Do the Benefits of Economic Growth Favor the Rich?

Theory and Evidence from Developed and Developing Countries

Jay T. Chittooran
May 5, 2009

Abstract: This paper focuses on the relationship between economic growth and the

distribution of the income. However, previous attempts to answer this question have ignored, for the most part, government social spending, aimed at redistributing wealth. Using data from 40 countries over 80 country-years, this paper analyzes economic growth in terms of GDP, GDP Change, and GDP per capita, income inequality in terms of the Gini index, and government social spending in terms social contributions in both the currency and as a percentage of GDP, to determine this relationship. Based on the multivariate regression output, this study has shown that as a country grows economically, the Gini index increases. Concurrently, social spending begins to increases, albeit slowly. However, at a point, the Gini index plummets as the amount of social contributions drastically increases. Based on this, the hypothesis is correct in poor countries, but is incorrect in wealthy countries.

Key Words: income inequality, economic growth, Gini index, government entitlements, development, distribution of benefits, social spending, GDP per capita

John C. Whitehead School of Diplomacy and International Relations, Seton Hall University, email chittoja@shu.edu, telephone: 314/795/5524.

Electronic copy available at: http://ssrn.com/abstract=1505649

Table of Contents
1 2 3 4 Introduction ............................................................................................................ 1 Issue/Literature Survey .......................................................................................... 3 Claim/Testable Hypotheses .................................................................................... 8 Analysis and Findings .......................................................................................... 10 4.1 Analysis/Model ............................................................................................... 10 4.2 Findings .......................................................................................................... 11 5 Policy Implications ............................................................................................... 23 6 Concluding Comments ......................................................................................... 25 Appendices ................................................................................................................... 27 Appendix 1: Data Description .................................................................................... 27 Appendix 2: Methodology ......................................................................................... 27 References .................................................................................................................... 30

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Electronic copy available at: http://ssrn.com/abstract=1505649

Do the Benefits of Economic Growth Favor the Rich? Theory and Evidence from Developed and Developing Countries
1 Introduction

Do the benefits of economic growth favor the rich? Essentially, this research question seeks to examine the relationship between economic growth and income inequality. Studying this, my research topic and this area, is of vital importance. Currently, there are about 3 billion people living in poverty, which is nearly 50 percent of the worlds total population.1 Of these, 2.6 billion people live on under $2 (adjusted for PPP) per day; this number represents about 40 percent of the worlds total population. 2 Even worse, roughly 1 billion people live on a mere $1 per day or less, which is the standard for absolute poverty.3 A majority of those living in absolute poverty live in Africa and Southeast Asia. Simultaneously, the richest 5 percent of the world receive more than 30 percent of the worlds total income. Indeed, we live in a society of diametric opposites. It is estimated that the worldwide Gini index, which measures income inequality on a scale of 1 being equal to 100 being completely unequal, is at approximately 65. 4 Branko Milanovic, an economist at the World Bank, best characterizes the significance of this: The top 5 percent of individuals in the world receive about 1/3 of total world income. The bottom 5 percent receive 0.2 percent of total world income. This means that the ratio between the average income received by the richest 5 percent and the poorest 5 percent of people in the world is
1

Human Development Report 2007/2008. Rep. 2007. United Nations Development Programme. 15 Sept. 2008 <http://hdr.undp.org/en/media/hdr_20072008_en_complete.pdf>. 1-384. 25 2 Human Development Report 2007/2008 25 3 Human Development Report 2007/2008 25 4 Milanovic, Branko. Global Income Inequality: What it is and Why it Matters? Working paper no. 26. Aug. 2006. United Nations Department of Economic and Social Affairs. 2 May 2009 <http://www.un.org/esa/desa/papers/2006/wp26_2006.pdf>. 1-17. 9

165 to 1. The richest people earn in about 48 hours as much as the poorest people earn in a year.5

These aforementioned numbers are simply shocking. This is no surprise; the wealthy control the preponderance of money, while those in poverty are living on nothing. As members of the global community, we must acknowledge that the lack of fair opportunities for all is simply inexcusable and something should be done to ameliorate the situation. Those in the depths of poverty should be helped by their respective states to lift them from a state of endemic poverty. Only recently has the relationship between economic growth, poverty, and inequality been studied properly. Because of this

ostensible dearth of study, research and analysis in this field, this particular research study aims to properly determine, using many statistical tools, including a multivariate regression, if those in poverty are receiving fair benefits when compared with those in the upper income quintiles in a given country. However, this paper will incorporate data under the government aid nomenclature. Government investment, which includes entitlements and pensions, is redistributive in nature and can alter the rates of income inequality; thus, this paper will attempt to control for these plausible alternatives. By understanding the situation of those in poverty, we can better work to solve these problems that plague not only certain countries in Africa, Southeast Asia, or other perceived Third World Countries, but rather, problems that face all countries across the globe. For this research project, economic growth, which will be measured using gross domestic product data, will be the independent variable, while income inequality, which will be measured using the Gini indices, will be the dependent variable. Additionally, this
5

