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Economics Letters xxx (2009) xxxxxx

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Economics Letters
j o u r n a l h o m e p a g e : w w w. e l s e v i e r. c o m / l o c a t e / e c o l e t

An empirical test of the inequality trap concept

Caroline Daymon a,1, Celine Gimet b,
a b

Institut of Political Economics, DEFI, Faculty of Economics and Management, University of the Mediterranean, Chateau Lafarges, route des Milles, 13290 Aix-en-Provence, France Group for Economic Analysis and Theory (GATE), University of Lyon 2, CNRS UMR 5824, ENS Lettres et Sciences Humaines - GATE, Bureau R132, 15 Parvis Ren Descartes BP 7000, 69342 Lyon cedex 07, France

a r t i c l e

i n f o

a b s t r a c t
The paper uses a GMM estimation to prove the impact of equity on inequality persistence which suggests the presence of inequality trap, and underline the signicant inuence of the credit market, wealth and education access initial levels. 2009 Elsevier B.V. All rights reserved.

Article history: Received 18 August 2008 Received in revised form 13 July 2009 Accepted 17 July 2009 Available online xxxx Keywords: Dynamic panel data model EHII Equity GMM-system Inequality traps JEL classication: D3 C23

1. Introduction Recently, the World Development Report 2006 (WDR, 2005) points out the existence of a circular causal relation between wealth, income, sociocultural capital, power and the institutions which contribute to the persistence of initial conditions. This phenomenon is called inequality traps (Rao, 2006; Bourguignon et al., 2007). This concept underlines the lack of opportunities which is characteristic of poverty traps (Azariadis and Stachurski, 2004), but is also accompanied by stagnation in the society's income distribution structure. In this case, even if opportunities for the poor increase, the nonegalitarian nature of the economic, social and polical environment is such that the comparative advantage is always in favour of the rich and leads to persistent inequality. Empirical evidence for the inequality trap concept has not yet appeared in the literature. The objective of this article is to underline the impact of equity on inequality persistence which suggests the presence of inequality trap. Moreover, the purpose is to shed light on

the determinants of the income inequality reproduction. What is important in the transmission of advantages is both the initial position of an individual and that of the distribution in general. However, the lack of data does not enable us to study individuals' mobility within income distribution according to their initial opportunities. In order to solve this problem, this study concentrates on comparing the inequality dynamics in countries facing very different initial conditions in terms of opportunity distribution. To this aim, an econometric application based on a system GMM estimator is more appropriate. Thus, if the results show that inequality in these countries is closely correlated to the initial conditions and that they are indeed being reproduced, we are facing worldwide reproduction of intergroup inequalities.

2. The empirical study 2.1. The GMM model Since the study of inequality traps refers to a dynamic process, we must study to what extent the lagged values of the variables inuence the current value of income distribution. When the ordinary least squares estimator is used for this purpose, there is an upward bias. The within estimator is also biased, but in the opposite direction. To solve this problem, we use a dynamic model allowing the introduction of instrumental variables, which are correlated to the lagged value of the endogenous variable and not with the error term (Bond, 2002).

We are grateful to Pr James K. Galbraith for providing us the UTIP-UNIDO database, to Charles La Tong and Daisy Connon for their precious help and we would like to thank the anonymous referee for his constructive comments. Corresponding author. Tel.: +33 437 376 282; fax: +33 437 376 024. E-mail addresses: carolinedaymon@hotmail.com (C. Daymon), gimet@gate.cnrs.fr (C. Gimet). 1 Tel.: +33 442 935 993; fax: +33 442 389 585. 0165-1765/$ see front matter 2009 Elsevier B.V. All rights reserved. doi:10.1016/j.econlet.2009.07.006

Please cite this article as: Daymon, C., Gimet, C., An empirical test of the inequality trap concept, Economics Letter (2009), doi:10.1016/j. econlet.2009.07.006

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2 Table 1 Explanatory variables. Variable Denition Expected sign pr (+) Role of the variable For Cling et al. (2005) the emergence of an inequality trap can be explained by political power inequality that leads to the establishment of inequitable institutions that maintain the inequality situation within the country. The assumption made here is that efcient markets and access to nancial resources guaranteeing equity are the necessary conditions for combating inequality traps. C. Daymon, C. Gimet / Economics Letters xxx (2009) xxxxxx

