Inequality Natural Resources, Inequality, and Economic Growth Thorvaldur Gylfason and Gylfi Zoega

Sources of Growth ++ + denotes a positive effect in the direction shown

Sources of Growth ++ + denotes a positive effect in the direction shown Adam Smith knew all this, and more Solow raised doubts on long-run linkages Phelps and Nelson on education

More Sources of Growth denotes a positive effect in the direction shown ?

More Sources of Growth denotes a positive effect in the direction shown ? Arthur Lewis: x is trade, stable politics, good weather Then Solow came along and said: growth is exogenous!

A Fuller View: More Sources of Growth – + denotes a positive effect in the direction shown – denotes a negative effect in the direction shown ? Endogenous growth: x can be almost anything!

Growth and Initial Income What do the data say? r = Botswana China Korea Nicaragua Thailand Indonesia No connection: No discernible sign that poor countries grow faster than rich r = rank correlation 87 countries

A Fuller View: Resources and Growth ––? Endogenous growth: x can be almost anything! Dutch disease Rent seeking – – Natural capital crowds out human and physical capital

Natural Capital and Economic Growth 85 countries What is the empirical evidence? r = rank correlation An increase in the natural capital share by 8% goes along with a decrease in per capita growth by 1% per year. r = African countries S/Y = Asian countries S/Y = 0.32 Notice two clusters

A Fuller View: Inequality and Growth ––– – Today x is inequality (with Zoega) – +

Aims and Overview I inequality and education Explore the relationship between inequality and education across countries since 1965 education and economic growth Explore also the linkages between education and economic growth across countries since 1965 Hypothesis: Education spurs growth Hypothesis: Education spurs growth through increased equality

Aims and Overview II inequality, and economic growth Explore also the relationship between natural resource abundance, inequality, and economic growth across countries since 1965 Hypothesis: Natural resource abundance hurts growth Hypothesis: Natural resource abundance hurts growth through increased inequality, inter alia

Background Commonly held view: efficiencyequality Economic efficiency and social equality are incompatible, like oil and water big trade-off Okun’s “big trade-off” Redistribution is costly Blunts incentives to work and save and invest in education Leaky-bucket analogy

Background: More Recent Arguments 1. Political economy redistribution Inequality may trigger demands for redistribution that hurts growth education It may also trigger demands for more and better education that helps growth 2. Social cohesion social conflict political instability Inequality may lead to social conflict and political instability that hinder growth volatility It may also lead to economic volatility

Background: 3. National saving Inequality may stimulate saving and hence also economic growth That is, if the rich save more that the poor But count the yachts! 4. Education hurt or helpeducation Inequality may hurt or help education Help? Poor countries and politics Hurt? Rich countries and imperfect markets Inequality and growth are endogenous variables and can move together or in opposite directions depending on the exogenous forces that affect both: anything can happen!

Equality South Africa Sweden France Equality and Efficiency Growth Increased equality reduces growth Increased equality spurs growth Utopia?

Equality South Africa Sweden France Equality and Efficiency Utopia? Increased equality spurs growth Growth

Equality South Africa Sweden France Equality and Efficiency Perhaps the social optimum involves accepting less than maximal growth in return for increased equality Social indifference curve Growth

Kuznets The Kuznets curve Inequality tends to increase with income at low levels of income and to decrease with income at higher levels of income 75 countries

Research Strategy Study 87 industrial and developing countries from 1965 to 1998 cross-country patterns Look for cross-country patterns in data from the World Bank Inequality and growth Inequality and education Education and growth regression analysis Dig deeper through regression analysis

An increase in Gini index by 12 points goes along with a decrease in per capita growth by almost 1% per year r = Growth and Inequality, What do the data say? Sweden Thailand Central African Republic South Africa France Brazil No discernible sign that equality stands in the way of economic growth Korea 75 countries Lesotho r = rank correlation

