Determinants of Income Inequality

DETERMINANTS OF INCOME INEQUALITY
Running head: DETERMINANTS OF INCOME INEQUALITY
Determinants of Income Inequality:

Does the government spending matter?
Korawit Booranakit 5204680093 Research Submitted for Seminar in international Economics Thammasat University February 2012
Supervisor: Archanun Kohpaiboon, Ph.D.
Abstract
One of the main issues undermining countries development is income inequality. The recent protests such as Occupy Movements in major cities provide a clear support. The governments response to the social unrest is to use public spending in order to reduce income gap. Nonetheless, the effect remains ambiguity. This paper examines determinants of income inequality by using 117 countries with 3 average periods (1994-1998, 1999-2003 and 2004-2008) panel data. The explanatory variables are government expense, trade openness, tax revenue and Annual GDP growth rate. Random effect model has been used in this study as the result of Hausman test. The assumptions of no perfect multicollinearity, no autocorrelation, and no heteroskedasticity are considered. The result shows that only coefficient of government expense is significant. Though other variables are not statistically significant, their coefficient signs turn out to be as expected. Government expense, trade openness and tax revenue received negative signs while GDP growth rate has a positive sign. The signs mean that the increase in government expense, trade openness and tax revenue could contribute to the decrease on income inequality (measured by Gini Index) while the increase in GDP growth rate could cause to increase on income inequality. The implication is that, in order to curb inequality, government needs to be proactive and takes a serious approach on spending focusing on income redistribution. Other measures such as taxation and trade openness cannot significantly help reducing income inequality. As the result, government spending is the only practical solution for the real reduction of income gap. Without government expense, inequality would be likely to stay at its normal state that has been lasting on a global scale contributing to many fundamental problems in societies. This result supports the historical trend of global income inequality that it has not been significantly changed during the last decade. It could be that many factors we believe they affect income inequality do not hold that fact on the global scale after all.
Acknowledgement
I would like to thank my advisor, Archanun Kohpaiboon, Ph.D., Econometric instructors Sittisak Leelahanon, Ph.D., and Napon Suksai, and a graduate student, Pit Jongwattanakul, for the tremendous contributions toward the completion of this research especially in the process of running panel data analysis. I believe that, without their help and guidance, this research would not have been completed Besides I am also grateful to my mother and my friends who give me encouragement and emotional supports. It was very helpful for me in writing this abstruse research.
Korawit Booranakit
1. Significance of Problem
Income inequality does matter in the overall economic development process. It is undeniable that income inequality is a fundamental issue in todays society. There are many researches conducting to explain the harmfulness of income inequality to both individual and collective welfare(Winkelmann & Winkelmann, 2010) of the population. Individually, society with big income inequality can contribute to health problems(Wilkinson & Pickett, 2006), envious society, and stressful life. Collectively, the income differences within the nation can hinder economic growth by undermining overall productivity and also countrys competitiveness(Witztum, 1997). However, income inequality has always been staying with us for centuries. The historical trend in global income inequality is mixed and unclear. There is no significant shift of income inequality rate on the global scale over the last decades of twentieth century (Dowrick & Akmal, 2005). On regional scale, however, there are some successful examples of countries that have relatively equal society, namely Scandinavian countries, which has the average Gini coefficient less than 0.25(Stephens, 1995), on the other hands, sub-Saharan African countries have the worst Gini coefficients index compared to all regions. Practically, it is not possible that we would eliminate income inequality in democratic society, so we can only curb the inequality to the acceptable range (Gini coefficients at 0.3-0.4 (Hong Xinjian,2007)) so that it can do less harm to individual and society as a whole. The adverse effect of income inequality is witnessed worldwide nowadays. The recent protests such as Occupy Movements in major cities provide a clear support. The government response to the social unrest or protest is to use public spending in order to reduce income gap. Nonetheless, the effect remains ambiguity. The main focus in this paper is not how harmful income inequality is, but it will be considering the determinants of income inequality and how government can do to make it better. Knowing the determination of fundamental problem in society can make a profound impact on how the government should work. Should the government spend a lot of money on the projects helping the poor? And does economic growth contribute to more income inequality? These are highly debated questions all over the world on the social issues and national Politics. This paper will be able
to give the tangible numbers by using time series and cross-sectional data to get the sense of how the income inequality change as the result of a controllable factor from the government. In this paper, it will be considering four possible determinants on income inequality which are government expense as percentage of GDP, tax revenue as percentage of GDP, annual GDP growth rate and international trade as percentage of GDP. These four factors often are used to explain the controversial policies. For example, government often launches new policies that are perceived as populist policies claiming that it would help the poor and reduce income inequality gap in our society. How significant are these policies affecting societys income inequality? It is difficult to indicate the result on inequality, since it is quite untouchable. So, there would be little assessment on how effective these policies are in the aspect of alleviating inequality. Two factors can even be opposed to each other in some cases. Government spending, for instance, can presumably reduce income inequality and boost the economic growth, but economic growth itself could also increase income inequality to the society. What should the government do now? Without knowing the determinants of income inequality, it is hard to know how the government should do to cope with inequality. So, analyzing these determinants and effectiveness of government spending could be the guide to understand and to be able to tackle perplexing problem as income inequality.
2. Research Objective
The objectives of the research project are to: 1. Understand more complete implications of income inequality. 2. Conduct original study and independent policy analysis that could provide information to policy makers and others. 3. Indentify determinants responsible for income inequality. 4. Examine the significance of factors in which contribute to income inequality especially government spending. 5. Establish the time series and cross-country correlations among Gini Coefficient, government expense as percentage of GDP, tax revenue as percentage of GDP and Annual GDP growth rate. 6. Use fundamental panel data analysis to analyze cross-sectional data of 117 selected countries chosen by clear criteria from 216 countries around the world with 15 years data.
3. Scope of Research
The coverage of this study is only in aspect of income inequality which can be determined by the indicator called Gini index. This study does not cover other kinds of inequality which is more intangible to consider such as political inequality, inequality of opportunity and so on. This paper focuses on government expense affecting Gini Index on cross-country and time series scales. Four other determinants that are likely to contribute to income inequality, namely, tax revenue, annual GDP growth rate, and trade openness are considered. These factors are selected by literature review process and the goal of this study. Fundamentally, the main point in this study will be considering the statistically significance of public spending in mitigating income inequality given other factors as constant variables.
DETERMINANTS OF INCOME INEQUALITY For the interpretation of each variable are as follows:
1. Gini index measures the extent to which the distribution of income (or, in some cases, consumption expenditure) among individuals or households within an economy deviates from a perfectly equal distribution. A Lorenz curve plots the cumulative percentages of total income received against the cumulative number of recipients, starting with the poorest individual or household. The Gini index measures the area between the Lorenz curve and a hypothetical line of absolute equality, expressed as a percentage of the maximum area under the line. Thus a Gini index of 0 represents perfect equality, while an index of 100 implies perfect inequality. In this study, percentile scale is used. 2. Expense is cash payments for operating activities of the government in providing goods and services. It includes compensation of employees (such as wages and salaries), interest and subsidies, grants, social benefits, and other expense such as rent and dividends. 3. Tax revenue (% of GDP) refers to compulsory transfers to the central government for public purposes. Certain compulsory transfers such as fines, penalties, and most social security contributions are excluded. Refunds and corrections of erroneously collected tax revenue are treated as negative revenue. 4. Trade is the sum of exports and imports of goods and services measured as a share of gross domestic product. 5. Annual percentage growth rate of GDP at market prices based on constant local currency. Aggregates are based on constant 2000 U.S. dollars. GDP is the sum of gross value added by all resident producers in the economy plus any product taxes and minus any subsidies not included in the value of the products. It is calculated without making deductions for depreciation of fabricated assets or for depletion and degradation of natural resources
