Essays on the Economics of Inequality

This thesis contributes to the literature on income inequality. It does so in three distinct chapters.

The first empirical chapter takes note of the rapid increase in income inequality in Asia since the 1990s. While greater trade openness is good for the region, it has contributed to widening income gaps between the “haves” and “have-nots”. This chapter examines the effects of trade openness and institutional quality on income inequality in 17 Asian countries for the period 1990-2013 using the System Generalised Method of Moments (GMM) approach. The results confirm that rising trade openness has unduly increased income inequality in Asia, even in the presence of good institutions. The positive relationship between income inequality and trade openness may possibly be caused by an increase in relative wages of workers among the group of Asian countries as predicted by the Heckscher- Ohlin (HO) model. It appears that improvements to institutional quality play a limited role in reducing inequality. The results suggest that institutional reforms that took place in the region may entail rising inequality in the short run. As reforms may be costly especially to the less-skilled workers, it is recommended that policy makers play a more active role to improve distributional consequences. Suggestions include congruence between trade liberalisation policies and provision for social protection or human capital development to combat the negative effects of rising inequality. The results give rise to the question whether income inequality will have an effect on a country’s long run growth.

The second empirical chapter investigates the link between income inequality, growth and financial development. It does so by first focusing on China, the fastest growing economy in Asia. China is a perfect example of a successful transition from a planned economy to a socialist market economy. The country’s remarkable growth rate is attributed to various economic and financial reforms which began in 1978. Nonetheless, there is a noticeable rise in income inequality over the past few decades. At the same time, proponents of financial development maintain that the availability of credit or access to finance will spur development but increase income inequality. Although this topic has been discussed at great length in the literature, there is still controversy over the long-run and short-run behaviour of income inequality on economic growth or availability of credit. In this study, the Bounds test approach to cointegration and error correction modelling is utilised to test the causal relationship between all three variables in China using data from 1980 to 2013. The Bounds test reveals that financial development has a significant long-run impact on China’s income inequality. The study further extends to a group of Asian countries to investigate whether the observed relationship is unique to China. Overall, this study suggests the importance of market reforms to open up more opportunities for the poor and government policies to improve income distribution in the country. The findings give rise to the next question whether government policies affect income distribution in the country.

In answer to this, the third empirical chapter outlines a subjective assessment of income inequality using recent data from the World Values Survey (WVS). The focus is on Malaysia, an extreme example of a multi-ethnic society with strong government interventions, described by some as correcting economic imbalances, by others as discriminating in favour of the ethnic majority. The Malaysian Government introduced preferential policies under the New Economic Policy (1971-1991) as a means of promoting ‘Bumiputera’ rights in a background of diverse ethnic interests. These policies have contributed towards a fall in the incidence of poverty and level of inequality in the country. However, more than half a century after the NEP, a majority of Malaysian citizens preferred larger income differentials as evidenced. The empirical results in this chapter suggest that the normative beliefs such as the individual’s belief, ideologies and education level will determine their preference towards distributional outcomes. The findings also support the view that economic surroundings play a part in an individual’s preference for greater or lesser inequality. The negative effects of actual inequality may have been reduced through government policies to assist the low-income groups. Social spending may have created economic opportunities for the less fortunate. The findings help explain why the country did not face severe inter-ethnic conflicts despite having preferential policies in place. In order to investigate whether the subjective view of inequality is exclusive to the country, the study extends to a group of Asian countries.