Economic and political inequalities Political Rating of political rights from 1 to 7, with 1 representing liberty the best mark and 7 representing the lowest degree of freedom (Freedom House (2005)). Credit Relation between domestic credit and the gross domestic access product (IMF (2007)).

domcred ()

Social and cultural inequalities Gender Share of literate women compared to literate men inequality between the ages of 15 and 24 (WDI (2007)). Youth literacy Share of young people between 15 and 24 likely to be rate able to read, write and understand a short, simple text about everyday life (WDI (2007)). Population Annual exponential change in the population actually growth present for a given period in a given country (WDI (2007)). Infantile Probability of a child dying before the age of 5 for 1000 mortality children (WDI (2007)).

gender () literacyyoung ()

This task discrimination based on sex causes a gender inequality which is passed on to the next generation (Rao, 2006). As the WDR 2005 stresses, promoting equity in the eld of human abilities inevitably involves paying particular attention to very young children. The Sarkar (2005) model underlines the role played by population growth in the persistence of inequalities. According to Deaton (2003) and Lynch et al.'s (2004) studies, the literature comes to the conclusion that there is a strong correlation between inequality and mortality.

popgrowth (+) mortalityyoung (+)

Table 2 Results of the OLS, within and GMM analyses over a period of 5 years. Explanatories variables ehiit 1 prt 1 domcredt 1 gendert 1 literacyyoungt 1 mortalityyoungt 1 popgrowtht 1 Region Cons 7.07 (2.45) R-squ = 0.73; Adj. R-squ = 0.72 .012 (1.39) .269 (1.25) REG (5 years) .791 (18.59) 0.045 (0.38) 0.007 (0.92) 020 (1.10) REG (5 years) .798 (20.17) 0.141 (1.36) 0.009 (0.14) Within (5 years) .390 (5.05) 0.080 (0.51) 0.025 (2.15) .013 (0.39) Within (5 years) .299 (5.05) 0.096 ( 0.71) 0.009 ( 1.07) GMM SYS (5 years) t2 .599 (12.60) 0.098 ( 0.79) 0.019 ( 2.21) .020 (1.19) GMM SYS (5 years) t2 .479 (10.02) 0.044 ( 0.66) 0.025 ( 2.68) GMM SYS (5 years) t3 .602 (12.64) 0.101 ( 0.419) 0.019 ( 2.15) .020 (1.20) GMM SYS (5 years) t3 .515 (10.79) 0.069 ( 0.57) 0.024 ( 2.64)

0.007 ( 0.71) .047 (3.04) 0.105 ( 0.24)

0.130 ( 1.21) .029 (3.21) .283 (1.26)

0.018 ( 1.72) .029 (3.22) .275 (1.22)

0.019 ( 1.78)

.198 (1.04) 1.43 (2.28) 8.91 (4.33) R-squ = 0.69; Adj. R-squ = 0.68

0.579 ( 1.12)

30.87 (5.67) Within = 0.38

24.15 (7.49) Within = 0.31

13.32 (4.14) Sargan = 0.131 AR(2) = 0.843

.365 (1.72) 1.70 (2.43) 22.64 (9.27) Sargan = 0.147 AR(2) = 0.553

13.12 (4.06) Sargan = 0.106 AR(2) = 0.891

.325 (1.47) 2.32 (1.47) 21.32 (8.74) Sargan = 0.035 AR(2) = 0.567

The system GMM therefore seems the method best adapted to our estimation2. The tests are based on databases over 5 years.3 The sample is composed of 71 countries over the period 1963 to 2003. Our model can be written as follows: yi;t = yi;t 1 + Xi;t 1 + ui + vi;t 1