Milanovic 9

paper will control for any entitlements, pensions, and other investments from the government, all of which seek to redistribute wealth and alter the real income inequality rates. This adjustment will fall under the government aid category. I will test my research question by running a multivariate regression to determine if a relationship exists between economic growth and favoritism of the rich, and if one exists, what kind of relationship is it. I will include data from many countries from many different time periods. By doing this, the results will hold greater explanatory power and be more applicable.

Issue/Literature Survey
There are many answers to the research question in the extant literature. The

literature review is divided into two distinct categories: articles that analyze the relationship between economic growth and income inequality, and articles that investigate the relationship between government spending and income inequality. The literature review will begin the survey with articles that study the economic growth/income inequality relationship. The first article, Income Inequality is not Harmful for Growth: Theory and Evidence by Hongyi Li and Heng-fu Zou, as the title indicates, suggests that income inequality and economic growth are positively correlated. Li and Zou use 46 developing and developed countries over the 1947-1994 period as their dataset.6 This article uses the CES utility function and a standard growth production function to evaluate the intersection of income inequality and economic growth. Based on their analysis, Li and

Li, Hongyi, and Heng-fu Zou. "Income Inequality is Not Harmful for Growth: Theory and Evidence." Review of Development Economics 2 (1998): 318-34. 318-320.

Zou determine that economic inequality is positively, and very often even significantly, associated with economic growth.7 While these authors proffer a strong claim, the main problem with this research is that the authors framed their answers by using a comparatively small dataset that they admittedly cleansed.8 The Harrod-Domar growth model also postulated a similar position. Harrod and Domar rationalized this relationship actually occurred because the rich control a higher percentage of the wealth and can invest their money in the market, goods, and services, while the poor can only use their money for buying necessary goods.9 Growth is Good for the Poor by David Dollar and Aart Kraay have promoted ideas that have been widely accepted and praised; while the previous article acknowledged that the benefits of economic growth often are not passed to everyone, Dollar and Kraay promote an antithetical notion. In this empirical study, Dollar and Kraay use a sample of 92 countries over the course of 285 country years (Dollar and Kraay 2002).10 Dollar and Kraay reveal that average incomes of the poorest fifth of a country on average rise or fall at the same rate as average incomes. 11 Based on this study, it is clear that the incomes of those in the poorest quintile did not vary significantly when compared to the average income. Further, average incomes across each income quintile did not show variance when compared to each other in times of economic boom or bust. However, data irregularities, which when accounted for, yield opposite results,

7 8

Li and Zou 322 Li and Zou 328 9 Van Den Berg, Hendrik, and Joshua J. Lewer. International Trade and Economic Growth. New York: M.E. Sharpe, 2006. 305. 84-85; Ghatak, Subrata. Introduction to Development Economics. London: Routledge, 2003. 458. 54-56. 10 Dollar, D. & Kraay, A. (2002). Growth is Good for the Poor. The World Bank, 1-43. 1-2 11 Dollar and Kraay 27

plague this article. This article goes so far as to say that the evidence provided does not even support the idea that the trickle-down sequence is either appropriate or effective. Other articles, including Inequality and Growth in a Panel of Countries, by Robert Barro, claim that the relationship between inequality and growth can vary greatly. Using a general panel of 100 countries from 1960-1995, the regression results reflected a Kuznets (an inverse U) curve, which essentially verifies his claim that inequality retards growth in poor countries but encourages growth in richer places.12 Barro avers that $2000 GDP per capita is the apex of the curve; that is, this is the point at which growth transitions from slowed to encouraged.13 Barro also fails to mention what countries he chose for the study. Knowing what countries Barro selected would strengthen his overall case as we can determine if there was a selection bias. Additionally, the results of Barros study could have been altered by many countries that were not included in this study; because Barro used a rather long period in which many countries, specifically in Eastern Europe and Africa, were not yet countries; thus, this possibly could have affected the results. This following section of the literature review examines the relationship between government social spending and income inequality. Studies on the effect of income distribution on economic growth that have included government social spending data have yielded interesting results. Some authors claim that social spending causes deeper income inequality, while others indicate that redistributive government practices are not related to income inequality.

