21 Most Influential Economic Papers Of All Time

21 Most Influential Economic Papers Of All Time
The word 'economics' comes from two Greek words, 'eco' meaning home and 'nomos' meaning accounts – which is a
social science concerned with the production, distribution, and consumption of goods and services. It studies how
economic agents and economies make choices on allocating resources to satisfy their wants and needs, trying to
determine how these groups should organize and coordinate efforts to achieve maximum output.
Contents
1. A Theory of Production
2. The Use of Knowledge In Society
3. Economic Growth and Income Inequality
4. The Cost of Capital, Corporation Finance and the Theory of Investment
5. A Theory of Optimum Currency Areas
6. Uncertainty and the Welfare Economics of Medical Care

7. National Debt In A Neoclassical Growth Model
8. The Role of Monetary Policy
9. Migration, Unemployment and Development
10. Optimal Taxation and Public Production I: Production Efficiency
11. Optimal Taxation and Public Production II: Tax Rules
12. Production, Information Costs, and Economic Organization
13. The Economic Theory of Agency: The Principal's Problem
14. Some International Evidence on Output-Inflation Tradeoffs
15. The Political Economy of the Rent-Seeking Society
16. Monopolistic Competition and Optimum Product Diversity
17. An Almost Ideal Demand System
18. On the Impossibility of Informationally Efficient Markets
19. Scale Economies, Product Differentiation, and the Pattern of Trade
20. Do Stock Prices Move Too Much to be justified by Subsequent Changes in Dividends?
21. Capital Theory and Investment Behavior

The American Economic Review
VOLUMEXXXV SEPTEMBER,1945 NUMBER FOUR
THE USE OF KNOWLEDGE IN SOCIETY
By F. A. HAYEK*
I
What is the problem we wish to solve when we try to construct a
rational economic order?
On certain familiar assumptions the answer is simple enough. If we
possess all the relevant information, if we can start out from a given
system of preferences and if we command complete knowledge of
available means, the problem which remains is purely one of logic.
That is, the answer to the question of what is the best use of the
available means is implicit in our assumptions. The conditions which
the solution of this optimum problem must satisfy have been fully
worked out and can be stated best in mathematical form: put at their
briefest, they are that the marginal rates of substitution between any
two commoditiesor factors must be the same in all their differentuses.
This, however, is emphatically not the economic problem which
society faces. And the economic calculus which we have developed to
solve this logical problem, though an important step toward the solu-
tion of the economic problem of society, does not yet provide an
answer to it. The reason for this is that the "data" from which the
economic calculus starts are never for the whole society "given" to a
single mind which could work out the implications, and can never be
so given.
The peculiar character of the problem of a rational economic order
is determinedprecisely by the fact that the knowledge of the circum-
stances of which we must make use never exists in concentrated or
integrated form, but solely as the dispersed bits of incomplete and
frequently contradictoryknowledge which all the separate individuals
possess. The economicproblemof society is thus not merely a problem
* The author is Tooke professorof political economyand statistics at the University
of London (London School of Economicsand Political Science).

520 THE AMERICAN ECONOMIC REVIEW [SEPTEMBER
of how to allocate "given" resources-if ''given' is taken to mean
given to a single mind which deliberately solves the problem set by
these "data." It is rather a problem of how to secure the best use of
resources known to any of the members of society, for ends whose
relative importanceonly these individuals know. Or, to put it briefly,
it is a problem of the utilization of knowledge not given to anyone
in its totality.
This character of the fundamental problem has, I am afraid, been
rather obscured than illuminated by many of the recent refinements
of economic theory, particularly by many of the uses made of mathe-
matics. Though the problem with which I want primarily to deal in
this paper is the problem of a rational economic organization, I shall
in its course be led again and again to point to its close connections
with certain methodological questions. Many of the points I wish to
make are indeed conclusions toward which diverse paths of reasoning
have unexpectedly converged. But as I now see these problems, this is
no accident. It seems to me that many of the current disputes with
regardto both economictheory and economicpolicy have their common
origin in a misconception about the nature of the economic problem
of society. This misconception in turn is due to an erroneoustransfer
to social phenomena of the habits of thought we have developed in
dealing with the phenomena of nature.
II
In ordinarylanguage we describe by the word "planning"the com-
plex of interrelated decisions about the allocation of our available
resources.All economic activity is in this sense planning; and in any
society in which many people collaborate, this planning, whoever does
it, will in some measure have to be based on knowledge which, in the
first instance, is not given to the planner but to somebody else,
which somehow will have to be conveyed to the planner. The various
ways in which the knowledge on which people base their plans is
communicatedto them is the crucialproblemfor any theory explaining
the economic process. And the problem of what is the best way of
utilizing knowledge initially dispersed among all the people is at least
one of the main problems of economic policy-or of designing an
efficient economic system.
The answer to this question is closely connected with that other
question which arises here, that of who is to do the planning. It is
about this question that all the dispute about "economic planning"
centers. This is not a dispute about whether planning is to be done
or not. It is a dispute as to whether planning is to be done centrally,
by one authority for the whole economic system, or is to be divided

1945] HAYEK: THE USE OF KNOWLEDGE IN SOCIETY 521
among many individuals. Planning in the specific sense in which the
term is used in contemporary controversy necessarily means central
planning-direction of the whole economic system according to one
unified plan. Competition, on the other hand, means decentralized
planning by many separate persons. The half-way house between the
two, about which many people talk but which few like when they
see it, is the delegation of planning to organizedindustries, or, in other
words, monopoly.
Which of these systems is likely to be more efficientdepends mainly
on the question under which of them we can expect that fuller use
will be made of the existing knowledge. And this, in turn, depends on
whether we are more likely to succeed in putting at the disposal of a
single central authority all the knowledge which ought to be used but
which is initially dispersed among many different individuals, or in
conveying to the individuals such additional knowledge as they need
in order to enable them to fit their plans in with those of others.
III
It will at once be evident that on this point the position will be
differentwith respect to differentkinds of knowledge; and the answer
to our question will therefore largely turn on the relative importance
of the different kinds of knowledge; those more likely to be at the
disposal of particular individuals and those which we should with
greaterconfidenceexpect to find in the possession of an authoritymade
up of suitably chosen experts. If it is today so widely assumed that
the latter will be in a better position, this is because one kind of
knowledge, namely, scientific knowledge, occupies now so prominent
a place in public imaginationthat we tend to forget that it is not the
only kind that is relevant. It may be admitted that, so far as scientific
knowledge is concerned, a body of suitably chosen experts may be in
the best position to commandall the best knowledgeavailable though
this is of coursemerely shifting the difficultyto the problemof selecting
the experts. What I wish to point out is that, even assuming that this
problem can be readily solved, it is only a small part of the wider
problem.
Today it is almost heresy to suggest that scientific knowledge is not
the sum of all knowledge. But a little reflection will show that there
is beyond question a body of very important but unorganizedknowl-
edge which cannot possibly be called scientific in the sense of knowl-
edge of general rules: the knowledge of the particular circumstances
of time and place. It is with respect to this that practically every
individual has some advantage over all others in that he possesses
unique information of which beneficial use might be made, but of

which use can be made only if the decisions depending on it are left
to him or are made with his active cooperation.We need to remember
only how much we have to learn in any occupation after we have
completedour theoretical training, how big a part of our working life
we spend learning particular jobs, and how valuable an asset in all
walks of life is knowledge of people, of local conditions, and special
circumstances.To know of andput to use a machinenot fully employed,
or somebody'sskill which could be better utilized, or to be aware of a
surplus stock which can be drawn upon during an interruption of
supplies, is socially quite as useful as the knowledge of better alterna-
tive techniques. And the shipper who earns his living from using
otherwise empty or half-filled journeys of tramp-steamers, or the
estate agent whose whole knowledge is almost exclusively one of
temporary opportunities, or the arbitrageur who gains from local
differences of commodity prices, are all performing eminently useful
functions based on special knowledge of circumstancesof the fleeting
moment not known to others.
It is a curious fact that this sort of knowledge should today be
generally regardedwith a kind of contempt, and that anyone who by
such knowledge gains an advantage over somebody better equipped
with theoreticalor technical knowledgeis thought to have acted almost
disreputably.To gain an advantage from better knowledge of facilities
of communication or transport is sometimes regarded as almost dis-
honest, although it is quite as important that society make use of the
best opportunities in this respect as in using the latest scientific
discoveries. This prejudice has in a considerablemeasure affected the
attitude toward commerce in general comparedwith that toward pro-
duction. Even economists who regard themselves as definitely above
the crude materialist fallacies of the past constantly commit the same
mistake where activities directed toward the acquisition of such prac-
tical knowledge are concerned-apparently because in their scheme of
things all such knowledgeis supposed to be "given."The commonidea
now seems to be that all such knowledge should as a matter of course
be readily at the command of everybody, and the reproach of irra-
tionality leveled against the existing economicorderis frequentlybased
on the fact that it is not so available. This view disregardsthe fact that
the method by which such knowledge can be made as widely available
as possible is precisely the problemto whichwe have to find an answer.
IV
If it is fashionable today to minimize the importance of the knowl-
edge of the particular circumstancesof time and place, this is closely
connectedwith the smallerimportancewhich is now attached to change