The Gini Index and the 20/20 Ratio 20/20 ratio The Gini index is closely related to the 20/20 ratio Gini = 25  ratio = 3 (Nordic countries) Gini = 30  ratio = 4 (Germany) Gini = 35  ratio = 6 (Britain) Gini = 40  ratio = 8 (US, China, Russia) Gini = 50  ratio = 15 (Nigeria) Gini = 60  ratio = 26 (Brazil) rich and poor Relationship between inequality and growth also holds for rich and poor separately

The Gini Index and the 20/20 Ratio 20/20 ratio The Gini index is closely related to the 20/20 ratio Gini = 25  ratio = 3 (Nordic countries) Gini = 30  ratio = 4 (Germany, Greece) Gini = 35  ratio = 6 (Britain) Gini = 40  ratio = 8 (US, China, Russia) Gini = 50  ratio = 15 (Nigeria) Gini = 60  ratio = 26 (Brazil) Each ten-point increase in the Gini index roughly doubles the 20/20 ratio

The Gini Index and the 20/20 Ratio 20/20 ratio The Gini index is closely related to the 20/20 ratio Gini = 25  ratio = 3 (Nordic countries) Gini = 30  ratio = 4 (Germany, Greece) Gini = 35  ratio = 6 (Britain) Gini = 40  ratio = 8 (US, China, Russia) Gini = 50  ratio = 15 (Nigeria) Gini = 60  ratio = 26 (Brazil) Each ten-point increase in the Gini index roughly doubles the 20/20 ratio

The Gini Index and the 20/20 Ratio 20/20 ratio The Gini index is closely related to the 20/20 ratio Gini = 25  ratio = 3 (Nordic countries) Gini = 30  ratio = 4 (Germany, Greece) Gini = 35  ratio = 6 (Britain) Gini = 40  ratio = 8 (US, China, Russia) Gini = 50  ratio = 15 (Nigeria) Gini = 60  ratio = 26 (Brazil) Each ten-point increase in the Gini index roughly doubles the 20/20 ratio

The Gini Index and the 20/20 Ratio 20/20 ratio The Gini index is closely related to the 20/20 ratio Gini = 25  ratio = 3 (Nordic countries) Gini = 30  ratio = 4 (Germany, Greece) Gini = 35  ratio = 6 (Britain) Gini = 40  ratio = 8 (US, China, Russia) Gini = 50  ratio = 15 (Nigeria) Gini = 60  ratio = 26 (Brazil) Each ten-point increase in the Gini index roughly doubles the 20/20 ratio

The Gini Index and the 20/20 Ratio 20/20 ratio The Gini index is closely related to the 20/20 ratio Gini = 25  ratio = 3 (Nordic countries) Gini = 30  ratio = 4 (Germany, Greece) Gini = 35  ratio = 6 (Britain) Gini = 40  ratio = 8 (US, China, Russia) Gini = 50  ratio = 15 (Nigeria) Gini = 60  ratio = 26 (Brazil) Each ten-point increase in the Gini index roughly doubles the 20/20 ratio

The Gini Index and the 20/20 Ratio: Quite Close

Education and Inequality: A Missing Link? Now consider the linkages between inequality and different measures of education The aim is to see if such linkages can help explain the observed cross- country pattern of inequality and economic growth

More on Education three Specifically, consider the relationship between inequality and three different measures of education inputs, outcomes, and participation: 1. Public expenditure on education 2. Expected years of schooling for girls 3. Secondary-school enrolment

Expenditure on Education and Inequality An increase in public expenditure on education by 1% of GNP is associated with a 2.3 point decrease in Gini. r = countries

Expenditure on Education and Economic Growth An increase in public expenditure on education by 3% of GNP is associated with an increase in per capita growth by 1% per year. 87 countries r = 0.31

Years of Schooling and Inequality An increase by one year in the schooling that girls can expect is associated with a decrease of almost one point on the Gini scale. r = countries

Years of Schooling and Economic Growth 49 countries r = 0.57 An increase by four years in the schooling that girls can expect is associated with an increase in per capita growth by 1% per year.

