Kuznets curve is the graphical representation of Simon Kuznets's theory that economic inequality increases over time, then at a critical point begins to decrease.

One theory as to why this happens, in early stages of development, when investment in physical capital is the main mechanism of economic growth, inequality encourages growth by allocating resources towards those who save and invest the most. Whereas in mature economies human capital accrual, or an estimate of cost that has been incurred but not yet paid, takes the place of physical capital accrual as the main source of growth, and inequality slows growth by lowering education standards because poor people lack finance for their education in imperfect credit markets. Kuznets curve diagrams show an inverted U curve, although variables along the axes are often mixed and matched, with inequality or the Gini coefficent on the Y axis and economic development, time or per capita incomes on the X axis.

Kuznets had two similar explanations for this historical phenomenon:

• workers migrated from agriculture to industry,
• rural workers moved to urban jobs.

In both explanations, inequality will decrease after 50% of the work force switches over to the higher paying sector. Economic historians have since used skill gap theories and the theories of capital concentration in early economies from classical economists and Marxists to further explain the Kuznets curve.

Criticism of Kuznets Curve

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Kuznets' conclusion that inequality must increase before decreasing, however, rests on shaky ground, because he used cross-sectional data of many countries during the same time period, rather than time series data that showed the progression of individual countries' development. The U-shape in the curve comes not from progression in the development of individual countries, but rather from historical differences between countries. In his data set, many of the middle income countries were in Latin America, a region with historically high levels of inequality. When controlling for this variable, the U-shape of the curve tends to disappear.

Environmental Kuznets Curve

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Another situation where Kuznets type curves appear is the environment. It is claimed that many environmental health indicators, such as water and air pollution, show the inverted U-shape: in the beginning of economic development, little weight is given to environmental concerns, raising pollution along with industrialization. After a threshold, when basic physical needs are met, interest in a clean environment rises, reversing the trend. Now society has the funds, as well as willingness to spend to reduce pollution.

The extension to environmental health in general has been doubted. For example, energy, land and resource use (sometimes called the "ecological footprint") do not fall with rising income. While the ratio of energy per real GDP has fallen, total energy use is still rising in most developed countries. In general, Kuznets curves have been found for some environmental health concerns (such as air pollution) but not for others (such as landfills).

References

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• Van Zanden, J.L. (1995). Tracing the Beginning of the Kuznets Curve: Western Europe during the Early Modern Period. The Economic History Review 48 (4), 643-664.

Economics curves | Environmental economics

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