12

Barro, Robert. "Inequality and Growth in a Panel of Countries." Journal of Economic Growth 5 (2000): 5-32. 29 13 Barro 31-32

In both Distributive Politics and Economic Growth and The Political Economy of Growth: A Critical Survey of the Recent Literature by Alberto Alesina and Dani Rodrik, the authors indicate that redistributive spending that is financed by taxation has the potential to reduce the incentive for capital accumulation and investment.14 By curtailing this enhancement of wealth, economic growth is significantly limited. Similarly, Perrson and Tabellini in their article Is Inequality Harmful for Growth? Theory and Evidence, aver that a negative relationship exists between income inequality and growth when government aid, or social expenditure aimed at the redistribution of wealth, is frequently utilized.15 Essentially, when government aid systems are in place and engaged, income inequality will worsen, despite a growing economy. In the IMF Working Paper entitled Income Inequality and Redistributive Government Spending by Luiz de Mello and Erwin Tiongson, the authors believe the opposite to be true. Based on statistical analysis, the authors determine that countries with higher rates of income inequality spend less on redistribution (or government aid programs); thus, high rates of income inequality will continue unabated.16 In Unequal Societies: Income Distribution and the Social Contract by Roland Benabou, the author concluded that income inequality is determined to be less related to redistribute government spending; that is, government spending and income inequality are not significantly related at all. Benabou rationalizes this because public support is

14

Alesina, Alberto, and Dani Rodrik. "The Political Economy of Growth: A Critical Survey of the Recent Literature." World Bank Economic Review 8 (1994): 351-71. 364-365 15 Persson, Torsten, and Guido Tabellini. "Is Inequality Harmful for Growth? Theory and Evidence." American Economic Review 84 (1994): 600-21. 16 de Mello, Luiz, and Erwin R. Tiongson. Income Inequality and Redistributive Government Spending. Working Paper WP/03/14. Washington DC: International Monetary Fund, 2003. 1-26. 17-21

closely tied to redistribution.17 However, this point is suspect as participation in government social spending programs is not a public choice. Rather, it is a requirement. Income Distribution and Tax and Government Social Spending Policies in Developing Countries by Ke-young Chu, Hamid Davoodi, and Sanjeev Gupta examine what the relationship between income distribution and social spending policies is from a different angle; the authors focus on the income distribution solely in developing countries. From their analysis, the authors prove that, before taxes, income inequality in developing countries is lower than developed countries.18 However, because most developed countries have effective tax systems, income inequality rates in developed countries generally are on pace with these rates in developing countries.19 In their closing, the authors indicate that additional methods of improving income inequality need to be examined, as simply having high economic growth rates cannot combat distribution issues by itself; this idea is the crux of the following work. In Economic Growth and Income Inequality in Hong Kong: Trends and Explanations by Simon Zhao and L. Zhang, the authors explain how Hong Kong has managed high growth rates despite consistently large income inequality rates. Based on their analysis, it seemed that the redistributive role of government social policies was, in part, worsening income inequality in Hong Kong. Interestingly, social spending seemed to be not helping improve income inequality, but actually, worsening income inequality.20

17

Benabou, Roland. "Unequal Socities: Income Distribution and the Social Contract." American Economic Review 90 (2000): 96-129. 119 18 Chu, Ke-young, Hamid Davoodi, and Sanjeev Gupta. Income Distribution and Tax and Government Social Spending Policies in Developing Countries. Working Paper WP/00/62. Washington DC: International Monetary Fund, 2000. 1-48. 35-37. 19 Chu, Davoodi, and Gupta 36-37 20 Zhao, Simon, and L. Zhang. "Economic Growth and Income Inequality in Hong Kong: Trends and Explanations." China: An International Journal 3 (2005): 74-103. 101

Now that a conclusive albeit brief literature review has been provided, the paper will delve into the issue at hand; that is, determining whether a relationship exists between economic growth and income inequality when government social spending is adjusted for.

