between the two. Given the state of technology, I model inequality as a function of the growth process, i.e., inequality as a function of the factor ratio. Two types of agents are introduced, capitalists and human-capitalists, and the relationship between the consumption growth-path of the two agents and the factor ratio is formalized. The production side is then incorporated and the relationship between the functional income distribution and the factor ratio is analyzed, all conditional on the state of technology. It then becomes possible to infer the relationship between the functional and personal income distributions. Finally, the determinants of inequality of a cross-section of countries is examined with special reference to the impact of the growth-process on income inequality. The empirical results indicate that, along with other variables, the factor ratio exhibits a significant non-linear partial association with income inequality.