Secondary Enrolment and Inequality 75 countries An increase in the secondary-school enrolment rate by five percentage point goes along with a decrease of almost one point on the Gini scale. r = -0.54

Secondary Enrolment and Economic Growth An 25 point increase in secondary-school enrolment goes along with an increase in per capita growth by 1% per year. 87 countries r = 0.72

Secondary Enrolment and Growth, Again Positive but diminishing returns to education An 25 point increase in secondary-school enrolment goes along with an increase in per capita growth by 1% per year. r = countries

Summary of Results We have seen that, across countries: 1.Economic growth varies inversely inequality 2.Three different measures of education intended to reflect education inputs, outcomes, and participation are all inversely related to inequality 3.Economic growth varies directly with all three measures of education Can replace income inequality by inequality of education

One Possible Interpretation of Results Growth Inequality Growth Education Inequality + =

Another Possible Interpretation Growth Education Growth Inequality Education + =

Natural Resources and Inequality: A Link? Now consider the linkages between inequality and natural resource abundance The aim is, again, to see if such linkages can help explain the observed cross-country pattern of inequality and economic growth

Inequality and Natural Capital Increase in natural capital by 3% of national wealth goes along with an increase in Gini by 1 point 7 African countries where saving is 5% of GDP and per capita growth is -1% per year Notice cluster Increased natural resource abundance increases inequality and reduces growth Rwanda Mauritania Norway Bangladesh r = countries

Education and Natural Capital r = Finland Niger Vietnam Uruguay An increase in natural capital by 5% of national wealth goes along with a reduction in secondary enrolment by almost 10% of cohort 91 countries Congo Increased natural resource abundance discourages education and growth

Regression results Note: 87 observations. Method of estimation is SUR. t-statistics are shown within parentheses. Dependent variable Initial income Natural capital Investment rate Enrolment rate Gini coefficient R2R2R2R2 Economic growth -1.04(5.51)-0.06(4.22)0.13(4.61)0.71(2.60)-0.03(2.28)0.67 Investment rate -0.20(3.97)0.15 Enrolment rate 20.42(13.13)-0.71(4.50)0.72 Gini coefficient -0.16(4.97)0.31

Regression results Note: 87 observations. Method of estimation is SUR. t-statistics are shown within parentheses. Dependent variable Initial income Natural capital Investment rate Enrolment rate Gini coefficient R2R2R2R2 Economic growth -1.04(5.51)-0.06(4.22)0.13(4.61)0.71(2.60)-0.03(2.28)0.67 Investment rate -0.20(3.97)0.15 Enrolment rate 20.42(13.13)-0.71(4.50)0.72 Gini coefficient -0.16(4.97)0.31 Direct effect of natural capital on growth is -0.06

Regression results Note: 87 observations. Method of estimation is SUR. t-statistics are shown within parentheses. Dependent variable Initial income Natural capital Investment rate Enrolment rate Gini coefficient R2R2R2R2 Economic growth -1.04(5.51)-0.06(4.22)0.13(4.61)0.71(2.60)-0.03(2.28)0.67 Investment rate -0.20(3.97)0.15 Enrolment rate 20.42(13.13)-0.71(4.50)0.72 Gini coefficient -0.16(4.97)0.31 Indirect effect through investment is -0.20·0.13  -0.03

Regression results Note: 87 observations. Method of estimation is SUR. t-statistics are shown within parentheses. Dependent variable Initial income Natural capital Investment rate Enrolment rate Gini coefficient R2R2R2R2 Economic growth -1.04(5.51)-0.06(4.22)0.13(4.61)0.71(2.60)-0.03(2.28)0.67 Investment rate -0.20(3.97)0.15 Enrolment rate 20.42(13.13)-0.71(4.50)0.72 Gini coefficient -0.16(4.97)0.31 Indirect effect through education is -(0.71/E)·0.71  E = 35