as such. Indeed, there are few points on which the assumptions made
(usually only implicitly) by the "planners"differ from those of their
opponents as much as with regardto the significanceand frequency of
changes which will make substantial alterations of production plans
necessary. Of course, if detailed economic plans could be laid down
for fairly long periods in advance and then closely adhered to, so that
no further economic decisions of importance would be required, the
task of drawing up a comprehensive plan governing all economic
activity would appear much less formidable.
It is, perhaps, worth stressing that economic problems arise always
and only in consequence of change. So long as things continue as
before,or at least as they were expected to, there arise no new problems
requiring a decision, no need to form a new plan. The belief that
changes, or at least day-to-day adjustments, have become less im-
portantin moderntimes implies the contention that economicproblems
also have become less important. This belief in the decreasing im-
portance of change is, for that reason, usually held by the same people
who argue that the importance of economic considerations has been
driveninto the backgroundby the growingimportanceof technological
knowledge.
Is it true that, with the elaborate apparatus of modern production,
economic decisions are requiredonly at long intervals, as when a new
factory is to be erected or a new process to be introduced? Is it true
that, once a plant has been built, the rest is all more or less mechanical,
determined by the character of the plant, and leaving little to be
changedin adaptingto the ever-changingcircumstancesof the moment?
The fairly widespread belief in the affirmativeis not, so far as I
can ascertain, borne out by the practical experience of the business
man. In a competitive industry at any rate-and such an industry
alone can serve as a test-the task of keeping cost from rising requires
constant struggle, absorbinga great part of the energy of the manager.
How easy it is for an inefficientmanager to dissipate the differentials
on which profitability rests, and that it is possible, with the same
technical facilities, to producewith a great variety of costs, are among
the commonplaces of business experience which do not seem to be
equally familiar in the study of the economist. The very strength of
the desire, constantly voiced by producers and engineers, to be able
to proceed untrammeledby considerationsof money costs, is eloquent
testimony to the extent to which these factors enter into their daily
work.
One reason why economists are increasinglyapt to forget about the
constant small changes which make up the whole economic picture is
probablytheir growingpreoccupationwith statistical aggregates,which

show a very much greater stability than the movements of the detail.
The comparative stability of the aggregates cannot, however, be ac-
counted for-as the statisticians seem occasionally to be inclined to
do-by the "law of large numbers" or the mutual compensation of
randomchanges. The numberof elements with which we have to deal
is not large enough for such accidental forces to produce stability. The
continuous flow of goods and services is maintained by constant de-
liberate adjustments, by new dispositions made every day in the light
of circumstancesnot known the day before, by B stepping in at once
when A fails to deliver. Even the large and highly mechanized plant
keeps going largely because of an environmentupon which it can draw
for all sorts of unexpected needs; tiles for its roof, stationery for its
forms, and all the thousand and one kinds of equipment in which it
cannot be self-contained and which the plans for the operation of the
plant require to be readily available in the market.
This is, perhaps, also the point where I should briefly mention the
fact that the sort of knowledge with which I have been concerned is
knowledge of the kind which by its nature cannot enter into statistics
and thereforecannot be conveyed to any centralauthority in statistical
form. The statistics which such a central authority would have to use
would have to be arrived at precisely by abstracting from minor differ-
ences between the things, by lumping together, as resources of one
kind, items which differas regardslocation, quality, and other particu-
lars, in a way which may be very significant for the specific decision.
It follows from this that central planning based on statistical informa-
tion by its nature cannot take direct account of these circumstances
of time and place, and that the central planner will have to find some
way or other in which the decisions depending on them can be left to
the "man on the spot."
V
If we can agree that the economic problem of society is mainly one
of rapid adaptation to changes in the particularcircumstancesof time
and place, it would seem to follow that the ultimate decisions must be
left to the people who are familiarwith these circumstances,who know
directly of the relevant changes and of the resources immediately
available to meet them. We cannot expect that this problem will be
solved by first communicating all this knowledge to a central board
which, after integrating all knowledge, issues its orders. We must
solve it by some form of decentralization.But this answers only part
of our problem. We need decentralization because only thus can we
ensure that the knowledge of the particularcircumstancesof time and
place will be promptly used. But the "man on the spot" cannot decide

1945] IIAYEK: THE USE OF KNOWLEDGE IN SOCIETY 525
solely on the basis of his limited but intimate knowledge of the facts
of his immediate surroundings. There still remains the problem of
communicatingto him such further information as he needs to fit his
decisions into the whole pattern of changes of the larger economic
system.
How much knowledge does he need to do so successfully? Which
of the events which happen beyond the horizon of his immediate
knowledge are of relevance to his immediate decision, and how much
of them need he know?
There is hardly anything that happens anywhere in the world that
might not have an effect on the decision he ought to make. But he need
not know of these events as such, nor of all their effects. It does not
matter for him why at the particularmoment more screws of one size
than of anotherare wanted, why paper bags are more readily available
than canvas bags, or why skilled labor, or particular machine tools,
have for the moment become more difficult to acquire. All that is
significant for him is how much more or less difficult to procure they
have become compared with other things with which he is also con-
cerned, or how much more or less urgently wanted are the alternative
things he produces or uses. It is always a question of the relative
importance of the particular things with which he is concerned, and
the causes which alter their relative importance are of no interest to
him beyond the effect on those concrete things of his own environment.
It is in this connectionthat what I have called the economiccalculus
proper helps us, at least by analogy, to see how this problem can be
solved, and in fact is being solved, by the price system. Even the single
controlling mind, in possession of all the data for some small, self-
contained economicsystem, would not-every time some small adjust-
ment in the allocation of resources had to be made-go explicitly
throughall the relationsbetween ends and means which might possibly
be affected. It is indeed the great contribution of the pure logic of
choice that it has demonstrated conclusively that even such a single
mind could solve this kind of problem only by constructing and
constantly using rates of equivalence (or "values," or "marginalrates
of substitution"), i.e., by attaching to each kind of scarce resource a
numericalindex which cannot be derived from any property possessed
by that particular thing, but which reflects, or in which is condensed,
its significancein view of the whole means-endstructure.In any small
change he will have to consider only these quantitative indices (or
"values") in which all the relevant information is concentrated; and
by adjusting the quantities one by one, he can appropriatelyrearrange
his dispositions without having to solve the whole puzzle ab initio, or
withoutneedingat any stage to survey it at once in all its ramifications.

Fundamentally, in a system where the knowledge of the, relevant
facts is dispersedamong many people, prices can act to co6rdinate the
separate actions of different people in the same way as subjective
values help the individual to co6rdinate the parts of his plan. It is
worth contemplating for a moment a very simple and commonplace
instance of the action of the price system to see what precisely it
accomplishes.Assume that somewherein the world a new opportunity
for the use of some raw material, say tin, has arisen, or that one of
the sources of supply of tin has been eliminated. It does not matter
for our purpose-and it is very significant that it does not matter-
which of these two causes has made tin more scarce. All that the users
of tin need to know is that some of the tin they used to consumeis now
more profitably employed elsewhere, and that in consequence they
must economize tin. There is no need for the great majority of them
even to know where the more urgent need has arisen, or in favor of
what other needs they ought to husband the supply. If only some of
them know directly of the new demand,and switch resourcesover to it,
and if the people who are aware of the new gap thus created in turn
fill it from still other sources, the effect will rapidly spread throughout
the whole economic system and influence not only all the uses of tin,
but also those of its substitutes and the substitutes of these substitutes,
the supply of all the things made of tin, and their substitutes, and so
on; and all this without the great majority of those instrumental in
bringing about these substitutions knowing anything at all about the
original cause of these changes. The whole acts as one market, not
because any of its members survey the whole field, but because their
limited individual fields of vision sufficiently overlap so that through
many intermediariesthe relevant information is communicatedto all.
The mere fact that there is one price for any commodity-or rather
that local prices are connected in a manner determinedby the cost of
transport,etc.-brings about the solution which (it is just conceptually
possible) might have been arrived at by one single mind possessing
all the information which is in fact dispersed among all the people
involved in the process.
VI
We must look at the price system as such a mechanism for com-
municatinginformation if we want to understandits real function-a
function which, of course, it fulfills less perfectly as prices grow more
rigid. (Even when quoted prices have become quite rigid, however, the
forces which would operate through changes in price still operate to a
considerableextent throughchangesin the otherterms of the contract.)
The mostsignificantfact about this system is the economyof knowledge

with which it operates, or how little the individualparticipants need to
know in orderto be able to take the right action. In abbreviated form,
by a kind of symbol, only the most essential information is passed on,
and passed on only to those concerned.It is more than a metaphorto
describethe price system as a kind of machineryfor registeringchange,
or a system of telecommunicationswhich enables individual producers
to watch merely the movement of a few pointers, as an engineermight
watch the hands of a few dials, in order to adjust their activities to
changes of which they may never know more than is reflected in the
price movement.
Of course, these adjustments are probably never "perfect" in the
sense in which the economist conceives of them in his equilibrium
analysis. But I fear that our theoretical habits of approaching the
problemwith the assumptionof more or less perfect knowledge on the
part of almost everyone has made us somewhat blind to the true
function of the price mechanismand led us to apply rathermisleading
standards in judging its efficiency. The marvel is that in a case like
that of a scarcity of one raw material, without an order being issued,
without morethan perhapsa handful of people knowingthe cause, tens
of thousands of people whose identity could not be ascertained by
months of investigation, are made to use the material or its products
more sparingly; i.e., they move in the right direction. This is enough
of a marvel even if, in a constantly changing world, not all will hit it
off so perfectly that their profit rates will always be maintained at the
same constant or "normal"level.
I have deliberately used the word "marvel"to shock the reader out
of the complacency with which we often take the working of this
mechanism for granted. I am convinced that if it were the result of
deliberatehumandesign, and if the people guided by the price changes
understood that their decisions have significance far beyond their
immediate aim, this mechanism would have been acclaimed as one of
the greatest triumphsof the human mind. Its misfortune is the double
one that it is not the product of human design and that the people
guidedby it usually do not knowwhy they are made to do what they do.
But those who clamor for "conscious direction"-and who cannot be-
lieve that anythingwhichhas evolved without design (and even without
our understandingit) should solve problems which we should not be
able to solve consciously-should rememberthis: The problem is pre-
cisely how to extend the span of our utilization of resources beyond
the span of the controlof any one mind; and, therefore,how to dispense
with the need of conscious control and how to provide inducements
which will make the individuals do the desirablethings without anyone
having to tell them what to do.

