Kuznets Curve

Kuznets Curve, a hypothetical model devised by economist Simon Kuznets, shows changes in economic inequality during different stages of economic development. Kuznets Curve plays a pivotal role in forecasting income disparities, guiding policymaking for equitable growth, and evaluating the effectiveness of strategies aimed at income inequality reduction. Kuznets Curve is an important topic for GS Paper-3 Economy Subject of UPSC IAS Exam. To explore other interesting Economics concepts similar to Kuznets curve, check out other articles of IASToppers.  

Table of Content

• What is Kuznets curve?
• What is the objective of Kuznets curve?
• Kuznets’s Hypothesis
• Application of Kuznets Curve
• Criticism of Kuznets Curve
• Conclusion

What is Kuznets curve?

• It is a hypothetical curve that graphs economic inequality against income per capita over the course of economic development.
• The inverted U-shape curve has income per capita on the horizontal x-axis and economic inequality on the vertical y-axis.
  • However, variables along the axes are often mixed, with inequality or the Gini coefficient on the Y-axis and economic development, time or per-capita incomes on the X-axis.

What is the objective of Kuznets curve?

• It aims to illustrate economist Simon Kuznets’ (1901-1985) hypothesis about how inequality changes with economic development when an economy develops from a rural agricultural society to an industrialized urban economy.

Kuznets’s Hypothesis

There are two phases in the curve:

1. Inequality increases with increase in income per capita:

• In the early development of an economy, new investment opportunities increase for those who already have money to invest.
• These mean that those who already hold the wealth have the opportunity to increase that wealth.
• On the other hand, the constant migration of cheap rural labour to the cities keeps wages down for the working class.
• Both of these widens the income gap and thus economic inequality increases.  

2. Inequality decreases with increase in income per capita:

• As the industrialization increase and demand for labour increases, more and more rural labour enters cities in search of better paying job.
• However, a point is reached where enough rural labour has migrated to cities and thus there is not much opportunity left for new rural migrants to enter in cities.
• Here, as the time goes, average income of rural labour (that are already working in the cities) increases. This way, the income gap comes down and inequality decreases.

Application of Kuznets Curve

Forecasting Income Inequality

• The Kuznets Curve can help forecast a nation’s future income inequality.
• By analyzing the current development stage and economic growth, policymakers can estimate a country’s position on the Kuznets Curve and predict how income inequality might evolve in the future.

Strategies for Reducing Disparities:

• The Kuznets Curve can guide policymakers in creating strategies to lessen income disparities during early development phases and promote economic expansion in subsequent stages.

Evaluating Policy Effectiveness:

• The Kuznets Curve can be used to evaluate the effectiveness of economic policies aimed at reducing income inequality. By contrasting income disparities before and after a policy’s execution, policymakers can ascertain whether the policy has reached its desired outcomes.

Understanding Inequality Drivers:

• The Kuznets Curve implies that income inequality is influenced by economic shifts during development. By studying the elements that cause income disparities at various developmental stages, policymakers can pinpoint the most efficient methods for minimizing inequality.

Criticism of Kuznets Curve

• Not applicable universally: Critics argue that the Kuznets Curve isn’t universally applicable, as factors like government policies, social institutions, and cultural norms can have varying impacts on the relationship between economic development and income inequality.
• Questioning the U-shape: The U-shape of the Kuznets Curve has been questioned since it doesn’t represent individual nations’ progress but rather their historical differences. This is mainly because the most data used for the Kuznets Curve comes from Latin America, a middle-income region with a history of inequality. When this factor is considered, the U-shape disappears.
• Contradiction from the East Asian Miracle: The East Asian Miracle (EAM) undermines the Kuznets Curve theory. The EAM, involving rapid economic growth in eight East Asian countries (Japan; South Korea, Taiwan, Singapore, Hong Kong; Indonesia, Thailand, and Malaysia) between 1965 and 1990, contradicts the Kuznets Curve’s notion that growth leads to inequality and that inequality is essential for overall growth. Despite rapid manufacturing and export growth, the EAM experienced rising life expectancy and falling severe poverty rates.

Environmental Kuznets Curve (EKC) hypothesis

• In environmental economics, the environmental Kuznets curve (EKC) shows relationship between per capita income and indicators of environmental degradation.
• The Environmental Kuznets curve theory proposes that at the beginning stages of economic development, the natural surroundings deteriorate.
• However, once a specific point of economic prosperity is reached, the society starts to foster a better coexistence with the environment, thus reducing environmental harm.
• In other words, a thriving economy could be beneficial for the environment.
• There is substantial evidence backing the relevance of the environmental kuznet’s curve, specifically when it comes to water quality, air pollution, and ecological footprint.
• These environmental indicators show inverted U shape for environmental Kuznets curve as per capita income and/or GDP increase.

Environmental Kuznets Curve (EKC) Example

Consider a developing city where more factories are built, and more people are buying cars, leading to increased pollution. The environment starts to suffer. However, as it continues to grow economically, it invests in cleaner technologies. People become more aware of the environment, and pollution levels start to decrease. Eventually, it strikes a balance where economic growth and environmental well-being go hand in hand, creating a cleaner and healthier town for everyone.

Conclusion

Kuznets Curve serves as a useful framework for analysing income inequality in the context of economic development, but its limitations must also be considered when utilizing it for policy decisions.

Ref: Source-1

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