Regression results Note: 87 observations. Method of estimation is SUR. t-statistics are shown within parentheses. Dependent variable Initial income Natural capital Investment rate Enrolment rate Gini coefficient R2R2R2R2 Economic growth -1.04(5.51)-0.06(4.22)0.13(4.61)0.71(2.60)-0.03(2.28)0.67 Investment rate -0.20(3.97)0.15 Enrolment rate 20.42(13.13)-0.71(4.50)0.72 Gini coefficient -0.16(4.97)0.31 Total effect of natural capital is  -0.10

Regression results Note: 87 observations. Method of estimation is SUR. t-statistics are shown within parentheses. Dependent variable Initial income Natural capital Investment rate Enrolment rate Gini coefficient R2R2R2R2 Economic growth -1.04(5.51)-0.06(4.22)0.13(4.61)0.71(2.60)-0.03(2.28)0.67 Investment rate -0.20(3.97)0.15 Enrolment rate 20.42(13.13)-0.71(4.50)0.72 Gini coefficient -0.16(4.97)0.31

Regression results Note: 87 observations. Method of estimation is SUR. t-statistics are shown within parentheses. Dependent variable Initial income Natural capital Investment rate Enrolment rate Gini coefficient R2R2R2R2 Economic growth -1.04(5.51)-0.06(4.22)0.13(4.61)0.71(2.60)-0.03(2.28)0.67 Investment rate -0.20(3.97)0.15 Enrolment rate 20.42(13.13)-0.71(4.50)0.72 Gini coefficient -0.16(4.97)0.31 Direct effect of education on growth is 0.71/E  0.02 E = 35

Regression results Note: 87 observations. Method of estimation is SUR. t-statistics are shown within parentheses. Dependent variable Initial income Natural capital Investment rate Enrolment rate Gini coefficient R2R2R2R2 Economic growth -1.04(5.51)-0.06(4.22)0.13(4.61)0.71(2.60)-0.03(2.28)0.67 Investment rate -0.20(3.97)0.15 Enrolment rate 20.42(13.13)-0.71(4.50)0.72 Gini coefficient -0.16(4.97)0.31 Indirect effect through inequality is (-0.16)·(-0.03)  0.005

Regression results Note: 87 observations. Method of estimation is SUR. t-statistics are shown within parentheses. Dependent variable Initial income Natural capital Investment rate Enrolment rate Gini coefficient R2R2R2R2 Economic growth -1.04(5.51)-0.06(4.22)0.13(4.61)0.71(2.60)-0.03(2.28)0.67 Investment rate -0.20(3.97)0.15 Enrolment rate 20.42(13.13)-0.71(4.50)0.72 Gini coefficient -0.16(4.97)0.31 Total effect of education is 0.71/E + (-0.16)·(-0.03)  E = 35

Dependent variable Initial income Initial income squared Natural capital Investment rate Enrolment rate (log) Gini index Gender inequality R2R2R2R2 Economic growth (6.05) (5.19) 0.11(3.82)1.08(3.88)-0.04(2.84)-0.01(0.76)0.68 Investment rate -0.20(3.98)0.15 Enrolment rate 0.54 (11.31) (6.29) 0.70 Gini index (3.54) (3.69) 0.30 (2.84) 0.31 Gender inequality 0.25 (2.98) 0.09 Regression Results Note: 87 observations. Method of estimation is SUR. t-statistics are shown within parentheses.