DETERMINANTS OF INCOME INEQUALITY 4. Literature Review The role of government is conducted through the traditional tools available such as taxes,
government spending and regulation. It was concluded by one study(Tanzi, 1998) that the role the government plays has the most important impact to income distribution in a society. Even though, there are exogenous variables that government cannot entirely control that influence income gap such as financial crisis and natural disaster, still government often makes a goal and uses its tools to achieve that objective by using fiscal and monetary policies. However, the role of government on income distribution has often been emphasized on just taxing and government spending. Though, the regulatory role can also be very important in income distribution through policies such as rent and price control and land reform. For political or administrative reasons, many countries especially the poor ones, have been ineffective in handling redistribution of wealth and property(Tanzi, 1998) and it is much more complex to measure and compare regulations in different countries. As the result, the role of government to reduce income inequality is often more effective and measurable on taxation and government spending. For this study, four major determinants that will be used to explain income inequality are economic growth, taxation, trade openness and government spending. The relevant reviews on these four factors are as follows. Firstly, economic growth seems to have been pro-rich over the twentieth century. In the period when a country has grown faster than average, top income earners have benefited more than other groups proportionately. A likely explanation for this is simply that, top incomes are and have been more closely related to actual performance than incomes on average. The finding is significant and robust across all specifications.(Roine, Vlachos, & Waldenstrm, 2009) Secondly ,in advanced industrial countries, with more efficient market, tend to have much larger governments, measured by the share of public spending into GDP(Tanzi, 1998), than developing countries. The reason is not because the developed countries need bigger government
DETERMINANTS OF INCOME INEQUALITY than the developing countries, but they can collect more taxes. Being unable to raise taxes,
government of the poor countries need to use less effective tools available to cope with inequality, such as regulations and fiscal policies. Thus, government of the poor countries finds it much more difficult to promote policies aiming at reducing income inequality. For example, rich and developed welfare states including countries such as Sweden, Norway, Denmark and Finland use large amount of tax revenue system to redistribute wealth, while failed states such as Somalia, Chad and Sudan can collect very low tax revenue, so it is almost impossible to use tax system to reduce income inequality. Thirdly, for trade openness, empirical evidences suggest that there is a correlation between trade openness and income inequality. During the 1980s and 1990s, more and more countries opened up their economies to international trade and the volumes were dramatically increased(Jakobsson, 2006). In the same period of time, it has been said that income inequality increased in many part of the world as well. The result of trade openness affecting inequality is different. Hecksher-Ohlin Theory says that inequality increase in wealthy countries and decrease in poor countries as a result of increase in trade. The reason is that when economies in developing are opened, the wage of unskilled worker of those developing countries will increase, while the wage of skilled labors will decrease; the decreased of wage gap will narrow income inequality(Anderson, 2005). However, this prediction is based on some assumptions. One major assumption is that developing countries are relatively abundant in unskilled labors. Lastly and most importantly, the ability of governments to reduce inequality through using public spending is clear. There are evidences showing that developed countries with high public spending level tend to have more even income distributions and less extreme inequality. In the United States, for instance, a large number of public spending policies are justified in the name of income redistribution plans such as Food Stamps, Medicare and Medicaid programs in order to create equity or justice in the society. However, there are two major problems that decrease the potential of government spending contributing to equity (Alesina,1998b). The first one is hijacking of expenditure programs by special interest groups. Political pressures and rent-seeking behavior can hinder the effectiveness of government programs by
10
redirect resources from people in need toward some specific group. For example, subsidiary may be spent on modern hospital in big cities and not enough for basic health care especially in poorer areas. Or it is commonly know that roads in poorer areas are less well-maintained than roads in the richer areas. The problem show that (Alesina,1998b) the level of social spending may not indicate that government spending is helping the poorer groups as it is commonly believed. It is extremely important to know who the real beneficiaries are. The second problem is that hijacking will not be done politically, by the recipient of the public services, but administratively, by the provider of the service. These providers are supposed to produce an output or service such as education or health care that benefits the users of that output or service; instead they take that public spending to their own interest. There is a tendency to measure the output, education, health care etc, on the basis of the cost of the input, government spending, but in reality, the two may be widely different. (See Tanzi, 1974) In conclusion, it was found that the period of high economic growth is strongly pro-rich. It does not benefit everyone equally and as the result, income inequality become larger especially during the economic boom. On the other hand, economic crises reduce income share of the rich. Another factor is government spending, it is slightly negative for the upper middle class and positive for the poor but it does not seem to affect on the rich significantly. For trade openness, it affects income inequality depending on the wealth of countries. Lastly, tax progressivity is an important determinant for income distribution; it can significantly reduce shares of the rich and narrow income gap. (Roine, Vlachos, & Waldenstrm, 2009)
DETERMINANTS OF INCOME INEQUALITY 5. Research Methodology
11
This research methodology requires gathering descriptive and inferential statistics from secondary data from World Bank in order to analyze material and arrive at a more complete understanding of income inequality. The criteria of selecting data are as follows: 1. Collect 216 countries data, 1994-2008, of all five considered factors, and make an average during each 5-year period of 216 countries, which are 1994-1998, 19992003, and 2004-2008. This process is proceeded in order to screen out some missing variables. (Five factors are Percentage of Gini Index, Government Expense as Percentage of GDP, Tax revenue as percentage of GDP, Annual Growth Rate, and International Trade as Percentage of GDP) 2. Drop countries that do not have available average figures of three consecutive periods, in other word, the countrys data that miss every data in, at least, one factor are dropped. 3. As the result, it will be an unbalanced panel, 5-year average, and data of 117 countries, in all five factors in this analysis. Panel data allows us to take both three periods (5 years average each) factor in each country and the differences of patterns between countries into account. In other word, it allows us to control for both common and country specific trends. The study will be conducted by using Gini index as a dependent variable. Annual GDP growth rates, Governments expense (% of GDP), tax revenue (% of GDP) and trade openness (% of GDP) are independent variables in this study which would help explaining the correlations among these factors. Stata is used in the analysis of this study. The dependent variable Y is used to refer to Gini index while independent variables X2, X3, X4 and X5 refer to Government expense, trade openness, tax revenue, and annual GDP growth respectively.
DETERMINANTS OF INCOME INEQUALITY In this study, it will be using standard linear function. Y= c(1)+c(2)*X2+c(3)*X3+c(4)*X4+c(5)*X5 This fundamental linear function is used because it is the relationship explaining the effect of each independent variable (X2, X3, X4 and X5) to dependent variable (Y). Due to specific and unique problem in this study, the process of literature review does not give any certain model that can be applied in this case. As the result, the first step will be using this standard linear function.
12
DETERMINANTS OF INCOME INEQUALITY 6. Data Sources All of data here is retrieved from data.worldbank.org. Five year averages have been made and divided into three periods, 1994-1998, 1999-2003, and 2004-2008. Table 1
Gini Index (Percentage)
No. Country Name
13
Government Expense (% of GDP)

