What Kuznets and his Followers Failed to Understand

Many Economists like to believe that things get better in the long run. Here comes the truth. – A Guest-Post by Laura Schnurr.

In 1955 Simon Kuznets wrote an influential piece about the relationship between economic growth and income inequality. He proposed that as a country develops, economic inequality first increases but eventually decreases in later stages of development. His hypothesis of an inverted U- shaped curve representing the relationship between growth and inequality, the ‘Kuznets curve’, was explained by the processes of urbanization and industrialization. It was believed that the transition from an agrarian to industrial sector would initially increase inequality as physical capital accrual represents the main source of growth, and firm owners would be the primary beneficiaries. Over time, however, as education and welfare policies increase and human capital replaces physical capital as the most important source of growth, inequality would decline and gains would spread more evenly across society (Kuznets 1955).

In the early 1990s proponents of the Kuznets curve extended the theory to the environment, arguing that although growth may have negative effects on the environment in the short run it would eventually lead to positive developments and environmental protection. In each case the message is clear: economic growth will eventually lead to greater social and environmental justice. Liberals would like to have us believe this as it legitimizes our endless pursuit of growth and continuous neglect for positive actions to be taken to promote equality and justice, yet there is no logical reason that this would be the case (and in general it has not been, if history is any indication). Kuznets’ simple cause and effect correlation ignores the important role that governments play in the process, as well as that of private interests. It also assumes homogenous development paths across countries while overlooking historical differences and national preferences.

Contrasting experiences of growth and inequality
The assumption that growth inevitably leads to an increase in inequality in the short run was proven wrong by the experience of the East Asian Miracle. From the 1960s to the mid 1990s eight East Asian countries -Singapore, South Korea, Taiwan, Hong Kong, Japan, Thailand, Malaysia, and Indonesia- experienced high economic growth rates and rapid industrialization. Though contrary to what the Kuznets curve would predict, they simultaneously managed to reduce absolute poverty and share the wealth generated across all levels of society. Nobel prize-winning economist Joseph Stiglitz (1996) studied how the East Asian countries were able to achieve both rapid growth rates and an immediate reduction in inequality, and concluded that it was due its export-led growth policies in a stable, market-oriented environment coupled with active government intervention. The World Bank’s East Asian Miracle report published in 1993 stressed the importance of free market capitalism in explaining East Asia’s growth, while downplaying the crucial role of the government. In fact, much of East Asia’s success was a result of government policies that invested heavily in physical and human capital. Large investments were made in education, making it more accessible to all classes. At the same time, land reform policies were pursued which increased productivity, incomes and savings rates of rural populations (Stiglitz 1996). Initial growth enabled governments to invest in policies that encouraged equality, which in turn promoted further growth. The result was less inequality and a broad distribution of income between urban and rural populations, contrary to the conventional belief that urban industrialization would necessarily lead to lower wages due to an influx of cheap labour from rural areas to cities.

Kuznets’ theory goes on to state that as countries industrialize, income inequality levels will decrease. Yet this is the exact opposite of what we have observed in industrialized countries over the past few decades. In the United States for example, income inequality has grown significantly since the 1970s after several decades of relatively stable levels. The Gini index measured income inequality in the US at 38.6 in 1968 and 46.69 in 2008, representing a 21% increase over the 30 year period (US Census Bureau 2009). Similar trends can be observed in other OECD countries, such as the UK, Australia and New Zealand. As high income countries, we should expect to find both decreasing inequality and inequality coefficients well below the average value for all countries, neither of which has been true (Weeks 2005). As with the case of the East Asian Miracle, the reason these countries refute the Kuznets curve hypothesis is simple: government policies. Each of these countries underwent drastic neoliberal reforms during the past 30 years in which they cut back the role of the state and pursued an agenda that would result in greater concentration of wealth among those at the top of the distribution. Changes in US federal tax policies since the 1960s are an example of the how the government acted in support of the top earners in society. The total federal tax rates have fallen significantly for high and very high earners (highest earning 1% and 0.01% of taxpayers) since the 1960s while a general convergence among earners in various tax brackets can be observed (Piketty & Saez 2007).

Providing tax cuts for the rich while at the same time reducing government spending in education and welfare programs led to policy-driven inequality. Contrasting the experiences of East Asian countries that pursued policies that encouraged equality with liberalizing countries whose policies promoted inequality sheds light on the wide spectrum of distributive outcomes that can emerge from growth, either in the short or long run. The Kuznets curve theory therefore depends on a certain minimal role of the state in welfare enhancing activities and redistribution of wealth but not an excessive amount. Additionally, the role of the state should be weak in the beginning and gain weight over time. As soon as a government acts outside the ‘appropriate’ limits or follows an alternative path, the theory is of no use.

