Economic Growth and Income Inequality Relationship: Role of Credit Market Imperfection

Amina Tabassum, M. Tariq Majeed


The 20th century has witnessed unequalled success in improving
the living standard of people in most part of the world. According to
World Bank annual Statistical reports, poverty has declined
significantly in developing countries over the past twenty years but the
progress has been uneven. The number of people living in poverty fell
from 1.5 billion in 1981 to 1.1 billion in 2001. However, many
low-income developing countries are still trapped in vicious circle of
poverty. In Sub-Saharan Africa, the number of poor rose from 41 percent
to 46 percent between 1981 to 2001.While in Eastern Europe and Central
Asia, the numbers of poor people have risen to around 20 percent in
2001.1 Therefore; reduction of widely scattered poverty is the most
challenging goal for low income developing countries. Economic growth is
considered to be a powerful force for reducing poverty. High and
sustained economic growth increases the labor demand and wages which in
return will reduce poverty. Similarly, better earnings as a result of
reduction in poverty lead to increase productivity and growth. But the
extent of poverty reduction as a result of economic growth depends on
how the distribution of income changes with economic growth and on
initial Inequalities in income. If income inequality increases, then
economic growth does not lead to a significant poverty reduction. Many
developing countries achieved high growth rates in different periods but
poverty does not reduce significantly in these periods due to increase
in income inequalities. Most South and East Asian economies grew at
higher per capita rates since early 1970 along with rise in income
inequality over time. In contrast, Latin American countries grew by less
than the half of average growth rates in South and East Asia while
maintaining high income inequality.2 The differences in income
inequality at a given rate of growth require that efforts to reduce
poverty by stimulating growth are not sufficient and need to be
complemented by efforts to reduce income inequalities.

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