Claim/Testable Hypotheses
The previous attempts to determine the relationship between economic growth and

income inequality when government aid (social spending) is controlled have yielded insufficient answers. Dollar and Kraay claimed that the benefits of economic growth do not favor any income group. However, common sense tells us this is incorrect. Barro classifies the relationship between economic growth and inequality as non-monotonic. Li and Zou indicate that growth favors the rich because the rich have more money, are able to invest more, and thus, receive larger returns. While the above work has directly impacted the discourse in this field, all of the above authors apparently discounted the role and impact of the government domestic aid. Additionally, many of the articles examined in the social spending literature survey failed to adjust for the value of economic growth, cross-country data, and/or used cleansed data. These factors impacted their findings. While the Perrson and Tabellini paper is strong and includes all the relevant variables, it is very dated. Because of this, it does not hold great significance now. Government aid, in which I include pensions, entitlements, tax breaks, and any other form of government intervention, can directly impact the distribution of income. In its most basic form, government aid is simply redistributive practices aimed at leveling the playing field. Obviously, these redistributive measures will impact income inequality

rates and thus, need to be utilized in studies on income inequality. By including the level of government aid for each country, the results should proffer clear and easily dissectible results. This paper will be using a model similar to the one utilized in Li and Zou, but will use a larger data set that incorporates more countries from a series of years. With this in mind, my hypothesis is: Adjusting for government social spending, if a country grows economically, then it is more likely that the benefits will favor the rich. In more simple language, the higher the economic growth rate, the more favoritism (inequality) will occur. While this hypothesis seems to be in violation of the basic economic theory, the literature review revealed scholarship (i.e. Perrson and Tabellini) in which their results contradicted economic foundations. This legitimizes the rationale behind my work and the creation of my hypothesis. The null, in this case would be: Adjusting for government social spending, if a country grows economically, then the benefits of economic growth will not favor anyone. For this paper, the word rich will be defined by the upper twenty percent of the population. While this hypothesis seems palpable, the paper will verify this statement with evidence from a wide range of countries all with different development paths, societal issues and structures, and historical memories. Additionally, this paper will show what kind of relationship exists, if at all, and will be able to issue predictions for these countries for the future. In this study, I expect that this study will verify the claim that benefits of economic growth are not passed on equally to all members of society, irrespective of socioeconomic status. Indeed, the favoritism of the rich in most countries has grown, to some degree, with economic growth. While foundational economic theory contends that as an economy grows, each member receives the benefits, I believe this macro-level

approach does not properly analyze the depth of this problem. Benefits that are received by the lower income brackets are often times inconsequential and minute, so small that the increase does not even cover cost of living adjustments. A major criticism of this position is that the rich, often times, contribute more extensively to the economy of a country than a poor person would and as such, should receive a higher share of the rewards.

Analysis and Findings

This section will present the quantitative model utilized for determining the relationship between economic growth and income inequality, which includes defining the variables, cases, and data that was used. Once this has been done, this section will present the findings of the regression run.

3.14.1 Analysis/Model I will test my research question by running a cross panel multivariate regression to determine if a relationship exists between economic growth and favoritism of the rich, when government aid is adjusted for, and if one exists, what kind of relationship is it. However, before doing this, the paper will conduct a regression comparing economic growth and income inequality. This regression will serve as Model I and the foundation for further analysis; essentially, the results are a tipping off point for Model II, in which government aid data will be included and an additional regression will be run to determine the validity of my claim.

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My analysis will consist of data from forty (40) randomly selected countries21 in two (2) different periods (1994-6 and 2004-6). For each country, I ensured that all the data was available and useable; if this was not the case, the country was removed from the study. I have taken many steps to control for bias and to ensure my results are widely applicable. For example, countries included in this analysis are rich, poor, and middleincome. This group represents most of the continents (excluding Australia and This group of countries also has many unique and disparate political,

Antarctica).

economic, and social conditions. These many factors together make the case selection in this study highly important for an objective assessment. In order to conduct research on my question, I employ variables that will help answer whether the above hypothesis is fully correct, partially correct, not correct, or another unforeseeable alternative. Each variable is fully operationalized; that is, the definition, why this is significant in measuring the research question, and the location where the data can be found is included. Listed first are the independent variables, followed by the dependent variable. A list of all variables that will be utilized in

attempting to answer this research question are catalogued in the Appendix. 22 3.24.2 Findings23

In Model I, the results from the study of the relationship between economic growth and income inequality depict that there is some correlation between the independent variables (GDP, GDPChange, GDPpercapita) and the dependent variable (Gini index). While this relationship is not strong and thus telling, it is significant enough to note the existence of
21 22

A full list of these countries can be found in the Appendix. As mentioned in text, all variables utilized in this study are listed, fully operationalized, in the Appendix. 23 All data used in this study will be included, only in hard copy, after the Appendix.