Still awaiting environmental justice
If the Kuznets curve theory applied to inequality was based on questionable logic and implausible assumptions, the environmental Kuznets curve may be even worse. The notion that economic growth will inevitably lead to environmental protection after an initial period of decline is misleading and even preposterous. The highly industrialized countries are amongst the worst per capita polluters in the world and much of the pollution in the developing world comes from production fueled by developed countries’ demands. Greenhouse gas emissions in particular, the main contributor to climate change, are much higher in industrialized countries (Carbon Planet). Similarly, natural resource use is greater among developed countries and ecosystems and biodiversity suffer disproportionately. Economists reluctant to recognize the incompatibility of infinite growth on a finite planet continue to argue that growth will provide the solution. Not surprisingly they fail to provide any sort of timeframe, reassuring us to wait patiently. But how long is too long? As economist John Maynard Keynes famously stated “in the long run we are all dead”.

Even supposing growth could lead to more efficient technology and forms of production in an acceptable period of time, who is to say that it will? The significant role of private actors is such that potentially greener, more environmentally sound technologies are consistently blocked from emerging by powerful lobbyists. The energy lobby in the United States, consisting of representatives of large oil, gas, coal and electric utilities corporations, has long had a stronghold over government policy. Contributions of tens of millions of dollars to political campaigns reflect its influence. In 2006, the energy lobby contributed over US$19 million to political campaigns, 82% of which went to Republican candidates. Election years reported even greater contributions, with over US$25 million donated in 2004 and US$34 million in 2000 (Center for Responsive Politics). The case of the electric car demonstrates the power of multinational corporations and private interests in maintaining the status quo in face of progressive alternatives. When electric cars were being developed and marketed in Southern California in the 1990s to provide an alternative to fuel- run cars and reduce the emissions of harmful gases into the atmosphere it seemed that progress was being made. Then production, marketing and sales of the electric cars were abruptly stopped by inefficient industries that would have been negatively affected by the new developments. Oil and car companies were reluctant to lose market share to a greener alternative and used their power and financial resources to ensure no change would occur. Unfortunately the electric car was not a unique case, and countless similar examples have occurred over the past decades where political power allowed private interests to prevail.

Economics can no longer ignore politics
The Kuznets curve relating growth to inequality, and the environmental Kuznets curve derived from it, have fundamental flaws. In both cases there exists ample evidence that disputes the theories and proves that inequality and environmental degradation are path dependent, and uniquely defined by the actors and external forces involved. For better or worse, government policies and private actors have significant influence on shaping inequality and the natural environment. The contrasting cases of growth in East Asia and the United States demonstrate the influence of government policies on inequality, while the power of lobbies show that private interests will too often act in preventing environmentally sustainable alternatives from gaining space. Kuznets failed to understand the importance of politics in developing economic theory and as result proposed a grand theory with few practical applications. The good news is that once we acknowledge this fundamental failure, we can no longer justify taking a passive role when it comes to social justice and the environment. Instead we need to develop policies aimed directly at reducing poverty and inequality while improving environmental sustainability. Sitting around waiting for positive change has not gotten us anywhere in the past, and there is no reason to believe that it will now.

Laura Schnurr a full-blood globetrotter from Montreal, Canada is currently enrolled in Global Studies at four different universities around the world. She is passionate about what economics could and should be and enjoys and enjoys the culinary side of her travels.

Visit her Social business at: www.beadsofawareness.org.

Picture courtesy by Georgie Sharp, thanks!


3 thoughts on “What Kuznets and his Followers Failed to Understand

  1. What we require is not just a way to correctly manage growth, but rather an entirely new economic model in which wealth is not defined by growth. Keynsian or otherwise, we need to entirely reconsider such commonly-held concepts as currency, trading, and measurement of success. We must acknowledge that if things continue as they are now it is conceivable that the world will eventually have just one mega-corporation, just one infinitely wealthy person, and billions of people living as corporate slaves because they are too poor to purchase any products. Redesigning our economy does not mean that Adam Smith need be thrown out the window, but rather that the factors which have led us to corporate insatiability must be made sustainable. No easy task, I would refer you to http://www.neweconomics.org/ and http://neweconomicsinstitute.org/

    • I am constantly telling Laura that the nef would be the perfect place for her… so hopefully you’ll soon see her work there, Rob 🙂

  2. Pingback: Bye Bye GDP | Kosmos 9

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