Interrelationships Among Income Distribution, Institutions and Growth

and Hypotheses on the Effects of

Different Types of FDI

Daniel S.C. Lee

THE DETERMINANTS AND THE EFFECTS OF INCOME INEQUALITY

Income Inequality

Fertility

Skill-complementary technological change

International Trade FDI inflows and outflows Growth

Growth retarding Neutral or conditional Growth enhancing

Rich vs. poor countries

Democracy vs. non-demo

Short/medium vs. long-term effect

Redistribution

Political instability and violence

Incentive

Redistribution Imperfect capital market

Institution/Property rights

INSTITUTION/PROPERTY RIGHTS

Author Data/Methodology Findings

Chong andGradstein 2004

Deininger and Squire(1996) Milanovic (2002a, 2002b)

GMM-IV

The authors establish double causality between better institutional qualityand a more equal distribution of income, but also demonstrate that the linkfrom the latter dominates the former.

Keefer and Knack2002 PC

Deininger and Squire(1996)

Cross-country

Income inequality reduces the security of property and contract rights and,through this channel, reduces growth.

Sonin 2003 JCE Case of Russia In unequal societies, the rich and powerful have an incentive to subvert theemergence of efficient institutions. They may instead benefit from shapinginstitutions in their favor. And they can afford private protection.

Glaeser,Sheinkmand andShleifer 2003 JME

Deininger and Squire(1996)

Cross-country

In many countries, the operation of legal, political and regulatoryinstitutions are subverted by the wealthy and politically powerful for theirown benefit. Inequality in economic and political resources increases suchsubversion, thus hindering economic growth.

Hoff and Stiglitz2004 AER

Game theoretic analysis In societies with poor institutions and assets to steal, individuals maydecide to strip assets rather than to build value. Thus, they may oppose theestablishment of the rule of law.

FERTILITYAuthor Data(income inequality) Findings

Croix and Doepke 2003AER

Deininger and Squire(1996)

GMM

Income inequality increases the fertility differential. Poor parentstend to have more children and invest little in education.Consequently, an increase in inequality lowers the average educationand thus growth. Who is having the children matters.

Perotti 1996 JEG Income inequality impedes economic growth via sociopoliticalinstability, education/fertility and borrowing constraints.

SOCIO-POLITICAL CONFLICTPerotti 1996 JEG Income inequality impedes economic growth via sociopolitical

instability, education/fertility and borrowing constraints.

Alesina and Perotti 1995 EER

The share of total income of the 3rd and 4th quintile (Jain 1975)Cross-country for the period 1960-85

Income inequality, by increasing socio-political instability, creates uncertainty in the political and economic environment. This in turn reduces investment and thus growth.

IMPERFECT CAPITAL MARKET

Benabou 1996NBER

Deininger and Squire(1995a).the LuxembourgIncome Study (LIS).

Benabou shows how redistributive policies simultaneously depress savings incentivesand ameliorate the wealth constraints that impede investment by the poor. He alsosuggests that inequality increases socio-political conflict which in turn reduces thesecurity of property rights and thus accumulation.

Alesina and Rodrik 1994 QJE

Gini coefficient (Jain 1975; Fields 1989)

Cross-country from 1965-85

The greater the inequality of wealth and income, the greater the political pressure for redistribution. As a consequence, the rate of taxation may increase in order to redistribute income. High tax rates can reduce growth by lowering the incentive for economic activities.

Persson and Tabellini 1994AER

The share in personal income (pre-tax) of the top 20%

Cross-country from 20 year period

In a society where distributional conflict is an important issue, political decisions produce economic policies that tax investment and growth-promoting activities. This relation is only present in democracies.

REDISTRIBUTION

NEUTRAL AND/OR CONDITIONALRavallion2001 WB

Growth effect of inequality varies widely from one country toanother. In other words, the relationship between inequality andgrowth is not significant enough to make a generalization.

Barro 2000JEG

Deininger and Squire (1996)

Panel of the averages from eachdecade for the sample period1965-95

3SLS

Higher inequality tends to retard growth in poor countries, butencourage it in richer ones.

Forbes 2000 AER Deininger and Squire (1996)

Panel of the averages fromeach 5-yr period for the sampleperiod 1966-95

Using a panel analysis, she shows that inequality may be apositive influence on growth in the short and medium term.Yet, she admits that its positive relationship may diminish oreven reverse in the long run.