20042008 21.94 18.29 18.09 24.94 39.93
GDP Growth rate

19941998 6.64 4.10 5.76 4.13 2.71 19992003 6.60 -2.13 20042008 6.00 8.42
Trade (% of GDP)
19941998 47.44 21.19 85.63 37.59 74.34 73.82 28.49 120.87 129.93 83.82 50.24 105.50 16.27 107.60 39.30 30.45 73.19 40.02 19992003 59.76 29.03 74.85 40.79 90.63 85.18 33.90 132.93 146.26 77.04 47.26 107.81 24.27 108.01 32.13 28.71 112.48 41.50 20042008 75.41 44.35 64.74 39.59 107.08 105.70 43.14 128.61 157.57 105.21 71.71 112.35 26.76 125.42 36.32 52.63 137.51 47.29
Tax Revenue (% of GDP)

19941998 11.65 19992003 16.59 11.17 14.00 23.53 19.22 20.69 20042008 17.29 14.20 15.20 24.33 20.13 15.85 7.79 20.26 26.24 7.34 16.19 26.52 9.19 13.08 19.76 11.49 19.46 14.68 17.43 10.70 14.30 13.60 7.86 9.01 11.20 8.89 8.27 21.96 25.62 8.23 16.25 21.13 16.52 22.36 12.08
1994- 1999- 2004- 1994- 19991998 2003 2008 1998 2003 29.12 28.15 32.88 25.57 23.50 49.21 52.52 49.81 44.42 35.42 30.86 35.19 29.15 34.96 36.50 25.27 30.63 30.72 31.02 9.06 19.76 16.41 25.34 41.78 40.71
1 Albania 2 Argentina 3 Armenia 4 Australia 5 Austria 6 Azerbaijan 7 Bangladesh 8 Belarus 9 Belgium 10 Bhutan 11 Bolivia 12
Bosnia and Herzegovina
9.20 11.64 3.67 2.12 3.52 2.75
14.63 -2.88 9.75 32.11 42.11 19.46 24.74 4.85 0.10 2.54 5.34 4.74
10.04 21.39 5.15 5.20 2.04 7.77 1.96 5.76 1.94 4.40 5.73 0.68 6.29 9.96 2.31 9.24 4.82 5.91 4.82 6.45 5.02 3.79
28.22 30.25 27.12 27.90 26.43 32.97 46.83 58.46 57.73 28.03 36.00 45.19 43.14 21.17 19.67 28.50 35.64
35.92 39.94 24.33 3.06
13 Brazil 14 Bulgaria 15 Burkina Faso 16 Burundi 17 Cambodia 18 Cameroon
59.25 58.28 55.97 25.81 22.89 27.24 31.78 45.32 39.20 31.40 48.78 39.60 42.39 38.28 10.66 33.27 23.40 20.65 43.11 9.34
31.07 -0.23 12.37 6.33 -3.32 8.22 6.32 3.19
8.78 10.25 4.23 3.12
46.82 44.56 38.91 11.15 12.00

No. Country Name
14

20042008 17.71
GDP Growth rate

19941998 3.51 19992003 3.47 20042008 2.37
Trade (% of GDP)
19941998 73.79 19992003 80.13 20042008 70.17

19941998 14.47 19992003 14.58 20042008 13.62
1994- 1999- 2004- 1994- 19991998 2003 2008 1998 2003 32.56 22.27 18.83
19 Canada
Central 20 African Republic
43.57 56.30 39.78 55.33 55.14 52.00 41.53 57.27 58.13 58.49 44.43 8.97 20.72 10.59 19.52 8.93
9.67
3.62 5.24
-0.40
2.58
45.37 50.13 55.92 38.70 35.79 50.29 134.88 83.92 73.31 81.35 106.41 72.06 92.06 76.50 51.33 46.70 58.98 149.19 26.96 67.20 46.33
34.85 75.23 63.59 45.92 34.83 46.18 135.67 92.66 77.15 88.00 124.68 84.86 85.10 79.37 58.63 40.87 67.40 155.16 37.49 72.52 53.44
34.86 104.20 77.84 66.96 37.11 69.75 134.07 101.09 90.53 91.84 147.13 97.81 103.54 69.75 66.31 63.81 73.06 152.72 46.90 83.06 54.32 19.41 9.27 22.20 20.50 27.25 17.52 13.38 10.93 16.02 9.46 23.12 22.84 24.08 16.83 31.95 14.91 21.88 15.82 30.24 4.35 9.83 5.25 16.61 7.49 10.70 4.40 8.00
6.21
21 Chad 22 Chile 23 China 24 Colombia 25 Congo, Dem.