528 THE AMERICAN
ECONOMIC
REVIEW [SEPTEMBER
The problem which we meet here is by no means peculiar to eco-
nomics but arises in connectionwith nearly all truly social phenomena,
with language and most of our cultural inheritance, and constitutes
really the central theoretical problem of all social science. As Alfred
Whiteheadhas said in anotherconnection,"It is a profoundlyerroneous
truism, repeated by all copy-books and by eminent people when they
are making speeches, that we should cultivate the habit of thinking
what we are doing. The precise opposite is the case. Civilization ad-
vances by extending the number of important operations which we
can perform without thinking about them." This is of profound sig-
nificancein the social field. We make constant use of formulas,symbols
and rules whose meaning we do not understand and through the use
of which we avail ourselves of the assistance of knowledge which
individually we do not possess. We have developed these practices and
institutions by buildingupon habits and institutions which have proved
successful in their own sphere and which have in turn become the
foundation of the civilization we have built up.
The price system is just one of those formations which man has
learned to use (though he is still very far fromhaving learned to make
the best use of it) after he had stumbledupon it without understanding
it. Throughit not only a division of laborbut also a cobrdinatedutiliza-
tion of resources based on an equally divided knowledge has become
possible. The people who like to deride any suggestion that this may
be so usually distort the argument by insinuating that it asserts that
by some miracle just that sort of system has spontaneously grown up
which is best suited to modern civilization. It is the other way round:
man has been able to develop that division of labor on which our
civilization is based because he happened to stumble upon a method
which made it possible. Had he not done so he might still have de-
veloped some other, altogether different,type of civilization, something
like the "state" of the termite ants, or some other altogether un-
imaginabletype. All that we can say is that nobody has yet succeeded
in designing an alternative system in which certain features of the
existing one can be preserved which are dear even to those who most
violently assail it-such as particularly the extent to which the indi-
vidual can choose his pursuits and consequently freely use his own
knowledge and skill.
VII
It is in many ways fortunate that the dispute about the indispensa-
bility of the price system for any rational calculation in a complex
society is now no longer conducted entirely between camps holding
differentpolitical views. The thesis that without the price system we

could not preserve a society based on such extensive division of labor
as ours was greeted with a howl of derisionwhen it was first advanced
by von Mises twenty-five years ago. Today the difficultieswhich some
still find in accepting it are no longer mainly political, and this makes
for an atmosphere much more conducive to reasonable discussion.
When we find Leon Trotsky arguing that "economic accounting is
unthinkable without market relations"; when Professor Oscar Lange
promisesProfessor von Mises a statue in the marblehalls of the future
Central Planning Board; and when Professor Abba P. Lerner re-
discovers Adam Smith and emphasizes that the essential utility of the
price system consists in inducing the individual, while seeking his own
interest, to do what is in the general interest, the differencescan indeed
no longer be ascribed to political prejudice. The remaining dissent
seems clearly to be due to purely intellectual, and more particularly
methodological, differences.
A recentstatementby ProfessorJosephSchumpeterin his Capitalism,
Socialism and Democracy provides a clear illustration of one of the
methodological differences which I have in mind. Its author is pre-
eminent among those economists who approach economic phenomena
in the light of a certain branch of positivism. To him these phenomena
accordingly appear as objectively given quantities of commodities
impinging directly upon each other, almost, it would seem, without
any intervention of human minds. Only against this background can
I account for the following (to me startling) pronouncement.Professor
Schumpeterargues that the possibility of a rational calculation in the
absenceof marketsfor the factors of productionfollows for the theorist
"from the elementary proposition that consumers in evaluating ('de-
manding') consumers' goods ipso facto also evaluate the means of
production which enter into the production of these goods."'
Taken literally, this statement is simply untrue. The consumers do
nothing of the kind. What Professor Schumpeter's"ipso facto" pre-
sumably means is that the valuation of the factors of production is
'J. Schumpeter, Capitalism, Socialism, and Democracy (New York, Harper, 1942), p.
175. Professor Schumpeter is, I believe, also the original author of the myth that Pareto
and Barone have "solved" the problem of socialist calculation. What they, and many
others, did was merely to state the conditions which a rational allocation of resources
would have to satisfy, and to point out that these were essentially the same as the condi-
tions of equilibrium of a competitive market. This is something altogether different from
showing how the allocation of resources satisfying these conditions can be found in prac-
tice. Pareto himself (from whom Barone has taken practically everything he has to say),
far from claiming to have solved the practical problem, in fact explicitly denies that it
can be solved without the help of the market. See his Manuel d'Jconomie pure (2nd ed.,
1927), pp. 233-34. The relevant passage is quoted in an English translation at the begin-
ning of my article on "Socialist Calculation: The Competitive 'Solution,'" in Economica,
New Series, Vol. VIII, No. 26 (May, 1940), p. 125.

530 THE AMERICAN ECONOMIC REVIEW
implied in, or follows necessarily from, the valuation of consumers'
goods. But this, too, is not correct. Implication is a logical relationship
whichcan be meaningfullyasserted only of propositionssimultaneously
present to one and the same mind. It is evident, however, that the
values of the factors of productiondo not depend solely on the valua-
tion of the consumers'goods but also on the conditions of supply of
the various factors of production. Only to a mind to which all these
facts were simultaneously known would the answer necessarily follow
from the facts given to it. The practical problem,however, arises pre-
cisely because these facts are never so given to a single mind, and
because, in consequence, it is necessary that in the solution of the
problem knowledge should be used that is dispersed among many
people.
The problem is thus in no way solved if we can show that all the
facts, if they were known to a single mind (as we hypothetically
assume them to be given to the observing economist), would uniquely
determine the solution; instead we must show how a solution is pro-
ducedby the interactionsof people each of whompossesses only partial
knowledge. To assume all the knowledge to be given to a single mind
in the same manner in which we assume it to be given to us as the
explainingeconomists is to assume the problemaway and to disregard
everything that is importantand significant in the real world.
That an economist of Professor Schumpeter'sstanding should thus
have fallen into a trap which the ambiguity of the term "datum"sets
to the unwary can hardly be explained as a simple error. It suggests
ratherthan there is something fundamentallywrong with an approach
which habitually disregards an essential part of the phenomena with
which we have to deal: the unavoidable imperfection of man's knowl-
edge and the consequent need for a process by which knowledge is
constantly communicatedand acquired.Any approach,such as that of
much of mathematical economics with its simultaneous equations,
which in effect starts from the assumption that people's knowledge
corresponds with the objective facts of the situation, systematically
leaves out what is our main task to explain. I am far from denying
that in our system equilibriumanalysis has a useful function to per-
form. But when it comes to the point where it misleads some of our
leading thinkers into believing that the situation which it describes
has direct relevance to the solution of practical problems, it is time
that we rememberthat it does not deal with the social process at all
and that it is no more than a useful preliminary to the study of the
main problem.

The American Economic Review
VOLUMEXLV MARCH,1955 NUMBER ONE
ECONOMIC GROWTH AND INCOME INEQUALITY*
By SIMON
KUZNETS
The central theme of this paper is the characterand causes of long-
term changes in the personal distribution of income. Does inequality
in the distribution of income increase or decrease in the course of a
country's economic growth? What factors determine the secular level
and trends of income inequalities?
These are broad questions in a field of study that has been plagued
by looseness in definitions, unusual scarcity of data, and pressures of
strongly held opinions.While we cannot completely avoid the resulting
difficulties, it may help to specify the characteristics of the size-of-
income distributions that we want to examine and the movements of
which we want to explain.
Five specificationsmay be listed. First, the units for which incomes
are recordedand groupedshould be family-expenditureunits, properly
adjusted for the number of persons in each-rather than income re-
cipients for whom the relations between receipt and use of income can
be widely diverse. Second, the distribution should be complete, i.e.,
should cover all units in a country rather than a segment either at the
upper or lower tail. Third, if possible we should segregate the units
whose main income earnersare either still in the learningor already in
the retiredstages of their life cycle-to avoid complicatingthe picture
byincludingincomesnot associatedwith full-time,full-fledgedparticipa-
tion in economicactivity. Fourth, income should be definedas it is now
for national income in this country, i.e., received by individuals, in-
cludingincome in kind, before and after direct taxes, excludingcapital
gains. Fifth, the units should be grouped by secular levels of income,
free of cyclical and other transient disturbances.
For such a distributionof matureexpenditureunits by secular levels
* Presidentialaddressdeliveredat the Sixty-seventhAnnualMeetingof the American
EconomicAssociation,Detroit,Michigan,December29, 1954.