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a relationship. With regards to each particular connection, there is a negative relationship between Gini and both GDPpercapita and GDPChange. The relationship between Gini and GDP, on the other hand, is positive. Below are the results from the regression. MODEL I

As it is clearly portrayed above, the R Square is fairly strong (for a cross-sectional analysis) at .351. This value, R Square, measures the strength of association of all the independents variables in explaining the variance in the dependent; in this case, this model explains 35 percent of the variance in the Gini index. While this number is not particularly revealing, it certainly does indicate that some kind of relationship does exist. 12

In the Coefficients table, the standardized beta coefficients are telling and yield unique and interesting conclusions. It is important to note that generally speaking, the value of R Square in cross sectional regressions will be substantially lower when compared to timeseries analysis because of the wide variance in the data. The first independent variable is GDP. The beta coefficient for the Gini/GDP relationship is .049. This is indicative of a very poor finding with no real statistical value. The t-stat, a measure that determines correlation between variables, is a very low .362. Any score above an absolute value of 2 is necessary for a significant t-stat. Even less impressive is the p-value, which registers at .719. This high value means that there is a 72% margin of error. This very low value indicates that this data cannot be trusted. For GDPchange, the second independent variable, the beta coefficient is -.298. This is a negative relationship, meaning, for every unit move in the dependent variable, the independent moves in the opposite direction. Thus, for every one unit move in Gini, GDPchange moves approximately a third of the distance in the opposite way. While this shows a stronger relationship when compared with the first independent variable, this is not particularly surprising as it would make sense, based on the previous scholarship in this field, that a change in GDP will result in a change in the Gini index. The t-stat, at -2.185, is strong. The p-value for this coefficient is also representative of a strong relationship; the score is .035. The final independent variable and perhaps most interesting in terms of explanatory power for this study, is GDPpercapita. The beta coefficient for GDPpercapita was -.560. Much like GDPChange, this is a negative relationship, meaning, for every unit move in the dependent variable, the independent moves in the opposite direction half of a

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unit. The t-stat is a very strong -4.116. Perhaps even more impressive is that the p-value is perfect, registering .000. Graph 1: Scatter Plot with Trend Line for Gini and GDPpercapita

When graphed, the results are fascinating (See Graph I). Generally speaking, as an economy grows, the level of income inequality increases. However, at the apex of the curve (approximately $24,000 GDP per capita and a Gini index of 45) income inequality begins to decline very steeply. The ascent in the Gini is intuitive because industrialization is known for having winners and losers. 24 However, the graph indicates that the Gini index will continue to decline as long as the economy is growing. This is interesting and

24

Bruno, Michael, Ravallion, Martin, and Squire, Lyn. Equity and Growth in Developing Countries: Old and New Perspectives on the Policy Issues. Working Paper 1563. Washington DC: The World Bank, 1996. 1-30.; Kuznets, Simon. "Economic Growth and Income Inequality." The American Economic Review 45 (1955): 1-28. 4 May 2009 <http://courses.nus.edu.sg/course/ecshua/eca5374/Economics%20growth%20and%20income%20inequality _Kuznets_AER55.pdf>. 11-12.

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unexpected, especially considering the United States, one of the wealthiest countries in this dataset, has a high Gini index. These results are very important for this research paper as it yields the makings of research answers. However, this regression analysis output only signifies that a fairly significant relationship exists, but does not comment on specificities of the relationship. Model I has examined and explained the relationship between economic growth and income inequality. Now that the relationship between income inequality and economic growth, without adjusting for social spending, has been presented, Model II will investigate this relationship once again, but will account for government aid. In Model II, the study on the relationship between economic growth and income inequality when government social spending is controlled for, the results are telling. The model and regression analysis will be presented and recapitulated below.

MODEL II

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In the Model Summary, the R Square, when compared to Model I, has improved dramatically; it is .791. This means that these variables together explain approximately 80 percent of the variance in Gini. Alternatively, this depicts that the null hypothesis is correct only 20 percent of the time. Obviously, there is great strength in the association of these variables. As the R Square increased when compared to Model I, this also confirms the claim that government social spending does impact the relationship between economic growth and income inequality. However, while the R Square is important, the coefficients, significance, and t scores are more important. Determining if this statistical analysis is notable will be verified by these statistical measures. The coefficients of each independent variable will be investigated now as a means of providing greater depth and detail on the influence of government aid. Standardized beta coefficients indicate the relationship between each independent variable and the dependent variable. That is, for every one unit move in the dependent (Gini), there is x unit move in the independent. For the first independent variable, GDP, the beta coefficient was .193. Thus, for every unit move in Gini, GDP moves in the same direction approximately half of one 16