Rep.
6.66 10.19 2.64 4.89
18.15
6.72
19.48 9.39 12.22
11.12 10.22 23.74 3.42 -2.29 17.52 22.37 1.18 4.70 5.23 5.41 2.14 3.36 -1.84 14.70 5.99 3.00 29.34 18.11 27.72 15.63 35.26 45.38 4.63 4.43 4.89 4.28 4.48 2.18
8.68 11.58 1.66 -0.80 2.84 4.08 -1.02 3.32 2.59 1.53 2.09 3.94 2.05 4.11 2.39 6.69 5.44 6.13 4.28 5.92 1.56 4.11 5.24 1.79 4.54 7.00 5.72 5.93 2.89 5.81
26 Congo, Rep. 27 Costa Rica 28 Cote d'Ivoire 29 Croatia 30 Czech

Republic
47.32 32.19 23.70 47.03 48.77 47.23 40.22 48.39 41.50 17.36
7.05 15.72 14.20 20.12 15.18 33.14
17.13 34.47 34.96 34.33
26.82 30.05 31.32 36.46 37.36 25.82 24.70 36.77 39.96 49.15 52.00 50.11 52.77 62.09 54.01 26.30 30.13 32.76 32.14 27.58 27.29 51.27 51.20 48.14 16.58 32.48 34.92 39.24 35.04
31 Denmark 32 Djibouti 33 Dominican

Republic
14.62
34 Ecuador 35 Egypt, Arab

Rep.
14.88 13.09 15.98 9.27 22.02 22.16
36 El Salvador 37 Estonia 38 Ethiopia 39 Finland 40 France
33.85 36.62 36.00 32.28 28.99 39.96 30.00 29.76 12.63 16.44 26.88 32.74 44.16 35.68 47.20 45.73
3.78 11.69 3.07 2.13 3.42 1.81

No. Country Name
15

20042008 20.84 30.26 20.05 44.38 12.53
GDP Growth rate

19941998 3.40 1.71 4.18 2.69 4.26 4.66 19992003 5.21 1.22 4.36 4.30 3.24 3.73 2.98 3.17 3.90 5.75 3.73 5.08 6.96 2.66 1.47 1.85 4.57 9.02 2.03 6.38 4.28 6.18 20042008 7.90 1.98 6.56 3.01 4.28 2.91 5.85 6.25 2.73 8.32 5.72 5.15 3.47 5.07 1.08 1.20 8.14 8.44 5.18 4.23 5.38 7.41
Trade (% of GDP)
19941998 78.35 50.03 71.53 47.02 42.69 45.68 95.76 268.03 97.31 22.50 62.06 35.20 144.63 67.17 45.73 102.54 120.73 75.11 60.66 63.36 82.39 67.71 110.73 93.32 53.35 69.64 85.85 69.40 19992003 66.61 65.27 100.52 59.35 59.41 52.11 114.72 285.97 136.88 27.99 63.37 43.58 170.78 72.10 50.42 20042008 86.22 82.42 79.73 58.41 66.79 67.38 135.18 395.16 149.06 44.22 58.76 55.82 152.61 84.27 54.92 100.90 139.60 94.58 63.83 84.19 118.83 81.40

19941998 7.79 10.90 19992003 7.51 11.56 17.72 19.83 8.22 10.45 21.91 10.95 11.13 13.75 9.85 22.19 9.02 14.92 8.04 26.46 21.71 8.80 12.82 6.63 24.63 27.86 24.12 22.96 24.55 19.91 7.04 16.48 14.17 13.82 18.29 10.57 16.78 14.76 12.13 15.36 12.93 21.33 10.69 12.51 7.23 25.02 26.86 22.21 25.98 21.99 14.17 17.92 15.41 15.71 11.30 20042008 15.80 11.42 16.73 20.32 11.59
1994- 1999- 2004- 1994- 19991998 2003 2008 1998 2003 36.82 38.90 41.06 14.87 11.75 28.31 40.75 34.27 55.80 55.23 53.69 42.76 33.90 32.13 20.25 43.53 43.41 8.24 12.35
41 Georgia 42 Germany 43 Ghana 44 Greece 45 Guatemala 46 Guinea 47 Honduras 48

Hong Kong SAR, China
40.30 43.34 39.35 12.06 13.46 54.14 52.69 57.21 43.44 20.90 21.46 20.76 18.30 43.63 15.40 17.16 21.98 32.40 42.50 39.36 33.23 32.47
2.85 2.31 2.36 6.41 3.03 3.11 8.69 5.28 1.90 0.03 3.92
49 Hungary 50 India 51 Indonesia 52

Iran, Islamic Rep.
24.93 27.21 30.61 47.89 43.10 36.80 14.56 15.73 38.50 10.99 15.62 43.55 34.28 39.20 36.03 40.47 46.28 45.51 38.28 17.23 18.60 34.28 29.39 46.41 45.40 39.66 34.46
53 Ireland 54 Israel 55 Italy 56 Jamaica 57 Jordan 58 Kazakhstan 59 Kenya 60 Korea, Rep. 61 Kyrgyz
Republic
36.42 38.87 37.72 27.36 27.73 35.32 33.37 30.88 17.69 13.61 42.29 31.59 47.68 20.10 18.28 14.92 17.33
15.14 -4.10 19.93 19.97 2.99 4.50
35.98 33.14 33.18 21.89 16.43 34.91 32.63 36.74
16.89 -1.28 10.25 6.59
62 Lao PDR