Numiber 56 of a scrics of pbotographlIsof past pircsidecits of thte Associattioni.

of income per capita, we should measure shares of some fixed ordinal
groups-percentiles, deciles, quintiles, etc. In the underlyingarray the
units shouldbe classifiedby averageincomelevels for a sufficientlylong
span so that they form income-status groups-say a generation or
about 25 years. Within such a period, even when classified by secular
income levels, units may shift from one ordinal group to another. It
would, therefore,be necessary and useful to study separately the rela-
tive share of units that, throughoutthe generationperiod of reference,
were continuously within a specific ordinal group,and the share of the
units that moved into that specific group; and this should be done for
the shares of "residents" and "migrants" within all ordinal groups.
Without such a long period of reference and the resulting separation
between "resident" and "migrant"units at different relative income
levels, the very distinction between "low" and "high"income classes
loses its meaning,particularlyin a study of long-termchangesin shares
and in inequalities in the distribution. To say, for example, that the
"lower"income classes gained or lost during the last twenty years in
that theirshareof total incomeincreasedor decreasedhas meaningonly
if the units have been classified as members of the "lower" classes
throughoutthose 20 years-and for those who have moved into or out
of those classes recently such a statement has no significance.
Furthermore,if one may add a final touch to what is beginning to
look like a statistical economist'spipe dream,we shouldbe able to trace
secular income levels not only through a single generationbut at least
throughtwo-connecting the incomes of a given generationwith those
of its immediate descendants. We could then distinguish units that,
throughout a given generation, remain within one ordinal group and
whose children-through their generation-are also within that group,
from units that remain within a group through their generation but
whose childrenmove up or down on the relative economicscale in their
time. The numberof possible combinationsand permutationsbecomes
large; but it shouldnot obscurethe maindesignof the incomestructure
called for-the classification by long-term income status of a given
generation and of its immediate descendants. If living members of
society-as producers, consumers, savers, decision-makers on secular
problems-react to long-termchanges in incomelevels and shares, data
on such an incomestructureare essential. An economicsociety can then
be judged by the secular level of the income share that it provides for
a given generationand for its children.The importantcorollary is that
the study of long-termchanges in the income distributionmust distin-
guish betweenchangesin the sharesof residentgroups-resident within
either one or two generations-and changes in the income shares of

KUZNETS: ECONOMICGROWTHAND INCOMEINEQUALITY 3
groups that, judged by their secular levels, migrate upward or down-
ward on the income scale.
Even if we had data to approximatethe income structure just out-
lined, the broad question posed at the start-how income inequality
changes in the process of a country's economic growth-could be
answeredonly for growthunderdefinedeconomicand social conditions.
And, in fact, we shall deal with this question in terms of the experience
of the now developedcountries which grew underthe aegis of the busi-
ness enterprise. But even with this limitation, there are no statistics
that can be used directly for the purpose of measuring the secular
income structure. Indeed, I have difficulty in visualizing how such
information could practicably be collected-a difficulty that may be
due to lack of familiarity with the studies of our colleagues in de-
mography and sociology who have concerned themselves with prob-
lems of generationor intergenerationmobility and status. But although
we now lack data directly relevant to the secular income structure,
the setting up of reasonably clear and yet difficult specifications is
not merely an exercise in perfectionism. For if these specifications do
approximate,and I trust that they do, the realcore of ourinterest when
we talk about shares of economicclasses or long-termchanges in these
shares, then properdisclosure of our meaningand intentions is vitally
useful. It forces us to examineand evaluate critically the data that are
available; it prevents us from jumping to conclusions based on these
inadequate data; it reduces the loss and waste of time involved in
mechanical manipulations of the type represented by Pareto-curve-
fitting to groups of data whose meaning, in terms of income concept,
unit of observation, and proportion of the total universe covered, re-
mains distressingly vague; and most important of all, it propels us
towarda deliberateconstructionof testable bridges between the avail-
able data and the incomestructurethat is the real focus of our interest.
I. Trends in Income Inequality
Forewarned of the difficulties, we turn now to the available data.
These data, even when relating to complete populations, invariably
classify units by income for a given year. From our standpoint, this is
their major limitation. Because the data often do not permit many
size-groupings, and because the difference between annual income
incidenceand longer-termincomestatus has less effectif the numberof
classes is small and the limits of each class are wide, we use a few wide
classes. This does not resolve the difficulty; and there are others due to
the scantiness of data for long periods, inadequacy of the unit used-
whichis, at best, a family and very often a reportingunit-errors in the

4 THE AMERICANECONOMICREVIEW
data, and so on through a long list. Consequently, the trends in the
incomestructurecan be discernedbut dimly, and the results considered
as preliminaryinformed guesses.
The data are for the United States, England, and Germany-a scant
sample, but at least a starting point for some inferences concerning
long-term changes in the presently developed countries. The general
conclusion suggested is that the relative distribution of income, as
measuredby annual income incidencein ratherbroadclasses, has been
moving toward equality-with these trends particularly noticeable
since the 1920's but beginning perhaps in the period before the first
worldwar.
Let me cite some figures, all for income before direct taxes, in sup-
port of this impression.In the United States, in the distributionof in-
come among families (excluding single individuals), the shares of the
two lowest quintiles rise from 13? per cent in 1929to 18percent in the
years after the second world war (average of 1944, 1946, 1947, and
1950); whereasthe share of the top quintile declines from 55 to 44 per
cent, and that of the top 5 per cent from 31 to 20 per cent. In the
United Kingdom,the share of the top 5 per cent of units declines from
46 per cent in 1880 to 43 per cent in 1910 or 1913, to 33 per cent in
1929, to 31 per cent in 1938, and to 24 per cent in 1947; the share of
the lower 85 per cent remains fairly constant between 1880 and 1913,
between 41 and 43 per cent, but then rises to 46 per cent in 1929 and
55 per cent in 1947. In Prussia income inequality increases slightly
between 1875 and 1913-the shares of the top quintile rising from 48
to 50 per cent, of the top 5 per cent from 26 to 30 per cent; the share
of the lower 60 per cent, however, remainsabout the same. In Saxony,
the change between 1880 and 1913 is minor: the share of the two
lowest quintiles declines from 15 to 14Y2 per cent; that of the third
quintile rises from 12 to 13 per cent, of-the fourth quintile from 16?2
to about 18 per cent; that of the top quintile declines from 56>2 to
54j/2 per cent, and of the top 5 per cent from 34 to 33 per cent. In
Germany as a whole, relative income inequality drops fairly sharply
from 1913 to the 1920's, apparently due to decimation of large for-
tunes and property incomes during the war and inflation; but then
begins to return to prewar levels during the depression of the 1930's.'
1
The followingsourceswere used in calculatingthe figurescited:
UnitedStates.For recentyearswe usedIncomeDistributionby Size,1944-1950(Wash-
ington, 1953) and Selma Goldsmithand others, "Size Distributionof Income Since the
Mid-Thirties,"
Rev. Econ.Stat., Feb. 1954,XXXVI, 1-32; for 1929,the BrookingsInstitu-
tion data as adjustedin Simon Kuznets,Sharesof UpperGroupsin Incomeand Savings
(New York, 1953), p. 220.
UnitedKingdom.For 1938and 1947,DudleySeers,The Levellingof IncomeSince1938

KUZNETS:ECONOMICGROWTHAND INCOMEINEQUALITY 5
Even forwhat they are assumedto represent,let alone as approxima-
tions to shares in distributions by secular income levels, the data are
such that differencesof two or three percentage points cannot be as-
signed significance.One must judge by the general weight and consen-
sus of the evidence-which unfortunatelyis limited to a few countries.
It justifies a tentative impressionof constancy in the relative distribu-
tion of income before taxes, followed by some narrowing of relative
incomeinequalityafter the firstworldwar-or earlier.
Three aspects of this finding should be stressed. First, the data are
for income before direct taxes and exclude contributions by govern-
ment (e.g., relief and free assistance). It is fair to argue that both the
proportionand progressivity of direct taxes and the proportionof total
income of individuals accounted for by government assistance to the
less privilegedeconomicgroupshave grownduringrecentdecades.This
is certainly true of the United States and the United Kingdom,but in
the case of Germanyis subject to further examination.It follows that
the distributionof incomeafter directtaxes andincludingfree contribu-
tions by government would show an even greater narrowing of in-
equality in developed countries with size distributions of pretax, ex-
government-benefitsincome similar to those for the United States and
the United Kingdom.
Second,such stability or reductionin the inequality of the percentage
shares was accompaniedby significant rises in real income per capita.
The countries now classified as developed have enjoyed rising per
capita incomes except during catastrophic periods such as years of
active world conflict. Hence, if the shares of groups classified by their
annual income position can be viewed as approximationsto shares of
groups classified by their secular income levels, a constant percentage
share of a given group means that its per capita real income is rising
at the same rate as the average for all units in the country; and a re-
duction in inequality of the shares means that the per capita income
of the lower-incomegroups is rising at a more rapid rate than the per
capita income of the upper-incomegroups.
The thirdpoint can be put in the formof a question. Do the distribu-
(Oxford, 1951) p. 39; for 1929, Colin Clark, National Income and Outlay (London, 1937)
Table 47, p. 109; for 1880, 1910, and 1913, A. Bowley, The Change in the Distribution of
the NationalIncome,1880-1913(Oxford,1920).
Germany. For the constituent areas (Prussia, Saxony and others) for years before the
first world war, based on S. Prokopovich, National Income of Western European Countries
(published in Moscow in the 1920's). Some summary results are given in Prokopovich,
"The Distribution of National Income," Econ. Jour., March 1926, XXXVI, 69-82. See also,
"Das Deutsche Volkseinkommen vor und nach dem Kriege," Einzelschrift zur Stat. des
Deutschen Reicks, no. 24 (Berlin, 1932), and W. S. and E. S. Woytinsky, World Popula-
tion and Production (New York, 1953) Table 192, p. 709.