Dependent variable Initial income Initial income squared Natural capital Investment rate Enrolment rate (log) Gini index Gender inequality R2R2R2R2 Economic growth (6.05) (5.19) 0.11(3.82)1.08(3.88)-0.04(2.84)-0.01(0.76)0.68 Investment rate -0.20(3.98)0.15 Enrolment rate 0.54 (11.31) (6.29) 0.70 Gini index (3.54) (3.69) 0.30 (2.84) 0.31 Gender inequality 0.25 (2.98) 0.09 Regression Results Note: 87 observations. Method of estimation is SUR. t-statistics are shown within parentheses. Exogenous determinants of growth: initial income and natural capital

Dependent variable Initial income Initial income squared Natural capital Investment rate Enrolment rate (log) Gini index Gender inequality R2R2R2R2 Economic growth (6.05) (5.19) 0.11(3.82)1.08(3.88)-0.04(2.84)-0.01(0.76)0.68 Investment rate -0.20(3.98)0.15 Enrolment rate 0.54 (11.31) (6.29) 0.70 Gini index (3.54) (3.69) 0.30 (2.84) 0.31 Gender inequality 0.25 (2.98) 0.09 Regression Results Note: 87 observations. Method of estimation is SUR. t-statistics are shown within parentheses. Investment is good for growth

Dependent variable Initial income Initial income squared Natural capital Investment rate Enrolment rate (log) Gini index Gender inequality R2R2R2R2 Economic growth (6.05) (5.19) 0.11(3.82)1.08(3.88)-0.04(2.84)-0.01(0.76)0.68 Investment rate -0.20(3.98)0.15 Enrolment rate 0.54 (11.31) (6.29) 0.70 Gini index (3.54) (3.69) 0.30 (2.84) 0.31 Gender inequality 0.25 (2.98) 0.09 Regression Results Note: 87 observations. Method of estimation is SUR. t-statistics are shown within parentheses. Education is good for growth; notice diminishing returns

Dependent variable Initial income Initial income squared Natural capital Investment rate Enrolment rate (log) Gini index Gender inequality R2R2R2R2 Economic growth (6.05) (5.19) 0.11(3.82)1.08(3.88)-0.04(2.84)-0.01(0.76)0.68 Investment rate -0.20(3.98)0.15 Enrolment rate 0.54 (11.31) (6.29) 0.70 Gini index (3.54) (3.69) 0.30 (2.84) 0.31 Gender inequality 0.25 (2.98) 0.09 Regression Results Note: 87 observations. Method of estimation is SUR. t-statistics are shown within parentheses. Equality is good for growth, at least income equality

Dependent variable Initial income Initial income squared Natural capital Investment rate Enrolment rate (log) Gini index Gender inequality R2R2R2R2 Economic growth (6.05) (5.19) 0.11(3.82)1.08(3.88)-0.04(2.84)-0.01(0.76)0.68 Investment rate -0.20(3.98)0.15 Enrolment rate 0.54 (11.31) (6.29) 0.70 Gini index (3.54) (3.69) 0.30 (2.84) 0.31 Gender inequality 0.25 (2.98) 0.09 Regression Results Note: 87 observations. Method of estimation is SUR. t-statistics are shown within parentheses. Natural capital hurts growth, directly as well as through crowding out

Dependent variable Initial income Initial income squared Natural capital Investment rate Enrolment rate (log) Gini index Gender inequality R2R2R2R2 Economic growth (6.05) (5.19) 0.11(3.82)1.08(3.88)-0.04(2.84)-0.01(0.76)0.68 Investment rate -0.20(3.98)0.15 Enrolment rate 0.54 (11.31) (6.29) 0.70 Gini index (3.54) (3.69) 0.30 (2.84) 0.31 Gender inequality 0.25 (2.98) 0.09 Regression Results Note: 87 observations. Method of estimation is SUR. t-statistics are shown within parentheses. Natural capital crowds out real capital

Dependent variable Initial income Initial income squared Natural capital Investmen t rate Enrolment rate (log) Gini index Gender inequality R2R2R2R2 Economic growth (6.05) (5.19) 0.11(3.82)1.08(3.88)-0.04(2.84)-0.01(0.76)0.68 Investment rate -0.20(3.98)0.15 Enrolment rate 0.54 (11.31) (6.29) 0.70 Gini index (3.54) (3.69) 0.30 (2.84) 0.31 Gender inequality 0.25 (2.98) 0.09 Regression Results Note: 87 observations. Method of estimation is SUR. t-statistics are shown within parentheses. Natural capital crowds out human capital