No. Country Name
16

20042008 28.28 46.24
GDP Growth rate

19941998 3.61 4.21 19992003 6.66 3.12 4.78 5.20 5.01 1.61 2.51 5.34 7.53 6.73 2.50 3.84 3.78 3.86 3.90 2.19 4.13 3.47 1.95 3.59 2.73 0.25 20042008 7.45 3.71 6.44 7.15 4.44 5.02 5.65 5.85 9.74 4.57 3.37 6.11 9.12 4.77 4.21 2.68 1.85 4.73 2.34 5.70 9.22 4.56
Trade (% of GDP)
19941998 97.55 152.76 65.45 109.18 208.89 82.91 51.32 189.79 165.90 60.38 56.54 114.30 93.32 57.35 57.83 115.28 56.58 60.30 72.10 36.13 179.05 101.58 19992003 92.24 156.49 56.70 101.48 263.17 98.91 56.09 206.98 137.00 69.85 58.39 127.90 117.75 60.24 50.92 125.35 63.10 73.93 71.70 30.84 133.44 118.28 20042008 105.77 163.16 142.60 122.96 302.46 113.32 79.08 203.12 139.99 65.04 56.72 138.34 121.14 75.35 45.26 135.70 58.78 94.73 74.48 35.25 146.78 140.43

19941998 15.25 45.22 19992003 14.25 39.23 20042008 15.04 54.45 0.27 15.83 25.55 17.44 24.30 19.19 9.69 18.62 13.74 15.70 11.97 13.47 10.69 16.37 9.93 11.20 13.90 13.96 19.78 8.56 22.24 8.63 22.34 29.19 12.85 13.83 27.13 13.08 11.78 21.40 10.88 10.17 21.62 19.09 24.61 23.39 9.43 22.73 30.99 17.21 28.96 9.80 11.22 15.15 14.01 14.95
1994- 1999- 2004- 1994- 19991998 2003 2008 1998 2003 31.97 35.91 35.73 28.46 28.18 63.16 52.50 38.16 31.24 32.19 36.69 30.76 28.13 37.38 44.20 39.16 44.64 47.24 48.84 63.27 10.40 27.29 35.53 38.25 43.44
63 Latvia 64 Lesotho 65 Liberia 66 Lithuania 67 Luxembourg 68 Macedonia,

FYR
0.25 24.41 29.13 35.45 30.35 11.65 18.95 31.66 14.87 2.76 3.84 0.63 2.28 5.80 9.76 4.63 3.01 30.73 -8.48 24.01 29.30 14.83 44.67 40.12 31.73 40.16 31.61 18.72 32.76 15.85 3.60 4.28 5.02 3.54 3.08 4.65 4.48 3.42 4.24 0.54
69 Madagascar 70 Malaysia 71 Maldives 72 Mali 73 Mexico 74 Moldova 75 Mongolia 76 Morocco 77 Nepal 78 Netherlands 79 New Zealand 80 Nicaragua 81 Norway 82 Pakistan 83 Panama 84
Papua New Guinea
37.91 17.50 17.83 37.37 18.73 21.63 13.42
50.56 40.01 38.99
54.23 52.13 50.91 14.45 15.18 36.90 36.64 36.82 36.44 25.61 31.74 32.84 33.03 14.78 21.93 40.05 40.88 37.67 30.90 36.17 47.30 29.73
53.94 50.30 52.33 14.47 16.91 25.79 35.40
28.65 31.71 31.96 19.72 17.24 53.97 56.52 54.91 21.89 22.20 50.88 25.74 27.10

No. Country Name
17

20042008 14.61 16.84 16.94 35.69 40.03 19.41 24.71 22.80 12.92 38.66 38.30 26.54
GDP Growth rate

19941998 2.63 6.03 3.90 6.11 3.70 19992003 0.21 2.63 3.80 3.06 1.96 20042008 4.78 7.65 5.50 5.42 1.23
Trade (% of GDP)
19941998 115.48 30.97 90.24 47.82 62.04 85.07 59.22 51.42 64.32 47.68 129.23 43.58 330.70 119.10 104.84 46.59 47.68 79.71 140.24 70.65 135.97 90.85 71.77 19992003 88.24 33.80 100.57 60.56 65.24 89.79 71.86 63.49 65.53 58.85 169.09 53.13 364.80 145.38 107.50 54.50 57.55 79.99 184.10 83.26 151.61 120.09 79.75 20042008 105.10 47.55 91.67 80.58 69.53 92.79 74.74 54.62 71.22 80.44 211.17 53.57 426.87 165.19 130.72 62.12 58.15 71.26 167.43 95.49 93.08 143.48 96.49

19941998 11.63 13.74 16.07 19992003 10.52 12.44 12.54 16.65 19.90 20.64 20042008 11.79 14.60 13.02 17.27 21.06 20.74 12.01 13.48 14.58 15.92 23.36 27.99 9.19 15.66 27.48 10.28 14.09 17.23 20.61 20.47 24.24 15.78 16.47 14.59 14.08 24.70 9.15 7.69 10.15 8.46 15.46 10.32 9.82 16.49 14.84 27.36 10.69 12.58 14.48 20.32 27.48 12.42 13.85 13.12 15.76
1994- 1999- 2004- 1994- 19991998 2003 2008 1998 2003 57.83 57.42 53.06 14.40 16.76 45.56 53.83 50.76 16.52 17.37 44.53 45.29 44.04 32.76 33.23 35.00 38.45 41.10 28.82 30.76 31.33 46.11 37.59 39.89 41.44 41.25 39.19 28.16 42.73 65.77 48.40 42.56 42.52 42.48 25.81 26.53 13.79 16.47 39.37 17.48 36.52 36.64 37.76
85 Paraguay 86 Peru 87 Philippines 88 Poland 89 Portugal 90 Qatar 91 Romania 92 Russian 93 Senegal 94 Serbia 95 Seychelles 96 Sierra Leone 97 Singapore 98 Slovak
Republic Federation
4.65 19.85 0.85 3.38 6.71 4.29 1.25 -0.16 10.12 4.58 2.85 3.86 3.17 3.85 3.73 4.05 1.26 8.30 4.76 1.67 7.18 7.10 4.45 5.50 4.26 6.79 7.12 7.29 4.94 4.92 3.07 6.42 2.70 2.91 8.52 4.71 2.58
21.11 -4.84 3.28 5.44 4.73
20.99 -4.51 13.62 34.43 38.07 30.24 25.50 20.26 6.41 5.56 4.22 2.76 3.18 5.20 3.37 18.23 1.38
99 Slovenia 100 South Africa 101 Spain 102 Sri Lanka 103 Swaziland 104 Switzerland 105 Tajikistan 106 Thailand 107 Togo
28.41 29.99 31.15 34.81 38.36 56.59 57.77 67.40 34.66 28.06 35.17 29.22
35.41 41.06 40.26 23.97 22.13 60.65 50.68 33.68 22.36 26.33 21.83 9.91 15.86
32.07 33.61 11.36 42.38 42.88 42.45 34.41
13.75 -8.68 17.01 15.79 2.45 8.75

