Explaining Inequality the World Round: Cohort Size,

Kuznets Curves, and Openness.By Matthew Higgins and Jeffrey G. Williamson

The three hypothesis

• Inequality and cohort size• Inequality and openness• Kuznet curve hypothesis

Cohort size hypothesis

• „Fat age cohorts tend to get low rewards“• Important where the fat cohorts lie in the demographic structure• Cohort size variance across countries vs. within countries over time

Inequality and openness

• Rising inequality correlated with increasing globalization• Trade (Heckscher- Ohlin argument)• Immigration• Labor supply shifts important• Globalization as cause for falling inequality in developing countries

and increasing inequality in developed countries?

Kuznets curve hypothesis I – Strong version• Inequality first decreases and then declines during economic

development• Demand for different skill levels causes the inequality development

Kuznets curve hypothesis II – Weak version• Demand forces not necessarily the reason for Kuznet movements• Other forces possible• Forces of some demographic transition (cohort size)• Different policies (attitude towards liberal policies, schooling,…)• Natural resource endowments

EMPIRICS

• Pooled dataset of 111 countries, 1960-1990ies

• Variables:• Decadal average of Real GDP per worker (RGDPW)• RGDPW2• GINI-coefficent• Log of (Q5/Q1) income ratio (GAP)• 8 dummies, including decadal dummies

Problems

• Simultaneity bias - Instrumental variables?

• Omitted variable bias

• Heteroskedasticity - heteroskedasticity-robust-estimators

Monotonically declining

Inverted U, but

imprecise estimations

Extension of the model• MATURE: share of population with age between 40-59

• OPEN: Sachs-Warner index(i) a black market premium of 20 percent or more for

foreign exchange(ii) an export marketing board which appropriates most

foreign exchange earnings(iii) a socialist economic system(iv) extensive non-tariff barriers on imports of intermediate

and capital goods.

Quite high

Lacks degrees of freedom!

• M3/GDP is a measure for financial depth (how sophisticated are financial institutions in a country, how many have access to these…)

• FREEDOM geometric average of two indices, one measuring civil liberties and one measuring political rights

Alternative measures for openness:• quantitative and tariff restrictions on imports,• the share of imports plus exports in GDP• Natural level of openness:

the logs of country size, population, per capita income, per capita crude proven oil reserves, the average distance from trading partners, and two dummy variables describing, respectively, whether a country is an island or is landlocked

Globalization and Inequality

• Milanovic (2005) proxies openness by the ratio of trade to GDP, finds negative effect of openness on inequality in poor countries• Ravallion (2001) as well• Dollar and Kraay (2000, 2002) find that openness has no impact on

inequality

Alternative demographic measures:• total fertility rate• population growth rate• labor-force growth rate• the infant mortality rate• life expectancy at birth

Fertility rate

• De La Croix and Doepke (2003) find negative correlation between high fertility and growth, via education• Barro (2000): High correlation between inequality and fertility

Fixed country effects

• Dummy variable for every country• Unbiased and consistent under the assumption that unobserved

effects are correlated with the explanatory variables• Loss in efficiency• Serial correlation -> LDV

Explaining cohort size effect on inequality• Three channels• 1) altered age structure, leaving age-earnings profile constant (+)• 2) different age groups with different within inequality levels (+)• 3) age-earnings structure changing, different experience premium (-)

Simulations - I

• Three key sets of parameters• 1) Age profile of labor productivity over the lifecylce• 2) Age profile of the variance of earnings over the lifecylce• 3) Elasticity of substitution between different age groups

Simulations - II

• Treat estimated mean age-income as representing the age-profile of labor productivity• Select various values for the elasticity of substitution across age

groups• Evaluate inequality indexes associated with various steady-state

population growth rates

Simulations - III

• Perfect substitutability• Small effect by changing mix between older and younger workers

caused by different wage levels (32.5 to 32.1)• Larger effect caused by different variance within age groups (43.1 to

39.7)• Taking mean-earnings and variance effects together: similar effect

Simulations - IV

• Imperfect elasticity of substitution necessary for cohort size effect to be true• 3.0 : offsets first two channels• suggests lower elasticity of substitution

• Barro, R. J. (2000). Inequality and Growth in a Panel of Countries. Journal of economic growth, 5(1), 5-32.• De La Croix, D., & Doepke, M. (2003). Inequality and growth: why

differential fertility matters. The American Economic Review, 93(4), 1091-1113.• Dollar, D., & Kraay, A. (2002). Growth is Good for the Poor. Journal of

economic growth, 7(3), 195-225.• Milanovic, B. (2005). Can we discern the effect of globalization on

income distribution? Evidence from household surveys. The World Bank Economic Review, 19(1), 21-44.• Ravallion, M. (2001). Growth, inequality and poverty: looking beyond

averages. World development, 29(11), 1803-1815.