tions by annual incomes properly reflect trends in distribution by
secular incomes? As technology and economic performance rise to
higher levels, incomes are less subject to transient disturbances, not
necessarily of the cyclical order that can be recognized and allowed
for by reference to business cycle chronology, but of a more irregular
type. If in the earlier years the economic fortunes of units were sub-
ject to greater vicissitudes-poor crops for some farmers, natural
calamitylosses for some nonfarmbusiness units-if the over-allpropor-
tion of individual entrepreneurswhose incomes were subject to such
calamities, more yesterday but some even today, was larger in earlier
decades, these earlier distributions of income would be more affected
by transientdisturbances.In these earlierdistributionsthe temporarily
unfortunate might crowd the lower quintiles and depress their shares
unduly, and the temporarilyfortunatemight dominate the top quintile
and raise its share unduly-proportionately more than in the distribu-
tions for later years. If so, distributions by longer-term average in-
comes might show less reductionin inequality than do the distributions
by annual incomes; they might even show an opposite trend.
One may doubt whether this qualificationwould upset a narrowing
of inequality as marked as that for the United States, and in as short
a period as twenty-five years. Nor is it likely to affect the persistent
downwarddrift in the spread of the distributionsin the United King-
dom. But I must admit a strong element of judgment in deciding how
far this qualificationmodifiesthe findingof long-termstability followed
by reduction in income inequality in the few developed countries for
which it is observed or is likely to be revealed by existing data. The
importantpoint is that the qualificationis relevant; it suggests need for
further study if we are to learn much from the available data con-
cerning the secular income structure; and such study is likely to yield
results of interest in themselves in their bearing upon the problem
of trends in temporal instability of income flows to individual units
or to economically significant groups of units in different sectors of
the national economy.
II. An Attempt at Explanation
If the above summary of trends in the secular income structure of
developed countries comes perilously close to pure guesswork, an
attempt to explain these dimly discernible trends may surely seem
foolhardy.Yet it is necessary to do so if only to bring to the surface
some factors that may have been at play; induce a search for data
bearingupon these factors; and thus confirmor revise our impressions
of the trends themselves. Such preliminary speculations are useful

KUZNETS: ECONOMIC GROWTH AND INCOME INEQUALITY 7
provided it is recognized that we are at a relatively early stage in a
long process of interplay among tentative summaries of evidence,
preliminaryhypotheses, and search for additional evidence that might
lead to reformulation and revisions-as bases for new analysis and
furthersearch.
The present instalment of initial speculation may be introduced by
saying that a long-term constancy, let alone reduction,of inequality in
the secular income structure is a puzzle. For there are at least two
groupsof forces in the long-termoperationof developedcountriesthat
make for increasing inequality in the distribution of income before
taxes and excluding contributions by governments. The first group
relates to the concentration of savings in the upper-incomebrackets.
Accordingto all recent studies of the apportionmentof incomebetween
consumption and savings, only the upper-income groups save; the
total savings of groupsbelow the top decile are fairly close to zero. For
example, the top 5 per cent of units in the United States appear to
account for almost two-thirds of individuals' savings; and the top
decile comes close to accounting for all of it. What is particularly im-
portant is that the inequality in distributionof savings is greater than
that in the distribution of property incomes, and hence of assets.2
Granted that this finding is based on distribution of annual income,
and that a distributionby secular levels would show less inequality in
income and correspondingly less concentration of savings, the in-
equality in savings would still remain fairly sharp, perhaps more so
than in holdings of assets. Otherconditionsbeing equal, the cumulative
effect of such inequality in savings would be the concentrationof an
increasing proportion of income-yielding assets in the hands of the
upper groups-a basis for larger income slharesof these groups and
their descendants.
The second source of the puzzle lies in the industrial structure of
the income distribution. An invariable accompaniment of growth in
developed countries is the shift away from agriculture,a process usu-
ally referredto as industrializationand urbanization.The income dis-
tributionof the total population, in the simplest model, may therefore
be viewed as a combination of the income distributions of the rural
and of the urban populations. What little we know of the structures
of these two component income distributions reveals that: (a) the
averageper capita incomeof the ruralpopulationis usually lower than
that of the urban;' (b) inequality in the percentage shares within the
2 SeeKuznets,op. cit., particularly
Chapters2 and6.
The lower level of per capitaincomeof the agricultural
or ruralpopulationcompared
with that of urban is fairly well established,for this country by states, and for many

8 THEAMERICAN
ECONOMIC
REVIEW
distribution for the rural population is somewhat narrower than in
that for the urbanpopulation-even whenbasedon annualincome; and
this difference would probably be wider for distributions by secular
income levels.4Operatingwith this simple model, what conclusions do
we reach? First, all other conditions being equal, the increasingweight
of urbanpopulationmeans an increasingshare for the moreunequal of
the two componentdistributions.Second, the relative differencein per
capita income between the rural and urban populations does not
necessarily drift downwardin the process of economicgrowth: indeed,
there is some evidence to suggest that it is stable at best, and tends to
widen becauseper capita productivityin urbanpursuitsincreases more
rapidly than in agriculture. If this is so, inequality in the total in-
come distributionshould increase.
Two questions then arise: First, why does the share of the top-
income groups show no rise over time if the concentrationof savings
has a cumulative effect? Second, why does income inequality decline
and particularlywhy does the share of the lower-incomegroupsrise if
both the weight of the moreunequalurbanincome distributionand the
relative differencebetween per capita urban and per capita rural in-
comes increase?
The first question has been discussed elsewhere, although the re-
sults are still preliminary hypotheses,5and it would be impossible to
do moreherethansummarizethembriefly.
Factors Counteractingthe Concentrationof Saving
One group of factors counteracting the cumulative effect of con-
other countries (see, e.g., a summarytable of closely relatedmeasuresof product and
workersengaged,for variousdivisionsof the productivesystem,in ColinClark,Conditions
of EconomicProgress,2nd ed. [London 19511,pp. 316-18). The same table suggests,for
the countrieswith sufficiently
long records,a stableor increasing
relativedifference
between
per-worker
productin agriculture
andper-worker
productin othersectorsof the economy.
'This is true of the U. S. distributions
priorto the secondworldwar (see sourcescited
in footnote 1); in the yearsafterthe secondworldwar the difference
seemsto have disap-
peared.It is trueof the distributions
for Prussia,citedby Prokopovich;andmost conspicu-
ousfor Indiatoday as shownin the roughdistributions
by M. Mukherjee
andA. K. Ghosh
in "The Pattern of Incomeand Expendituresin the Indian Union: A Tentative Study,"
International Statistical Conferences, December 1951, Calcutta, India, Part III, pp. 49-68.
'Some elementsof the discussionappearedin "Proportionof CapitalFormationto Na-
tionalProduct,"a papersubmittedto the annualmeetingof the American
EconomicAssoci-
ation in 1951and publishedin Am. Econ. Rev., Proceedings,May 1952,XLII, 507-26.A
more elaboratestatementis presentedin "International
Differencesin CapitalFormation
and Financing"(particularlyAppendixC, Levels and Trendsin IncomeSharesof Upper
IncomeGroups),a papersubmittedto a Conferenceon CapitalFormationand Economic
Growthheld in 1953 under the auspicesof the Universities-National
BureauCommittee
for EconomicResearch.It is now in pressas part of the volume of proceedingsof that
conference.

KUZNETS:ECONOMICGROWTHAND INCOMEINEQUALITY 9
centrationof savings upon upper-incomeshares is legislative interfer-
ence and "political" decisions. These may be aimed at limiting the
cumulation of property directly through inheritance taxes and other
explicit capital levies. They may produce similar effects indirectly,
e.g., by government-permittedor -induced inflation which reduces the
economic value of accumulated wealth stored in fixed-pricesecurities
or other properties not fully responsive to price changes; or by legal
restrictionof the yield on accumulatedproperty, as happenedrecently
in the formof rent controlsor of artificiallylow long-terminterestrates
maintainedby the governmentto protect the market for its own bonds.
To discuss this complex of processes is beyond the competence of
this paper, but its existence and possible wide effect should be noted
and one point emphasized. All these interventions, even when not
directly aimed at limiting the effects of accumulationof past savings
in the hands of the few, do reflect the view of society on the long-term
utility of wide incomeinequalities.This view is a vital force that would
operate in democraticsocieties even if there were no other counteract-
ing factors. This should be bornein mind in connectionwith changes in
this view even in developed countries,which result fromthe process of
growth and constitute a re-evaluation of the need for income in-
equalities as a source of savings for economic growth. The result of
such changes would be an increasing pressure of legal and political
decisions on upper-incomeshares-increasing as a country moves to
higher economiclevels.
We turn to three other, less obvious groups of factors countervailing
the cumulative effects of concentrationof savings. The first is demo-
graphic. In the presently developed countries there have been dif-
ferential rates of increase between the rich and the poor-family con-
trol having first spread to the former. Hence, even disregardingmi-
gration,one can argue that the top 5 per cent of 1870 and its descend-
ants would account for a significantly smaller percentage of the popu-
lation in 1920. This is even more likely in a country like the United
States with its substantial immigration-usually entering the income
distribution at the lower-income levels; and may be less likely in a
country from which the poor have emigrated. The top 5 per cent of
population in 1920 is, therefore, comprised only partly of the de-
scendants of the top 5. per cent of 1870; perhaps half or a larger
fraction must have originated in the lower-incomebrackets of 1870.
This means that the period during which effects of concentration of
savings can be assumed to have cumulated to raise the income share
of any given fixed ordinalgroup (whether it be the top 1, 5, or 10 per
cent of the population) is much shorter than the fifty years in the
span; and hence these effects are much weaker than they would have