No. Country Name
18

20042008 26.25 23.17 19.28 27.67 38.39 36.99 20.30 16.26
GDP Growth rate

19941998 4.62 4.10 7.40 19992003 4.47 1.83 6.32 5.90 3.49 2.89 -2.93 20042008 5.28 6.00 8.21 6.46 2.00 2.25 6.54
Trade (% of GDP)
19941998 86.54 46.37 32.01 87.06 55.79 23.39 38.22 50.95 92.82 68.88 19992003 83.53 45.70 35.39 109.97 55.08 24.01 39.64 46.24 77.33 69.04 73.41 20042008 97.90 49.85 44.22 102.03 57.37 27.84 60.44 56.50

19941998 19.74 19992003 19.26 20042008 19.12 19.00 10.02 10.95 13.18 26.78 27.61 10.91 17.41 14.22 10.28 17.82 15.65 12.21 9.42 17.78 16.98 12.00 16.50 27.61 11.06 18.07 14.22
1994- 1999- 2004- 1994- 19991998 2003 2008 1998 2003 41.66 40.81 41.53 42.71 43.16 37.13 44.42 42.62 35.12 28.62 27.86 35.97 40.81 26.89 25.17
108 Tunisia 109 Turkey 110 Uganda 111 Ukraine 112 United
Kingdom
35.62 -10.01 40.63 21.54 26.12 24.89 4.05 3.89 4.90 1.61 6.86 20.63 -0.61
113 United States 114 Uruguay
44.47 44.78 45.59 27.50 27.21
115 Venezuela, RB 48.49 48.20 45.56 19.00 22.83 116 Yemen, Rep. 33.44 37.69 24.88 22.15 117 Zambia 51.62 42.08 50.74 21.43 16.74
-3.10 10.50 3.75 3.82 3.94 5.76
Links to each data are as follows: Gini Index: http://search.worldbank.org/data?qterm=gini%20&language=EN