Dependent variable Initial income Initial income squared Natural capital Investment rate Enrolment rate (log) Gini index Gender inequality R2R2R2R2 Economic growth (6.05) (5.19) 0.11(3.82)1.08(3.88)-0.04(2.84)-0.01(0.76)0.68 Investment rate -0.20(3.98)0.15 Enrolment rate 0.54 (11.31) (6.29) 0.70 Gini index (3.54) (3.69) 0.30 (2.84) 0.31 Gender inequality 0.25 (2.98) 0.09 Regression Results Note: 87 observations. Method of estimation is SUR. t-statistics are shown within parentheses. Natural capital crowds out social capital

Dependent variable Initial income Initial income squared Natural capital Investment rate Enrolment rate (log) Gini index Gender inequality R2R2R2R2 Economic growth (6.05) (5.19) 0.11(3.82)1.08(3.88)-0.04(2.84)-0.01(0.76)0.68 Investment rate -0.20(3.98)0.15 Enrolment rate 0.54 (11.31) (6.29) 0.70 Gini index (3.54) (3.69) 0.30 (2.84) 0.31 Gender inequality 0.25 (2.98) 0.09 Regression Results Note: 87 observations. Method of estimation is SUR. t-statistics are shown within parentheses. Natural capital crowds out social capital

Dependent variable Initial income Initial income squared Natural capital Investment rate Enrolment rate (log) Gini index Gender inequality R2R2R2R2 Economic growth (6.05) (5.19) 0.11(3.82)1.08(3.88)-0.04(2.84)-0.01(0.76)0.68 Investment rate -0.20(3.98)0.15 Enrolment rate 0.54 (11.31) (6.29) 0.70 Gini index (3.54) (3.69) 0.30 (2.84) 0.31 Gender inequality 0.25 (2.98) 0.09 Regression Results Note: 87 observations. Method of estimation is SUR. t-statistics are shown within parentheses. Total effect of natural capital on growth is –0.14

Dependent variable Initial income Initial income squared Natural capital Investment rate Enrolment rate (log) Gini index Gender inequality R2R2R2R2 Economic growth (6.05) (5.19) 0.11(3.82)1.08(3.88)-0.04(2.84)-0.01(0.76)0.68 Investment rate -0.20(3.98)0.15 Enrolment rate 0.54 (11.31) (6.29) 0.70 Gini index (3.54) (3.69) 0.30 (2.84) 0.31 Gender inequality 0.25 (2.98) 0.09 Regression Results Note: 87 observations. Method of estimation is SUR. t-statistics are shown within parentheses. Notice the Kuznets curve

Dependent variable Initial income Initial income squared Natural capital Investment rate Enrolment rate (log) Gini index Gender inequality R2R2R2R2 Economic growth (6.05) (5.19) 0.11(3.82)1.08(3.88)-0.04(2.84)-0.01(0.76)0.68 Investment rate -0.20(3.98)0.15 Enrolment rate 0.54 (11.31) (6.29) 0.70 Gini index (3.54) (3.69) 0.30 (2.84) 0.31 Gender inequality 0.25 (2.98) 0.09 Regression Results Note: 87 observations. Method of estimation is SUR. t-statistics are shown within parentheses. Bottom line: inequality and growth are both endogenous

Conclusion Diversification away from natural resources may spur economic growth 1. by increasing and improving human capital as well as social capital, by reducing inequality and also real capital This may be one reason why inequality and growth are inversely related across countries: an equilibrium outcome

Conclusion The End Other possible reasons 1. More and better education reduces inequality and encourages growth 2. Excessive inequality triggers demand for more and better education that reduces inequality and speeds up growth 3. Excessive inequality reduces social cohesion, efficiency, and growth Many possibilities!