been if the top 5 per cent of 1870 had, throughtheir descendants,filled
completely the ranks of the top 5 per cent of the population of 1920.
Although the cumulative effect of savings may be to raise the relative
income of a progressively diminishing top proportionof total popula-
tion, their effect on the relative share of a fixed top proportion of the
populationis much reduced.
The second group of forces resides in the very nature of a dynamic
economy with relative freedom of individual opportunity. In such a
society technological change is rampant and property assets that
originated in older industries almost inevitably have a diminishing
proportionalweight in the total because of the more rapid growth of
younger industries. Unless the descendants of a high-income group
manage to shift their accumulatingassets into new fields and partici-
pate with new entrepreneursin the growingshare of the new and more
profitableindustries, the long-rangereturnson their property holdings
are likely to be significantly lower than those of the more recent
entrantsinto the class of substantial asset holders. "From shirt-sleeves
to shirt-sleeves in three generations"probably exaggerates the effects
of this dynamismof a growing economy: there are, among the upper-
income groupsof today, many descendantsof the upper-incomegroups
of more than three or even four generations ago. But the adage is
realistic in the sense that a long unbrokensequenceof connectionwith
rising industries and hence with major sources of continued large
property incomes is exceedingly rare; that the successful great entre-
preneursof today are rarely sons of the great and successful entrepre-
neursof yesterday.
The third group of factors is suggested by the importance, even in
the upper-incomebrackets, of service income. At any given time, only
a limitedpart of the income differentialof a top groupis accounted for
by the concentration of property yields: much of it comes from the
high level of service income (professional and entrepreneurialearnings
and the like). The secularrise in the upperincomesdue to this sourceis
likely to be less markedthan in the service incomes of lower brackets,
and for two somewhat differentreasons. First, in so far as high levels
of service incomesof given upperunits are due to individualexcellence
(as is true of many professional and entrepreneurialpursuits), there
is much less incentive for and possibility of keeping such incomes at
continued high relative levels. Hence, the service incomes of the de-
scendantsof an initially high level unit are not likely to show as strong
an upward trend as the incomes for the large body of population at
lower-incomelevels. Second, a substantial part of the rising trend in
per capita income is due to interindustry shift, i.e., a shift of workers
fromlower-incometo higher-incomeindustries.The possibilities of rise

due to such interindustry shifts in the service incomes of the initially
high-incomegroups are muchmore limited than for the populationas a
whole: they are already in high-incomeoccupationsand industries and
the range for them toward higher paid occupations is more narrowly
circumscribed.
These three groupsof factors, even disregardingsuch legislative and
political intervention as is indicated above, are all characteristicsof a
dynamicgrowingeconomy. The differentialsin rate of natural increase
between the upper- and the lower-income groups are true only of a
rapidly growing population-with or without immigration-but ac-
companiedby declining death rates and declining birth rates, a demo-
graphic pattern associated in the past only with the growing Western
economies. The impact of new industries on obsolescence of already
establishedwealth as a source of property income is clearly a function
of rapid growth, and the more rapidthe growth the greater the impact
will be. The effect of interindustry shifts on the rise of per capita
income, particularly of lower-income groups, is also a function of
growth since only in a growing economy is there much shift in the
relative importanceof the several industrialsectors. One can then say,
in general, that the basic factor militating against the rise in upper-
income shares that would be produced by the cumulative effects of
concentration of savings, is the dynamism of a growing and free
economic society.
Yet while the discussion answers the original question, it yields
no determinate answer as to whether the trend in income shares of
upper groups is upward, downward,or constant. Even for the specific
question discussed, a determinate answer depends upon the relative
balance of factors-continuous concentration of savings making for
an increasing share, and the offsetting forces tending to cancel this
effect.To tell what the trend of upper-incomeshares is likely to be, we
need to know much more about the weights of these conflicting pres-
sures. Moreover,the discussionhas broughtto the surface factors that,
in and of themselves,may cause either an upwardor a downwardtrend
in the share of upper-incomegroups and hence in income inequality-
in distributionsof annual or of secular income. For example, the new
entrants into the upper groups-the upward "migrants"-who rise
eitherbecause of exceptionalability or attachmentto new industries or
for a variety of other reasons-may be enteringthe fixed uppergroup
of say the top 5 per cent with an income differential-either annual or
long-term-that may be relatively greater than that of entrants in the
preceding generation. Nothing in the argument so far excludes this
possibility-which would mean a rise in the share of upper-income
groups,even if the share of the old "resident"part remainsconstant or

12 THEAMERICAN
ECONOMIC
REVIEW
even declines.Even disregardingother factors that will be noted in the
next section, no firm conclusion as to trends of upper-incomeshares
can be derived from the bare model discussed. Search for furtherdata
might yield evidence that would permit a reasonably rough but deter-
minate conclusion; but I have no such evidence at hand.
The Shift from Agricultural to NonagriculturalSectors
What about the trend toward greater inequality due to the shift
from the agriculturalto the nonagriculturalsectors? In view of the im-
portance of industrialization and urbanization in the process of eco-
nomic growth, their implications for trends in the income distribution
should be explored-even though we have neither the necessary data
nor a reasonablycomplete theoretical model.
The implications can be broughtout most clearly with the help of a
numerical illustration (see Table I). In this illustration we deal with
two sectors: agriculture (A) and all others (B). For each sector we
assume percentage distributions of total sector income among sector
deciles: one distribution (E) is of moderateinequality, with the shares
starting at 5.5 per cent for the lowest decile and rising 1 percentage
point from decile to decile to reach 14.5 per cent for the top decile; the
other distribution (U) is much more unequal, the shares starting at 1
per cent for the lowest decile, and rising 2 percentagepoints fromdecile
to decile to reach 19 per cent for the top decile. We assign per capita
incomesto each sector: 50 units to A and 100 units to B in case I (lines
1-10 in the illustration); 50 to A and 200 to B in case II (lines 11-20).
Finally, we allow the proportionof the numbersin sector A in the total
numberto decline from0.8 to 0.2.
The numericalillustration is only a partial summaryof the calcula-
tions, showing the shares of the lowest and highest quintiles in the in-
come distributionfor the total populationunderdifferentassumptions.6
The basic assumptionsused throughoutare that the per capita income
of sector B (nonagricultural) is always higher than that of sector A;
that the proportionof sector A in the total numberdeclines; and that
the inequality of the income distribution within sector A may be as
wide as that within sector B but not wider. With the assumptionscon-
'The underlying
calculations
arequitesimple.For eachcasewe distinguish
20 cellswithin
the total distribution-sets of ten decilesfor each sector.For each cell we computethe
percentagesharesof both numberand incomein the numberand incomeof total popula-
tion, and hencealso the relativeper capitaincomeof eachcell. The cells are then arrayed
in increasingorder of their relative per capita income and cumulated.In the resulting
cumulativedistributionsof numberand countrywideincome we establish,by arithmetic
interpolation,if interpolationis needed, the percentageshares in total income of the
successivequintilesof the country'spopulation.

TABLE
I.-PERCENTAGE
SHARES
OF1STAND5THQUINTILES
INTHEINCOME
DISTRiBUTION
FOR
TOTAL
POPULATION
UNDERVARYING
ASSUMPTIONS
CONCERNING
PERCAPITA
INCOME
WITHIN
THESECTORS,
PROPORTIONS
OFSECTORS
IN TOTAL
NUMBER,
ANDINTRASECTOR
INCOME
DISTRIBUTIONS
Proportion
of Numberin SectorA
to TotalNumber
0.8 0.7 0.6 0.5 0.4 0.3 0.2
(1) (2) (3) (4) (5) (6) (7)
I. PerCapitaIncomeofSectorA= 50;
of SectorB= 100
1. Percapitaincomeof totalpop-
ulation 60 65 70 75 80 85 90
Distribution(E) for Both Sec-
tors
2. Shareof lst quintile 10.5 9.9 9.6 9.3 9.4 9.8 10.2
3. Shareof 5th quintile 34.2 35.8 35.7 34.7 33.2 31.9 30.4
4. Range(3-2) 23.7 25.9 26.1 25.3 23.9 22.1 20.2
Distribution(U) for Both Sec-
tors
5. Shareof 1stquintile 3.8 3.8 3.7 3.7 3.8 3.8 3.9
7. Range(6-5) 36.8 38.1 39.1 39.0 37.8 36.4 34.8
Distribution(E) for SectorA,
(U) forSectorB
10. Range(9-8) 28.3 32.7 35.4 36.0 35.5 34.8 33.8
II. PerCapitaIncomeofSectorA= 50;
of SectorB= 200
11. Percapitaincomeof total pop-
ulation 80 95 110 125 140 155 170
Distribution(E) forBoth Sec-
tors
12. Shareof 1st quintile 7.9 6.8 6.1 5.6 5.4 5.4 5.9
14. Range(13-12) 42.1 42.3 39.4 36.0 32.6 29.6 26.3
Distribution(U) forBoth Sec-
tors
15. Shareoflst quintile 3.1 2.9 2.7 2.6 2.6 2.7 3.1
17. Range(16-15) 49.6 53.1 51.8 48.6 44.8 41.4 37.9
Distribution(E) for SectorA,
(U) forSectorB
20. Range(19-18) 44.2 49.8 49.2 46.5 43.2 40.2 37.2
Formethodsofcalculating
thesharesofquintiles,seetext (p. 12andfn.6). Somedifferences
willnot checkbecauseof rounding.
cerning three sets of factors-intersector differencesin per capita in-
come, intrasectordistributions,and sector weights-varying within the
limitationsjust indicated,the following conclusionsare suggested:

14 THEAMERICAN
ECONOMIC
REVIEW
First, if the per capita income differentialincreases, or if the income
distributionis more unequal for sector B than for sector A, or if both
conditionsare present, the rise over time in the relativeweight of sector
B causes a marked increase in inequality in the countrywide income
distribution.We have here a demonstrationof the effects upon trends
in income inequality of interindustryshifts away from agriculturedis-
cussedabove (pp. 7-8).
Second, if the intrasector income distribution is the same for both
sectors,and the wideninginequalityin the countrywideincomedistribu-
tion is due only to the increasingper capita income differentialin favor
of sector B, such widening is greater when the intrasectorincome dis-
tributions are characterizedby moderate rather than wide inequality.
Thus, if the intrasectordistributionsare of the E type, the rangein the
countrywide distribution widens from 23.7 to 26.3 as proportionof A
drops from 0.8 to 0.2 and as the ratio of per capita incomeof sector B
to that of sector A changes from 2 to 4 (see line 4, col. 1, and line 14,
col. 7). If the U distributionsare used, the range, underidentical con-
ditions, widens only from 36.8 to 37.9 (see line 7, col. 1, and line 17,
col. 7). This differenceis revealed more clearly by the change in the
share of the 1st quintile, which bears the brunt of wideninginequality:
for the E distribution,the share drops from 10.5 (line 2, col. 1) to 5.9
(line 12, col. 7); for the U distribution,from 3.8 (line 5, col. 1) to 3.1
(line 15, col. 7).
Third, if the per capita income differentialbetween sectors is con-
stant, but the intrasectordistributionof B is moreunequalthan that of
A, the widening inequality in the countrywide distribution is the
greater, the lower the assumedper capita income differential.Thus for
a differentialof 2 to 1, the rangewidens from 28.3 when the proportion
of A is 0.8 (line 10, col. 1) to 36.0 at the peak when the proportionof
A is 0.5 (line 10, col. 4) and is still 33.8 when the proportionof A drops
to 0.2 (line 10, col. 7). For a per capitaincomedifferentialof 4 to 1, the
wideningof the range at the maximumis only from 44.2 (line 20, col.
1) to 49.8 (line 20, col. 2) and then the range declines to 37.2 (line 20,
col. 7), well below the initial level.
Fourth, the assumptions utilized in the numericalillustration-of a
rise in proportionsof total number in section B, of greater inequality
in the distribution within sector B, and of the growing excess of per
capitaincomein B over that in A-yield a declinein the shareof the 1st
quintile that is muchmore conspicuousthan the rise in the share of the
5th quintile. Thus the shareof the 1st quintile, with the proportionof A
at 0.8, distributionin B more unequal than in A, and a per capita in-
come differentialof 2 to 1, is 9.3 (line 8, col. 1). As we shift to a pro-
portion of A of 0.2, and a per capita income differentialof 4 to 1, the

KUZNETS:
ECONOMIC
GROWTH
ANDINCOME
INEQUALITY 15
share of the 1st quintile drops to 3.8 (line 18, col. 7). Under the same
conditions,the share of the 5th quintile changes from 37.7 (line 9, col.
1) to 40.9 (line 19, col. 7).
Fifth, even if the differentialin per capita income between the two
sectors remainsconstant and the intrasectordistributionsare identical
for the two sectors, the mere shift in the proportionsof numberspro-
duces slight but significant changes in the distributionfor the country
as a whole. In general, as the proportionof A drifts from 0.8 down-
wards,the rangetends firstto widenand then to diminish.Whenthe per
capita income differentialis low (2 to 1), the widening of the range
reaches a peak close to middle of the series, i.e., at a proportionof A
equal to 0.6 (lines 4 and 7); and the movementsin the rangetend to be
ratherlimited.WVhen
the per capita incomedifferentialis large (4 to 1),
the range contracts as soon as the proportionof A passes the level of
0.7, and the decline in the range is quite substantial (lines 14 and 17).
Sixth, of particularbearingupon the shares of upper-incomegroups
is the finding that the share of the top quintile declines as the propor-
tion of A falls below a certain, rather high fraction of total numbers.
There is not a single case in the illustration in which the share of the
5th quintile fails to decline, either throughoutor througha substantial
segment of the sequence in the downwardmovementof the proportion
of A from 0.8 to 0.2. In lines 6 and 9, the share of the 5th quintile de-
clines beyond the point at which the proportionof A is 0.6; and in all
other relevantlines the downwardtrendin the shareof the 5th quintile
sets in earlier.The reasonlies, of course,in the fact that with increasing
industrialization, the growing weight of the nonagricultural sector,
with its higher per capita income, raises the per capita income for the
whole economy; and yet per capita income within each sector and the
intrasectordistributionsare kept constant. Under such conditions, the
upper shares would fail to decline only if there were either a greater
rise in per capitaincomeof sector B than in that of sectorA; orincreas-
ing inequality in the intrasectordistributionof sector B.
Severalother conjecturalconclusionscould be drawnwith additional
variations in assumptions, and multiplication of sectors beyond the
two distinguishedin the numericalillustration. But even in the simple
model illustrated the variety of possible patterns is impressive; and
one is forced to the view that much more empirical information is
neededto permita properchoice of specificassumptionsand constants.
Grantedthat several of the conclusions could be generalizedin formal
mathematicalterms, useful inferenceswouldbe within our reachonly if
we knew moreabout the specificsector distributionsand the levels and
trendsin per capita incomedifferentialsamongthe sectors.
If then we limit ourselves to what is known or can be plausibly as-

16 THE AMERICANECONOMICREVIEW
sumed, the following inferences can be suggested. We know that per
capita income is greater in sector B than in sector A; that, at best, the
per capita income differentialbetween sectors A and B has been fairly
constant (e.g., in the United States) and has perhaps more often in-
creased; that the proportion of sector A in total numbershas dimin-
ished. Then, if we start with intrasectordistributionof B moreunequal
than for A, we would expect results suggested by either lines 8-10 or
18-20.In the formercase, the rangewidens as the proportionof A drops
from 0.8 to 0.5, and then narrows.In the latter case, the rangedeclines
beyond the point at which the proportionof A is 0.7. But in both cases,
the share of the 1st quintile declines, and fairly appreciably and con-
tinuously (see lines 8 and 18). The magnitude and continuity of the
decline are partly the result of the specific assumptionsmade; but one
would be justified in arguingthat within the broad limits suggested by
the illustration, the assumptionof greater inequality in the intrasector
distribution for sector B than for sector A, yields a downwardtrend
in the share of the lower-incomegroups. Yet we find no such trend in
the empiricalevidence that we have. Can we assume that in the earlier
periodsthe internaldistributionfor sector B was not moreunequalthan
for sector A, despite the more recent indicationsthat urbanincome dis-
tributionis moreunequalthanthe rural?
There is, obviously, room for conjecture. It seems most plausible
to assume that in earlier periods of industrialization, even when the
nonagriculturalpopulation was still relatively small in the total, its in-
come distributionwas more unequalthan that of the agriculturalpopu-
lation. This would be particularlyso duringthe periodswhen industri-
alizationand urbanizationwereproceedingapace and the urbanpopula-
tion was being swelled, and fairly rapidly, by immigrants-either from
the country's agricultural areas or from abroad. Under these condi-
tions, the urbanpopulationwould run the full gamut from low-income
positions of recent entrants to the economic peaks of the established
top-incomegroups.The urbanincome inequalitiesmight be assumedto
be far wider than those for the agriculturalpopulation which was or-
ganizedin relatively smallindividualenterprises(large-scaleunits were
rarerthen than now).
If we grant the assumptionof wider inequality of distributionin sec-
tor B, the shares of the lower-incomebrackets should have shown a
downwardtrend. Yet the earlier summary of empirical evidence indi-
cates that duringthe last 50 to 75 years there has been no wideningin
incomeinequality in the developedcountriesbut, on the contrary,some
narrowingwithin the last two to four decades. It follows that the intra-
sector distribution-either for sector A or for sector B-must have
shown sufficient narrowing of inequality to offset the increase called