Expense: http://search.worldbank.org/data?qterm=Expense+%28%25+of+GDP%29&language=EN&format=
Trade: http://search.worldbank.org/data?qterm=Trade+%28%25+of+GDP%29+&language=EN&format= Tax Revenue: http://search.worldbank.org/data?qterm=tax+revenue+%28%25+of+GDP%29+&language=EN&format= GDP Growth Rate: http://search.worldbank.org/data?qterm=GDP+growth+&language=EN&format=
DETERMINANTS OF INCOME INEQUALITY 7. Analysis 7.1 Model Based on research methodology above, the estimating equation is specified as follows: gini = c(1)+c(2)*(expense)+c(3)*(trade)+c(4)(tax)+c(5)*(growth)
19
The explanatory variables are described with expected signs of the regression coefficient of each variable given in the brackets below: expense (-) = government expense as percentage of GDP A negative relationship between gini and expense is hypothesized: a large amount of government spending should provide helps to people in need such as social welfares which is likely to reduce income inequality in the society. trade (+,-) = sum of exports and imports of goods and services as percentage of GDP Relationship between gini and can be both positive and negative (Jakobsson, 2006) because trade openness can reduce income inequality in poor countries while it also can increase inequality in rich countries according to Hecksher-Ohlin Theory. tax (-) = tax revenue as percentage of GDP A negative relationship between gini and tax is hypothesized: the rich usually generates tax revenue to government more than the poor especially in progressive tax system. Generally speaking, the more tax revenue the government collects, the less inequality it should be. growth (+) = annual percentage growth rate of GDP at market prices A positive relationship between gini and growth is hypothesized: economic growth trends to benefit disproportionately to the rich. As the result, income inequality trends to increase during economic boom.
DETERMINANTS OF INCOME INEQUALITY 7.2 Econometrics : Regression results
20
First, Balanced panel data has been used. Because of the limited availability of data especially gini index, the number of data collected in balanced panel, in this case, was only 25 countries. Of these 25 countries, the samples were very limited in only specific region and major countries are excluded. As the result, I decided to use unbalanced panel data of 117 countries retrieved from the criteria mentioned above. It includes almost all major countries and widespread samples from every region. Given that unbalanced panel data of 117 countries has been used, summary of data is shown below. The table 5 shows that numbers of observations of gini variable is the least among all others with 252 observations. Even though there are only 117 countries in this sample but the panel data allow me to gather 3 periods, five-year average in each period, in every country. Hence, the maximum observation in Table 5 of each variable should be 117*3 = 351 observations. However, this table summarizes unbalanced panel data that contain some missing variables, as the result, the number of observations below is less than 351 in every variable. Table 2: Data Summary
Variable | Obs Mean Std. Dev. Min Max
-------------+-------------------------------------------------------gini | expense | trade | 252 41.07774 9.438061 271 25.10517 10.1665 24.7 .25 67.4 48.4
350 87.27266 53.70507
16.27 426.87
-------------+-------------------------------------------------------tax | growth | 278 16.25522 6.717344 350 4.361486 3.833848 .27 -10.01 54.45 39.94
21
Before running analysis, correlations between explanatory variables, Multicollinearity, need to be tested. The result is shown below. The highest correlation would be 0.2087, which is the correlation between government expense and tax revenue that the government receives. This is logical in reality that the main source of government expenditure is from tax, so these two variables would have a large correlation as the result. However, the correlation in this case is not serious, because the largest correlation is only 0.2087 (Expense and tax) which is considered as a low correlation(Calkins, 2005.). Thus, it is not necessary to drop any variables to change this model. Table 3: Correlation matrix of variables used in the regression analysis
. correlate expense trade tax growth (obs=248)
Correlation
Expense Trade Tax Growth
Expense 1.0000 0.1074 0.2087 0.0223
Trade
tax
Growth
1.0000 0.0857 0.0703 1.0000 0.0745 1.0000
Another problem that might be occurring is Heteroskedasticity. It is the problem that explains inconstant variance of error term in the model. Breusch-Pagan test is examined. The result on the next page shows that the null hypothesis (H0: Constant variance) has been accepted. As the result, there is no Heteroskedasticity in this model. In other word, this panel data has the Homoskedasticity or the constant variance of error term.
DETERMINANTS OF INCOME INEQUALITY Table 4: Breusch-Pagan Test for Heteroskedasticity . estat hettest Breusch-Pagan / Cook-Weisberg test for heteroskedasticity Ho: Constant variance Variables: fitted values of gini chi2(1) = 0.40 Prob > chi2 = 0.5246 Wooldridge Test below used to examines autocorrelation between disturbances. The null hypothesis (H0: no first-order autocorrelation) is accepted (Prob > F = 0.3687) As the result, there is no autocorrelation in this case. Table 5: Wooldridge Test Wooldridge test for autocorrelation in panel data . xtserial gini expense trade tax growth Wooldridge test for autocorrelation in panel data H0: no first-order autocorrelation F( 1, 20) = 0.846 Prob > F = 0.3687
22
23
Apart from examining possible problems, there are three standard panel estimation methods to choose from (pooled OLS, fixed-effects model and random-effects model). First of all, in order to show standard regression of this panel data, pooled OLS is applied. The result shows that only coefficient of government expense is statistically significant in this model. Table 6: Pooled Ordinary Least Square . reg gini expense trade tax growth Source | SS df MS Number of obs = 181 -------------+-----------------------------F( 4, 176) = 6.30 Model | 2154.63719 4 538.659297 Prob > F = 0.0001 Residual | 15037.8596 176 85.4423844 R-squared = 0.1253 -------------+-----------------------------Adj R-squared = 0.1054 Total | 17192.4968 180 95.5138713 Root MSE = 9.2435 -----------------------------------------------------------------------------gini | Coef. Std. Err. t P>|t| [95% Conf. Interval] -------------+---------------------------------------------------------------expense | -.3396685 .0760914 -4.46 0.000 -.4898375 -.1894994 trade | -.002878 .0164168 -0.18 0.861 -.0352772 .0295211 tax | -.1291954 .1004523 -1.29 0.200 -.3274415 .0690506 growth | .1756018 .2379617 0.74 0.462 -.2940238 .6452274 _cons | 50.41172 2.721933 18.52 0.000 45.03989 55.78354 ------------------------------------------------------------------------------
24
However, there might be the influence of fixed-effect or random effect model; thus, fixed-effect and random effect panel analysis are tested below with the criterion of 5% significant level. The results show below. Table 7: Fixed-effect Model
. xtreg gini expense trade tax growth, fe Fixed-effects (within) regression Group variable (i): country R-sq: within = 0.1857 between = 0.0694 overall = 0.1081 F(4,75) corr(u_i, Xb) = -0.1691 = 4.28 Prob > F = 0.0036 Number of obs = 181 102 1
Number of groups = Obs per group: min = avg = max = 1.8 3
-----------------------------------------------------------------------------gini | Coef. Std. Err. t P>|t| [95% Conf. Interval]
-------------+---------------------------------------------------------------expense | -.4605505 .1220005 trade | -.0149579 .0253545 tax | .0542099 .1534674 growth | .0904044 .3313935 _cons | 51.60006 4.449849 -3.77 0.000 -0.59 0.557 0.35 0.725 0.27 0.786 11.60 0.000 -.7035879 -.2175131 -.0654667 -.2515128 -.5697653 42.73551 .0355509 .3599326 .7505742 60.46462
-------------+---------------------------------------------------------------sigma_u | 8.2096651 sigma_e | 9.0996899 rho | .44871687 (fraction of variance due to u_i) F test that all u_i=0: F(101, 75) = 1.06 Prob > F = 0.4056
DETERMINANTS OF INCOME INEQUALITY Table 8: Random Effect model . xtreg gini expense trade tax growth , re Random-effects GLS regression Number of obs = 181 Group variable: country Number of groups = 102 R-sq: within = 0.1601 Obs per group: min = 1 between = 0.1072 avg = 1.8 overall = 0.1252 max = 3 Random effects u_i ~ Gaussian Wald chi2(4) = 25.54 corr(u_i, X) = 0 (assumed) Prob > chi2 = 0.0000 -----------------------------------------------------------------------------gini | Coef. Std. Err. z P>|z| [95% Conf. Interval] expense | -.3475472 .0764462 -4.55 0.000 -.497379 -.1977155 trade | -.0032352 .0164759 -0.20 0.844 -.0355272 .0290569 tax | -.1153987 .1002363 -1.15 0.250 -.3118583 .0810609 growth | .1713241 .2384926 0.72 0.473 -.2961127 .6387609 _cons | 50.42204 2.743374 18.38 0.000 45.04512 55.79895 -------------+---------------------------------------------------------------sigma_u | 2.5497919 sigma_e | 9.0996899 rho | .07279974 (fraction of variance due to u_i) . estimates store random