unit. The t-stat is 1.120. In both cases, the values for GDP are far stronger than the values in Model I. The p-value for GDP is .271, a score well above the allowable norms for statistical significance, and for all intents and purposes, negates any benefits of this variable. The beta coefficient was -.223 for GDPchange, the second independent variable. This negative relationship is interesting; as Gini increases (more inequality), the GDP rates also decreases (or inequality improves and growth rates improve). GDPChange has improved, albeit in a very minor fashion, when compared with Model I. The t-stat, improved over Model I, is now -2.885, a number representative of a solid relationship. The p-value for this coefficient is very low, coming in at .007, a value well above the highest acceptable value for margin of error. The third independent variable is GDPpercapita. Because the results were so skewed and were impacting the other beta results, this variable was removed from Model II. When removed, a better relationship for all the variables was established. It is apparent that this variable, GDPpercapita was corrupting the entire study. With both GDP and GDPChange in this model, the economic growth aspect was still fairly represented. The fourth independent variable is SocialContributionsLCU. The beta coefficient is fairly strong and is also negative; the score is -.372. The p-value is .034, a value well within the acceptable norms and is elucidatory of sound results. The relationship is very interesting, especially for this paper. It verifies the claim that as Gini increases, social contributions decreases, or instead Gini decreases and social contributions increase (similar to the relationship between Gini and GDPChange).

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The fifth independent variable is SocialContributions%GDP. This variable has the strongest relationship with the Gini variable. The beta coefficient is -.813. The p-value is perfect, indicating that this relationship is 100% statistically significant. The t stat is a strong -9.883. Interestingly, when the amount of social contributions is normalized for a cross-country analysis (that is, utilized as a percent of GDP as opposed to the aggregate amount in the local currency), the relationship becomes much more significant. The beta coefficient becomes more substantial, the p-value perfects itself, and the t stat increases noticeably. Naturally, because of the great disparity is GDP levels and levels of social contributions across the panel of countries included in this study, adjusting for this broad variance makes this relationship much more easily comparable. In Graph 2, it is clear that the Gini index decreases as the level of social contribution increases. The impact of social contributions, even if small, holds weight in improving ameliorating income inequality. Simply increasing social contributions from 0 to 5 percent can result in an 8 point decrease in the Gini index. Many countries included in this study, including Chile, and El Salvador, contribute a fraction of their GDP to social issues; if these countries increased their social contributions, their Gini indices would decrease tremendously. Countries like Ukraine, which increased its social contribution by about 3 percent, reduced their Gini index by about 8 points in 10 years. However, it is noteworthy to mention that increasing social contributions has a diminishing return in terms of lowering the Gini index. Contributing more than 10 percent seems to have less of an impact of lowering Gini rates; even less of an impact is made on contributions of more than 15 percent of the GDP. It is apparent that a point exists (approximately 21 percent social contributions and 25 on the Gini index) at which,

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irrespective of the amount of social contribution, the Gini index will not traverse. Below, Graph 2 highlights the relationship between the Gini index and government social spending. Graph 2: Gini/Social Contribution Line Graph with Trend Line

Having presented this relationship, Graph 3 (below) depicts the relationship between economic growth and social contributions. Simply stated, as a country grows economically, its social contributions increases. This is fairly obvious, but the slope of the line is particularly noteworthy. Towards the higher GDPpercapita rates, the fit line is much steeper when compared with the lower GDPpercapita rates. Thus, the wealthier a country, the more it will contribute to social spending. We cannot infer causality, but the

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results are telling; the strength of an economy (or lack thereof) is related to the amount of social contributions.

Graph 3: Economic Growth and Social Contributions Scatter Plot

The below graph (Graph 4) presents the Gini index, GDPpercapita, and Social Contributions as a percent of the GDP. The purpose of this is to show the relationship between these three variables simultaneously. This method, more effective than others, will allow the reader to fully understand this relationship, despite its obvious complexities. The graph depicts the following: as a country grows economically, the Gini index increases. Concurrently, social spending also increases, albeit slowly. However, at

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a certain point, the Gini index begins to decrease, while the social contributions increase in a more precipitous fashion. Graph 4: Income Inequality, Economic Growth, Social Spending

There are two significant lessons that were can infer from this model. First, it seems that social spending has great bearing on gross domestic product rates. It makes sense that the link between GDP and Gini was strengthened when the social spending variable was added. Previous scholars have effectively argued the idea that increased economic growth often times occurs concurrently with an increase in social spending. Also, this seems to be intuitive; naturally, as a countrys economy grows, they will be able to afford more money to allocate towards social issues. As an impoverished, but