GROWTH-ENHANCING EFFECT

ARRIVAL OF NEW DATABASE: WIID2aRevision of the WIID1

data… Before any updating was done, WIID1 – including the data of Deninger & Squire 1997 (D&S 1997) –was first revised and cleaned… 1)…overlapping estimates in WIID1, resulting from the mergies of estimates collected by WIDER and

D&S 1997, were deleted.2) Low-quality estimates for country-years with high quality estimates available were also deleted…3) Almost all data points based on the Luxembourg Income Study5 (LIS) reported by D&S 1997, WIDER

or other authors were deleted and replaced by new estimates…4) The Transmonee data by UNICEF/ICDC6 were also re-entered, as updates to that source have been

made.5) If several authors referred to the same source using very similar methods or referred to a source already

included in the database, we strived to report only one estimate. This principle also led us to delete many estimates.

6) Finally, estimates for very limited groups such as wage earners in metropolitan towns, were deleted if information on larger population groups was available.

New estimates added The new data of Deininger & Squire 2004 (D&S 2004), the unit record data of the Luxembourg IncomeStudy (LIS), the Transmonee data by UNICEF/ICDC, Central Statistical Offices and research studies arecentral sources of the new estimates added in the database. The update by D&S 2004 is only published inWIID2a…

New variables added We report two different Gini coefficients in WIID2a. The first one is calculated by WIDER usingmethods developed by Tony Shorrocks and Guang Hua Wan to estimate the Gini coefficient fromdecile data almost as accurately as if unit record data were used… The second Gini coefficient is calledthe “reported Gini” and is the one reported by the source or calculated by WIDER or Deininger & Squirefor the old databases using POVCAL, a program for estimating the Gini coefficient using parametricextrapolation.…in WIID2a, survey estimates of means and medians are also included along with the income shares ofthe poorest 5 percent and richest 5 percent of the population whenever available… The decision toinclude survey means and medians was taken as these estimates at least in theory should provide anindication on the level of the living standards.

THE EFFECT OF DIFFERENT TYPES OF FDI ON INSTITUTIONS

Income Inequality

FDI inflows

Growth retarding

Institution/Property rights

PRIMARY

Author Finding

Ross 2001 WP Oil and mineral wealth impedes democracy.

Sachs and Warner 1995 NBER

Natural resource abundance retards growth.

SERVICESWorld Investment Report 2004

Rising importance of services in FDI flows

•The world’s inward stock of services FDI quadrupled between 1990 and 2002, from an estimated $950 billion to over $4 trillion.•On average, services accounted for about two-thirds of total FDI inflows (and 70% of outflows) over 2001-2002 – an estimated $500 billion ($450 for outflows) per year.    Why are service industries important for the overall competitiveness of economies?

•Services account for the largest share of economic activity in most countries.•…the availability, cost and quality of modern intermediate services – infrastructural, financial, professional, business – affect the competitiveness of products in all sectors…•…basic services such as health, education, water and sanitation, directly contribute to improving living standards as well as to building human resources. 

Konan and Maskus 2002

Services liberalization increases economic activity more evenly across sectors, while trade liberalization reorients production toward sectors with comparative advantage. As a result, services liberalization requires lower adjustment costs, as measured in terms of sectoral movement of workers, than goods trade liberalization does. 

BANKING

Clarke, Cull, Peria and Sanchez 2005 JMCB

Large foreign banks surpass large domestic banks in their share and growth of lending to small businesses.

Clarke, Cull, Peria and Sanchez 2002WB

While foreign banks tend to be large, and large banks devote smaller shares of their portfolios to small businesses than other banks, there are some signs that technological change might allow large foreign banks to serve this sector.

Bonin and Abel 2000 WB

Foreign entry provided healthy competition to OTP and prodded this widely held domestically controlled bank to develop new products and better services for Hungarian households.

PRODUCER SERVICES Markusen, Rutherford and Tarr 2000 NBER Markusen 1989 AER

FDI into producer services such as managerial and engineering consulting increases the productivity of the final goods sector that uses these firms’ services as intermediate inputs. The expansion of the final goods sector increases the demand for producer services of both foreign and domestic origin.

Jensen, Rutherford and Tarr 2004

Multinational service providers will reduce the quality-adjusted cost of purchasing business services.

Roller and Waverman 2001 AER

Network externalities (the more users, the more value is derived by those users), present in telecommunication infrastructure, imply that its effect on growth might not be linear. This suggests that increases in telecommunications infrastructure could create higher growth effects in OECD countries than in the less-developed non-OECD countries.

 

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