by From Richard Koo and issue 92 of RWER Income inequality has become one of the hottest and most controversial issues in economics not only in the developed world but also in China and elsewhere as well. Many are growing increasingly uncomfortable with the divide between the haves and the have-nots, especially after Thomas Piketty’s Capital in the 21st Century2sparked a fresh debate on the optimal distribution of wealth, an issue that had been largely overlooked by the economics profession. This paper argues that the determinants of income inequality changes depending on the stage of economic development. The three stages of industrialization identified for this purpose are: urbanizing era, when the economy has yet to reach the Lewis Turning Point (LTP), post-LTP maturing or golden era
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from Richard Koo and issue 92 of RWER
Income inequality has become one of the hottest and most controversial issues in economics not only in the developed world but also in China and elsewhere as well. Many are growing increasingly uncomfortable with the divide between the haves and the have-nots, especially after Thomas Piketty’s Capital in the 21st Century2sparked a fresh debate on the optimal distribution of wealth, an issue that had been largely overlooked by the economics profession.
This paper argues that the determinants of income inequality changes depending on the stage of economic development. The three stages of industrialization identified for this purpose are: urbanizing era, when the economy has yet to reach the Lewis Turning Point (LTP), post-LTP maturing or golden era when the economy moves along an upward sloping labor supply curve, and pursued era, when the return on capital is higher abroad in emerging economies than at home. The LTP refers to the point at which urban factories have finally absorbed all the surplus rural labor. (In this essay, the term LTP is used only because it is a well-known expression for a specific point in a nation’s economic development; the use of this term does not refer to the model of economic growth proposed by Sir Arthur Lewis.)
At the advent of industrialization, most people are living in rural areas. Only the educated elite, who are very few in number, have the technical knowledge needed to produce and market goods. Families whose ancestors have lived on depressed farms for centuries have no such knowledge. Most of the gains during the initial stage of industrialization therefore go to the educated few, while the rest of the population simply provides labor for the industrialists. And with so many surplus workers in the countryside, worker wages remain depressed for decades until the LTP is reached.
Exhibit 1 illustrates this from the perspective of labor supply and demand. read more