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burgeoning country must develop a political structure and functioning economy, a wealthy and developed country must limit the affect of social ills. Second, the relationship between the Gini index and the Social Contributions as a percent of the GDP is very interesting. As social contributions as a percent of the GDP increase, the Gini index decreases. That is, an increased ratio of social contributions leads to more income equality. The graph below demonstrates this point clearly. As you can see, the fit line (red dashed line) steeply decreases as social contributions increase. Interestingly, the graph indicates that if social contributions are increased by a 10 percent of the GDP, the Gini index will decline by approximately 20 Gini points. For example, the United States and Mexico contribute in a very minor fashion to social goods. Unsurprisingly, their Gini indices are generally high. On the other end of the spectrum, countries like Sweden and France; both of these contribute heavily to societal ills and have very low Gini indices (mid-twenties for both) In summation, the hypothesis (Adjusting for government social spending, if a country grows economically, then it is more likely that the benefits will favor the rich) seemingly yields two different research answers. In poorer countries, the benefits of growth will favor the rich. In more wealthy countries, the benefits do not favor the wealthy and are as egalitarian as our society is capable of achieving. Thus, my hypothesis was both right and wrong, depending on the approach at which it is analyzed. This study has shown that as a country grows economically, the Gini index (income inequality) increases. Though this seems counterintuitive, the transitioning of a country from a rural agrarian economic to an urban industrialized country results in

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winners and losers.25 However, concomitantly, social spending also increases very slowly. Again, this is no real surprise. Government contributions to social spending are often times not the first priority because of other, more pressing issues, including military and economic issues. Further, the enlargement of the economy allows more money to be spent in different places, including social programs. However, at a certain point, ostensibly when a country is transitioning from the industrialization process, the Gini index plummets as the amount of social contributions increases. The relationship between economic growth and income inequality presents a nonmonotonic Kuznets curve (inverse U) relationship. Interestingly, when government social spending is included, an upward trending line represents the relationship. Either way, it seems that the jury is out on this study. Further work needs to be done in this field, especially in relation to the burgeoning field of economic growth and social spending.

45 Policy Implications
There are many policy implications that can be deduced based on this analysis. Previous scholarship has indicated that economic growth does not have an exact and systematic impact on income inequality. That is, different studies have generated different results. This paper has produced a result similar to the previous research answers; the results seem to follow a Kuznets-curve relationship. An increase in the strength of the economy, measured by increases in the GDP per capita, yields an upward trend of the Gini rates. However, there is a decrease in the Gini index. I believe that this decrease in the impact of the Gini index is not because of the societal adjustment to

25

Bruno, Ravallion, and Squire 14; Kuznets 11-12.

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industrialization and urbanization as postulated in previous literature on this subject,26 but rather, the decreasing Gini index and its diminishing effect is a direct result of the increased investment of social contributions (Graph 4). These redistributive social contributions are able to counteract high Gini indices brought on by shift to an urbanized and manufacturing economy. This is obviously true as it was evidenced by numerous countries, many of which are in my dataset, that grew economically, but increased social contributions, which ultimately curbed the Gini index. This list of countries includes France, Dominican Republic, and South Africa, among others. Based on the analysis, it is apparent that contributing more to social goods will stifle any increase in the Gini index. Further, these social contributions will cause dramatic reductions in the Gini index. In Graph 2, we see the strong (negative) correlation between amount of social contributions as a percent of the GDP and the Gini index. Based on this graphical breakdown, it seems that poor countries that can provide more social contributions will ultimately be able to reduce the level of income inequality in their country. Even more interesting is that while the benefits of this practice are obviously more robust for poorer countries, employing this practice (increasing social contributions) can significantly reduce the Gini index and/or maintain it at a certain level and prevent it from increasing in rich countries as well. Thus, generally speaking, irrespective of any economic growth or previous economic standing, the Gini index can decline as social contributions increase. Lastly, as previously mentioned, it is important to note that there is a point at which, regardless of the amount of social contributions, the Gini index will not continue to decline.
26

That is, simply including more money as social contributions will not

Kuznets 12

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continually lower the Gini index and eventually make a country perfectly egalitarian (achieving a Gini index value of 0). This, simply stated, is practically impossible. Having some income inequality is normal and to be expected. However, ensuring that government social contributions are relatively high (at approximately 10 percent of the GDP) will ensure low Gini indices occur in a country. This section has briefly described the policy implications of this work. These take away points yield many significant answers that are relevant to many countries across the world. By applying these lessons to our global community, we can improve dramatically in the hopes for a brighter future.