2.2. Justication of the choice of variables To dene the dependant variable, we used the inequality estimator EHII (Estimation of the Household Inequality and Inequity) proposed by Galbraith and Kum (2003) which covers a large number of countries over a longer period than Deininger and Squire's (1996) database.4 Thanks to this database, we have a broader representation of emerging countries in our article (40) than in the majority of studies. The database being available until 1999, we have determined the EHII values up until 2003 thanks to the UTIP-UNIDO data supplied by James K. Galbraith. According to Galbraith and Kum's (2003) estimations, the most representative model of inequality is calculated from a Theil index on wage inequality in manufacturing UTIP-UNIDO,5 but it also incorporates the share of manufacturing employment in total population,6
4 For a detailed comparison of these two databases, refer to Galbraith and Kum (2003). 5 UTIP-UNIDO: University of Texas Inequality ProjectUnited Nations Industrial Development Organization. Using data from UNIDO has the advantage that it contains very little missing data that are perfectly harmonized globally. 6 Source: UNIDO.

with i = 1,,71 and t = 2,,9. With yi,t 1 the dependent lagged variable in the period t 1, Xi,t is the set of explanatory lagged variables, ui is the specic individual effect for each country, vi,t is the specic shock at each period and on each country. Where Exi;t ui + vi;t = 0.
2 It should be noted that Blundell and Bond (1998) Monte Carlo simulations showed that the system GMM estimator is more efcient than the rst-differenced one. Indeed when the number of instruments is small and when there is a nite sample, the rstdifferenced GMM estimator is biased. Moreover, it should also be underlined that in order to validate the use of a GMM model, the estimated coefcient of the dependent lagged variable must be larger than that of the within estimator and smaller than that of the OLS estimator. 3 The mean of the variable on each period of 5 years is retained.

Please cite this article as: Daymon, C., Gimet, C., An empirical test of the inequality trap concept, Economics Letter (2009), doi:10.1016/j. econlet.2009.07.006

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and three dummy variables relative to the Deininger and Squire (1996) database to harmonize the data. The rst one takes the value 0 or 1 depending on whether the inequality index of the country is based on gross or net income. The value of the second dummy is 0 or 1 depending on whether the calculation is based on household or per capita income. The last one is equal to 0 when the Deininger and Squire data are income-based and 1 when they are expenditurebased. These dummies allow us to solve the problem of the lack of continuity of the Deininger and Squire database. Taking the ehii variable one period lagged (ehiit 1) enables us to show the persistence of inequalities over time. The other explanatory variables chosen7 are described in Table 1. 3. Results The results are presented in Table 2. This study proves the inuence of equity on inequality persistence, which provides evidence of inequality traps at an international level (ehiit 1). This phenomenon is all the more marked in emerging regions as the dummy variable8 (region) shows. Indeed, the dependent lagged variable over 5 years has a signicant impact on distribution whatever methodology is chosen. We concentrate in particular on the results provided by the GMM estimation.9 The use of this model is validated because the coefcient of this GMM estimated variable is higher than that of the within estimator and lower than that of the OLS estimator. When we consider the t 2 and the t 3 periods, the Sargan test validates the instruments used in the model (p = 0.131, 0.147 and p = 0.106). Furthermore, the Arellano and Bond (1991) test does not allow us to reject the assumption of the absence of second order autocorrelation on the residuals (p = 0.843, 0.553; and p = 0.891, 0.567). This study therefore enables us to interpret the estimation's results correctly. The inuence of the rst category of indicators on inequality traps is underlined. The negative impact of the domcred indicator shows that low access to nancial resources for the most destitute tends to foster the inequality phenomenon. Since an individual's loan capacity is linked both to his or her earnings and to his or her initial provision of wealth, the investment ambitions of the neediest cannot be fullled. However, the pr variable is not signicant, meaning that we cannot draw a conclusion concerning the direct inuence of the institutional environment on inequality persistence. The second category of variables shows that to put an end to inequality traps it is necessary to improve the access of the most destitute to basic needs, notably with regard to health (mortalityyoung). It would seem therefore that access to health is a sine qua non condition for beginning a process of equalisation with respect to the opportunities offered to different groups. The same is true with regard to demographic transition as results show that population growth10 (popgrowth) tends to foster inequalities. The non-signicance of the gender variable does not allow us to conclude about the impact of gender inequality on the reproduction of income inequality. It should be noted that what is important in this variable is specically discrimination based on sex. When we study

