Development and income inequality: A new specification of the Kuznets hypothesis

Substantial research has assessed the Kuznets hypothesis, which is a traditional relationship between inequality and development. The Kuznets hypothesis suggests that as development proceeds a country will experience first rising then falling income inequality. However, the existing literature analyzes the relationship between income inequality and per capita income, which is, at best, an incomplete measure of the multi-dimensional process of economic development. This paper explores the relationship between income inequality and development utilizing the more expansive, multidimensional Human Development Index (HDI) as the measure of development. Based on the “capabilities” approach to development, the Human Development Index incorporates key dimensions of human development that are particularly suitable for examination in the context of the Kuznets hypothesis. These include health and education measures as a complement to more traditional measures of living standards, such as per capita gross domestic product (GDP). In the Human Development Index, population health is measured using life expectancy at birth, while a measure of education is formed from a weighted average of the primary, secondary, and tertiary enrolment ratio and the adult literacy rate. The standard of living is captured by per capita GDP, and all three are incorporated into the overall human development index. Using data from 147 countries for the years 1992 through 2007, we analyze the relationship between income inequality, as measured by the Gini coefficient, and economic development, measured with the Human Development Index (HDI) and its constituent dimensional indices: the GDP index, the Life Expectancy Index and the Educational Index. Using both ordinary least squares with clustered standard errors and a fixed effects analysis, we find that the use of different measures of development significantly affects the shape of the Kuznets curve. Specifically, the results imply an S-curve in which, beginning at the earliest stages of a country’s development, growth in human development (as measured by the HDI) results in falling income inequality followed by a brief rise and then another fall in income inequality. To the best of our knowledge, this is a relationship not seen in the existing literature to date. In doing so, the results call into question the traditionally held view of the relationship between income inequality and human development. They also provide a basis on which the Kuznets hypothesis may be further examined in the future and suggest that rising inequality may not be a necessary part of the process of a country’s development.