56 Concluding Comments
This paper has presented the relationship between economic growth and income inequality when government social spending is adjusted for. The results were very interesting, to say the least. As a country grows economically, the level of income inequality increases. While this is occurring, social contributions slowly begin to increase. This lethargic increase in social spending is purely derivative of an economy that needs to spend money in other areas, namely defense and infrastructure. However, at a certain point, ostensibly when a country is transitioning away from the industrialization process, the Gini index begins to noticeably decrease while the government social contributions increase precipitously. This is very significant and interesting as this seems to transpire equally; that is, both variables move approximately the same distance, but in the opposite direction. While studies have been very common, especially recently, on the relationship between economic growth and income inequality, the inclusion of government 25

(redistributive) social spending as a control variable has been all-but-forgotten in economics literature. This paper has provided the groundwork for further study in this area, but more work needs to be done, in two specific ways. First, studies that include more countries over longer periods need to be completed. Second, because government social spending occurs in many different forms, ranging from pensions to tax cuts, this paper was simply not able to find, quantify, and include every single government social spending program into this paper. Doing this, while onerous, would provide work that would be very prescriptively rich and offer great explanatory power.

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Appendices
Appendix 1: Data Description

METHOD: Model I: Multivariate regression comparing economic growth and income inequality. Model II: Multivariate regression comparing economic growth and social spending with income inequality.

VARIABLES Independent Variables -GDP (in both models) GDP, my first variable, is the gross domestic product of a nation. The gross domestic product of a nation is the whole market value of all goods and services produced in a given country in a given year. Essentially, this is the total value of all private consumption, investment, government spending, and the difference of the terms of trade. On a very basic level, the gross domestic product is a dollar value determination on how robust and healthy an economy actually is. For this variable, I will use the World Economic Outlook Database published by the International Monetary Fund (International Monetary Fund 2008). -GDPChange (in both models) GDPChange, my second variable, is the change of the gross domestic product of a country. This variable will calculate the overall change in GDP, from the first measured year to the last measured year (in this case, 1984-6 to 2004-6). This will provide a determination of not only whether a countrys economy grew or not, but to what extent the countrys economy changed during this period. I will use data from the World Economic Outlook Database published by the International Monetary Fund for each countrys GDP; however, I will be calculating this growth, or lack thereof, of the GDP on my own (International Monetary Fund 2008). -GDPpercapita (in both models) GDPpercapita is my third variable. This is the total gross domestic product, which is explained in great depth earlier, divided by the total population. This number yields the GDP per person, or GDP per capita. This will indicate the average value for each person in an economy. For this variable, I will use the World Economic Outlook Database published by the International Monetary Fund (International Monetary Fund 2008). -SocialContributionsLCU (only in Model II) SocialContributionsLCU is my fourth variable. Only used in the second model, this variable is the amount of contributions to social security and certain pension programs. This value in units of the local currency. For this variable, I will use data from the World Development Indicators database from the World Bank.

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-SocialContributions%GDP (only in Model II) Similar to the fourth variable, my fifth variable, SocialContributions%GDP is the amount of social contributions as a percent of the countrys gross domestic product. By using this method, the data is normalized can yield more telling results. For this variable, I will use data from the World Development Indicators database from the World Bank. Dependent Variable -Gini (in both models) Gini, my fifth variable, is the Gini Index. Using a scale 0-100, with 0 representing a fully egalitarian society while 100 is a completely unequal society, this measure evaluates the level of income inequality in a country. For this variable, I will use the PovcalNet Database and the Global Development Indicators dataset, both from the World Bank, data from the Human Development Reports, which are published by the United Nations Development Programme, data from United Nations University-World Institute for Development Economics Research as part of the World Income Inequality Database, and data from the CIA World Factbook, information from the Central Intelligence Agency (World Bank 2008; World Bank 2008; Central Intelligence Agency 2008; Human Development Report 2007/2008, 2007; United Nations University-World Institute for Development Economics Research 2008).

DATA: N: Forty (40) randomly selected countries (Austria, Armenia, Bulgaria, Burundi, Canada, Chile, Colombia, Costa Rica, Croatia, Dominican Republic, El Salvador, Estonia, Finland, France, Guatemala, Hungary, Ireland, Ivory Coast, Jamaica, Kazakhstan, Kenya, Korea, Latvia, Lithuania, Madagascar, Malaysia, Mexico, Peru, Philippines, Poland, Russia, Slovenia, Spain, South Africa, Sweden, Tunisia, Ukraine, United States, Venezuela, and Zambia) T: Two (2) different periods (1994-6 and 2004-6)

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Appendix 2: Methodology Using SPSS version 16, a multivariate regression was run between the Gini index and economic growth variables and social spending variables. Multivariate Regression Equation: Y = a + b1*X1 + b2*X2 + b3 * X3 + b4 * X4 + b5 * X5

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