more specically the elimination of illiteracy among very young children (literacyyoung), this variable plays an important role in the reproduction of inequality. Unless efcient education policies are set up, children from the poorest backgrounds thus have little chance of beneting from upward social mobility. 4. Conclusion The use of a panel data estimation has enabled us to stress the dynamics of inequalites. Our results empirically validate the assumptions made by Ferreira and Walton (2005), and conrm that the economic and sociocultural environment have a signicant inuence on the reproduction of inequality at a global level. This study should be complemented by more desagregate and microeconomical analyses regarding social, political and economic reproduction, and lack of mobility in order to prove the existence of inequality traps nationally. Overall, this paper allows us to dene the priority which must be given access to health, education and nancial resources in order to improve the opportunities offered to the neediest, thus putting a stop to the reproduction of inequality. For these measures to be effective, it is preferable for the countries to have achieved (or begun) their demographic transitions. We must nevertheless be vigilant, as the impact of these recommendations will vary according to the countries studied. References
Arellano, M., Bond, S.R., 1991. Some tests of specication for panel data: Monte Carlo evidence and an application to employment equations. Review of Economic Studies 58, 277297. Azariadis, C., Stachurski, J., 2004. Poverty traps. In: Aghion, P., Durlauf, S. (Eds.), Handbook of Economic Growth. Elsevier, Amsterdam. Blundell, R., Bond, S.R., 1998. Initial conditions and moment restrictions in dynamic panel data models. Journal of Econometrics 87 (1), 115143. Bond, S.R., 2002. Dynamic panel data models: a guide to micro data methods and practice. Portuguese Economic Journal 1, 141162. Bourguignon, F., Ferreira, F.H.G., Walton, M., 2007. Equity, efcient and inequality traps: a research agenda. Journal of Economic Inequality 5 (2), 235256. Cling, J.P., Cogneau, D., Loup, J., Naudet, J.D., Razandrakoto, M. and F. Roubaud, 2005, Le dveloppement, une question de chances: A propos du rapport sur le dveloppement dans le monde 2006 Equit et Dveloppement, Working Paper DIAL, No. DT/2005 (15). Deaton, A., 2003. Health, inequality, and economic development. Journal of Economic Literature 41, 113158. Deininger, K., Squire, L., 1996. A new data set measuring income inequality. World Bank Economic Review 10, 565591. Ferreira, F.H.G., Walton, M., 2005. The inequality trap: why equity must be central to development policy. Finance & Development 42 (4), 3438. Freedom House, 2005. The Freedom in the World survey, Washington, DC. Galbraith, J.K., Kum, H., 2003. Inequality and economic growth. A global view based on measures of pay. CESifo Economic Studies 49 (4), 527556. International Monetary Fond, 2007. International Financial Statistics, Washington, DC. Lynch, J., Smith, G.D., Harper, S., Hillemeier, M., Ross, N., Kaplan, G.A, Wolfson, M., 2004. Is income inequality a determinant of population health? Part 1, a systematic review. Milbank Quarterly 82 (1), 599. Rao, V., 2006. On inequality traps and development policy. World Bank: Development Outreach, February, 1013. Sarkar, J., 2005. Mortality, fertility and persistent income inequality. 75th Southern Economic Association Conference, Washington D.C. World Bank, 2005. World Development Report 2006: Equity and Development, Washington, DC. World Bank, 2007. World Development Indicators (WB-WDI), Washington, DC.

No collinearity bias exists between these variables. In the case of within regressions, the introduction of the dummy variable to distinguish the countries' prole is not desirable as the countries' specicity has already been taken into account by the introduction of xed effects. 9 The variables gender and literacyyoung are not studied jointly because of a redundancy of information which could lead to a collinearity bias in the analyses. 10 We have used population growth as a proxy for demographic transition, for there is no unanimously recognised indicator and there is the problem of the infrequency of samples for creating them.
8

Please cite this article as: Daymon, C., Gimet, C., An empirical test of the inequality trap concept, Economics Letter (2009), doi:10.1016/j. econlet.2009.07.006