25
26
To choose between fixed-effect and random effect, Hausman test has been applied. The result is in favor of Random effect model since it accepts null hypothesis (Prob>chi2 = 0.2108, H0: difference in coefficients not systematic). Table 5 Hausman test . hausman fixed random ---- Coefficients ---| (b) (B) (b-B) sqrt(diag(V_b-V_B)) | fixed random Difference S.E. -------------+---------------------------------------------------------------expense | -.4605505 -.3475472 -.1130033 .0950795 trade | -.0149579 -.0032352 -.0117227 .0192717 tax | .0542099 -.1153987 .1696086 .1162107 growth | .0904044 .1713241 -.0809197 .2300934 -----------------------------------------------------------------------------b = consistent under Ho and Ha; obtained from xtreg B = inconsistent under Ha, efficient under Ho; obtained from xtreg Test: Ho: difference in coefficients not systematic chi2(4) = (b-B)'[(V_b-V_B)^(-1)](b-B) = 5.85 Prob>chi2 = 0.2108 As the result of Hausman test, random effect model is chosen in this study. Possible problems that could jeopardize the result of this model have also been examined (no perfect Multicollinearity, no Heteroskedasticity and no autocorrelation). It reports that there is only variable that has statistically significant effect to dependent variable (Gini Index) while the effects of other variables do not exist according to this finding.
DETERMINANTS OF INCOME INEQUALITY 8. Conclusion and Policy Interferences 8.1 Conclusion
27
From the Econometric process in 7.2, it has shown that only government expense is the significant factor affecting income inequality (Gini Index). It strongly rejects the null hypothesis (H0: Government expense has no effect on Gini Index). Result of government expense affects on income inequality is reasonable given the fact that a large amount of spending directly focuses on the poor. But from this finding, the effects of trade, tax and growth are not significant. As the result, they might have only slightly indirect effects to income inequality in society. Even though, I cast a doubt on some factors that could have possibly been statistically significant in affecting inequality index, still all of the coefficient signs are in accordance with the hypothesis mentioned in 7.1 as follows: The coefficient of government expense is statistically significant with the expected (negative) sign, providing support for hypothesis that government expenditure can reduce inequality in society. The coefficient of trade openness is statistically insignificant with the expected (negative) sign. For trade openness, according to Hecksher-Ohlin Theory, the effect on income inequality may vary depending on the countries selected. In this case, the coefficient has a negative sign. The HecksherOhlin Theory implies that share of poor countries could outweighs share of the rich ones in this study. The coefficient of tax revenue is statistically insignificant with the expected (negative) sign. The negative sign means that increasing tax revenue could reduce Gini index (Gini index of 0 represents perfect equality, while an index of 100 implies perfect inequality). However, the effect from this finding is not significant. The coefficient of annual GDP growth is statistically insignificant with the expected (positive) sign. . If the Annual GDP growth increases, Gini index should increase, meaning that the inequality increase because of the increase of growth.
DETERMINANTS OF INCOME INEQUALITY 8.2 Policy interference
28
From this study, it can explain that among many factors that are likely to affect income inequality in society, government expense is the only one factor that has a significant effect toward inequality. This analysis focuses on cross-sectional and time-series data. It might not be appropriate to apply this result for any specific country. However, this study can support and oppose some fundamental concept on income inequality as follows: Because government spending is the only significant effect in reducing inequality according to this finding, it could say that a small government spending or minimal government interference could easily cause to the big income gap in the society. As the harmfulness of inequality in a society has been thoroughly explained in this paper, it would be practical for countries to have a big government approach that the government has ability to redistribute wealth in a certain extend. The consequence of tax on income inequality, according to this study, is not significant even though the sign is negative as expected. From the policy perspective, we could say that tax revenue should not be a measure to consider for reducing income inequality because it is simply not very effective. Though the country can collect a large amount of tax revenue, if the government does not use collected revenue as expenditure, the effect on income inequality would not be substantial. For trade openness, the effect is not significant from this finding with the biggest p-value among all. Thus, the typical implication to policy would say that income inequality should not be counted as a major issue in deciding whether or not the country should expose domestic market to the world. There are other factors such as the risk of opening market or the readiness of the country needed to be considered. However, applying to Hecksher-Ohlin Theory, it can take a different approach for interpreting this result. Hecksher-Ohlin Theory recommends that we should take the wealth of countries into account. In other words, if poor countries consider opening their market, it could help reducing inequality. But for rich countries, more exposed market to the world would increase income inequality. And from this finding, the data collected from both poor and rich countries. The result would likely to be offset between increased and decreased effects.
DETERMINANTS OF INCOME INEQUALITY Since the effect of GDP growth rate toward income inequality is not consequential from this finding, government spending that could boost growth in the country should still have full effect on
29
income inequality because there is no positive effect of growth to offset the negative effect of government expense. Also, it can be concluded that, we cannot blame economic growth as a culprit for income inequality after all. In conclusion, in order to curb inequality, government needs to be proactive and takes a serious approach on spending focusing on income redistribution. Other measures such as taxation and trade openness cannot significantly help reducing income inequality. As the result, government spending is the only practical solution for the real reduction of income gap. Without government expense, inequality would be likely to stay at its normal state which can contribute to many fundamental problems in societies. This result supports the historical trend of global income inequality that it has not been significantly changed during the last decade. It could be that many factors we believe it affects income inequality do not hold that fact on the global scale after all.
30
References
Anderson, E. (2005). Openness and Inequality in Developing Countries: A Review of Theoryand Recent Evidence. World Development, 1045. Calkins, K. G. (2005.). Correlation Coefficients, Applied Statistics - Lesson 5. Dowrick, S., & Akmal, M. (2005). CONTRADICTORY TRENDS IN GLOBAL INCOME INEQUALITY: A TALE OF TWO BIASES. Review of Income and Wealth, 51(2), 201-229. Jakobsson, A. (2006). Trade Openness and Income Inequality. Roine, J., Vlachos, J., & Waldenstrm, D. (2009). The long-run determinants of inequality: What can we learn from top income data? Journal of Public Economics, 93(78), 974-988. Stephens, J. D. (1995). THE SCANDINAVIAN WELFARE STATES ACHIEVEMENTS, CRISIS AND PROSPECTS. UNITED NATIONS RESEARCH INSTITUTE FOR SOCIAL DEVELOPMENT. Tanzi, V. (1998). Fundamental Determinants of Inequality and the Role of Government. SSRN eLibrary. Wilkinson, R. G., & Pickett, K. E. (2006). Income inequality and population health: A review and explanation of the evidence. Social Science & Medicine, 62(7), 1768-1784. Winkelmann, L., & Winkelmann, R. (2010). Does Inequality Harm the Middle Class? Kyklos, 63(2), 301-316. Witztum, A. (1997). Inequality and Competitiveness. Business Strategy Review, 8(2), 38-46.

Determinants of Income Inequality

Transféré par

Informations du document

Description originale:

Copyright

Formats disponibles

Partager ce document

Partager ou intégrer le document

Options de partage

Avez-vous trouvé ce document utile ?

Ce contenu est-il inapproprié ?

Droits d'auteur :

Formats disponibles

Determinants of Income Inequality

Transféré par

Droits d'auteur :

Formats disponibles

DETERMINANTS OF INCOME INEQUALITY

Running head: DETERMINANTS OF INCOME INEQUALITY