KUZNETS: ECONOMICGROWTHAND INCOMEINEQUALITY 17
for by the factorsdiscussed. Specifically,the sharesof the lower income
groupsin sectors A and/or B must have increasedsufficientlyto offset
the declinethat would otherwisehave been producedby a combination
of the elements shownin the numericalillustration.
This narrowingin inequality, the offsetting rise in the shares of the
lowerbrackets, most likely occurredin the income distributionfor the
urbangroups,in sector B. While it may also have beenpresent in sector
A, it wouldhave had a morelimited effecton the inequalityin the coun-
trywide income distributionbecause of the rapidly diminishingweight
of sector A in the total. Nor was such a narrowingof incomeinequality
in agriculturelikely: with industrialization,a higherlevel of technology
permitted larger-scale units and, in the United States for example,
sharpened the contrast between the large and successful business
farmersand the subsistence sharecroppersof the South. Furthermore,
since we accept the assumption of initially narrowerinequality in the
internaldistributionof incomein sector A than in sector B, any signifi-
cant reductionin inequalityin the formeris less likely thanin the latter.
Hence we may conclude that the major offset to the widening of in-
come inequality associated with the shift from agriculture and the
countrysideto industryand the city must have beena rise in the income
share of the lower groups within the nonagricultural sector of the
population. This provides a lead for explorationin what seems to me
a most promisingdirection: considerationof the pace and characterof
the economicgrowthof the urbanpopulation,with particularreference
to the relative position of lower-incomegroups. Much is to be said for
the notion that once the early turbulentphases of industrializationand
urbanizationhad passed, a variety of forces converged to bolster the
economicposition of the lower-incomegroupswithin the urbanpopula-
tion. The very fact that after a while, an increasingproportionof the
urban population was "native," i.e., born in cities rather than in the
ruralareas, and hence more able to take advantage of the possibilities
of city life in preparation for the economic struggle, meant a better
chance for organization and adaptation, a better basis for securing
greater income shares than was possible for the newly "immigrant"
populationcoming from the countryside or from abroad. The increas-
ing efficiencyof the older, established urbanpopulation should also be
taken into account. Furthermore,in democratic societies the growing
political power of the urban lower-income groups led to a variety of
protective and supporting legislation, much of it aimed to counteract
the worst effects of rapid industrialization and urbanization and to
supportthe claims of the broadmasses for more adequateshares of the
growingincome of the country. Space does not permit the discussionof
demographic,political, and social considerationsthat could be brought

to bear to explain the offsets to any declines in the shares of the lower
groups, declines otherwise deducible from the trends suggested in the
numericalillustration.
III. Other Trends Related to Those in Income Inequality
One aspect of the conjectural conclusion just reached deserves em-
phasis because of its possible interrelation with other important ele-
ments in the process and theory of economic growth. The scanty em-
pirical evidence suggests that the narrowing of income inequality in
the developed countries is relatively recent and probably did not char-
acterize the earlierstages of their growth.Likewise, the various factors
that have been suggested above would explain stability and narrowing
in income inequality in the later rather than in the earlier phases of
industrializationand urbanization.Indeed, they would suggest widen-
ing inequalityin these earlyphases of economicgrowth,especiallyin the
older countries where the emergenceof the new industrial system had
shatteringeffects on long-establishedpre-industrialeconomicand social
institutions. This timing characteristicis particularlyapplicableto fac-
tors bearing upon the lower-incomegroups: the dislocating effects of
the agriculturaland industrialrevolutions,combinedwith the "swarm-
ing" of populationincident upon a rapid decline in death rates and the
maintenance or even rise of birth rates, would be unfavorable to the
relative economic position of lower-income groups. Furthermore,
there may also have been a preponderancein the earlierperiodsof fac-
tors favoring maintenance or increase in the shares of top-income
groups: in so far as their position was bolsteredby gains arising out of
new industries,by an unusually rapidrate of creation of new fortunes,
we would expect these forces to be relatively stronger in the early
phases of industrializationthan in the later when the pace of industrial
growth slackens.
One might thus assume a long swing in the inequality characterizing
the secular income structure: wideningin the early phases of economic
growth when the transition from the pre-industrial to the industrial
civilization was most rapid; becomingstabilized for a while; and then
narrowingin the later phases. This long secular swing would be most
pronounced for older countries where the dislocation effects of the
earlierphases of moderneconomicgrowthwere most conspicuous; but
it mightbe foundalso in the "younger"countrieslike the United States,
if the periodprecedingmarkedindustrializationcouldbe comparedwith
the early phases of industrialization, and if the latter could be com-
paredwith the subsequentphases of greatermaturity.
If there is some evidence for assuming this long swing in relative
inequality in the distributionof income before direct taxes and exclud-

ing free benefits from government, there is surely a stronger case for
assuming a long swing in inequality of income net of direct taxes and
including government benefits. Progressivity of income taxes and, in-
deed, theirvery importancecharacterizeonly the morerecentphases of
development of the presently developed countries; in narrowing in-
come inequality they must have accentuated the downwardphase of
the long swing, contributing to the reversal of trend in the secular
wideningand narrowingof income inequality.
No adequate empirical evidence is available for checking this con-
jectureof a long secularswingin incomeinequality;-7 norcan the phases
be datedprecisely. However,to make it morespecific,I wouldplace the
early phase in which incomeinequalitymight have been widening,from
about 1780 to 1850 in England; fromabout 1840 to 1890, andparticu-
larly from 1870 on in the United States; and, from the 1840's to the
1890's in Germany. I would put the phase of narrowing income in-
equality somewhat later in the United States and Germany than in
England-perhaps beginningwith the first worldwar in the formerand
in the last quarter of the 19th century in the latter.
Is there a possible relation between this secular swing in income
inequality and the long swing in other important components of the
growthprocess? For the older countriesa long swing is observedin the
rate of growth of population-the upwardphase representedby accel-
eration in the rate of growth reflectingthe early reductionin the death
rate which was not offset by a decline in the birth rate (and in some
cases was accompaniedby a rise in the birth rate); and the downward
phase representedby a shrinking in the rate of growth reflecting the
more pronounceddownwardtrend in the birth rate. Again, in the older
countries, and also perhaps in the younger, there may have been a
secular swing in the rate of urbanization,in the sense that the propor-
tional additions to urban population and the measures of internal mi-
gration that produced this shift of population probably increased for
a while-from the earliermuchlowerlevels; but thentendedto diminish
as urban population came to dominate the country and as the rural
reservoirsof migration became proportionallymuch smaller. For old,
and perhaps for young countries also, there must have been a secular
swing in the proportionsof savings or capital formation to total eco-
nomicproduct.Per capita productin pre-industrialtimes was not large
enoughto permit as high a nationwiderate of saving or capital forma-
tion as was attained in the course of industrial development: this is
7Prokopovich's data on Prussia, from the source cited in footnote 1, indicate a sub-
tantial widening in income inequality in the early period. The share of the lower 90 per
cent of the population declines from 73 per cent in 1854 to 65 per cent in 1875; the share
of the top 5 per cent rises from 21 to 25 per cent. But I do not know enough about the
data for the early years to evaluate the reliability of the finding.

20 THEAMERICAN
ECONOMIC
REVIEW
suggested by present comparisonsbetween net capital formation rates
of 3 to 5 per cent of national product in underdevelopedcountriesand
rates of 10 to 15 per cent in developedcountries.If then, at least in the
older countries,and perhaps even in the younger ones-prior to initia-
tion of the process of moderndevelopment-we begin with low secular
levels in the savings proportions, there would be a rise in the early
phases to appreciably higher levels. We also know that during recent
periods the net capital formationproportionand even the gross, failed
to rise andperhapseven declined.
Other trends might be suggested that would possibly trace long
swingssimilarto those for inequalityin incomestructure,rateof growth
of population,rate of urbanizationand internalmigration,and the pro-
portion of savings or capital formation to national product. For ex-
ample, such swings might be found in the ratio of foreign trade to
domestic activities; in the aspects, if we could only measurethemprop-
erly, of government activity that bear upon market forces (there
must have been a phase of increasing freedom of market forces,
givingway to greaterinterventionby government). But the suggestions
alreadymadesufficeto indicatethat the long swing in incomeinequality
must be viewed as part of a wider process of economic growth, and
interrelatedwith similar movementsin other elements. The long alter-
nation in the rate of growthof populationcan be seen partly as a cause,
partly as an effect of the long swing in income inequality which was
associated with a secular rise in real per capita incomelevels. The long
swing in income inequality is also probably closely associated with the
swing in capital formation proportions-in so far as wider inequality
makes for higher,and narrowerinequality for lower, country-widesav-
ings proportions.
IV. Comparisonof Developed and UnderdevelopedCountries
What is the bearingof the experienceof the developedcountriesupon
the economic growth of underdeveloped countries? Let us examine
brieflythe data on income distributionin the latter, and speculateupon
some of the implications.
As might have been expected,such data for underdevelopedcountries
are scanty. For the present purpose distributionsof family income for
India in 1949-50, for Ceylon in 1950, and for Puerto Rico in 1948 were
used. While the coverage is narrowand the margin of errorwide, the
data show that income distribution in these underdevelopedcountries
is somewhat more unequal than in the developed countries during the
periodafter the second worldwar. Thus the sharesof the lower 3 quin-
tiles are 28 per cent in India, 30 per cent in Ceylon, and 24 per cent in
Puerto Rico-compared with 34 per cent in the United States and 36

KUZNETS:
ECONOMIC
GROWTH
AND INCOME
INEQUALITY 21
per cent in the United Kingdom. The shares of the top quintile are 55
percent in India, 50 per cent in Ceylon, and 56 per cent in Puerto Rico,
comparedwith 44 per cent in the United States and 45 per cent in the
United Kingdom.8
This comparisonis for income before direct taxes and excludingfree
benefitsfromgovernments.Since the burdenand progressivityof direct
taxes are much greater in developed countries, and since it is in the
latter that substantialvolumesof free economicassistance are extended
to the lower-incomegroups, a comparison in terms of income net of
direct taxes and including government benefits would only accentuate
thewiderinequalityof incomedistributionsin the underdevelopedcoun-
tries. Is this difference a reliable reflection of wider inequality also
in the distributionof secularincomelevels in underdevelopedcountries?
Even disregarding the margins of error in the data, the possibility
raised earlierin this paper that transient disturbancesin income levels
may be more conspicuous under conditions of primitive material and
economictechnology would affect the comparisonjust made. Since the
distributionscited reflect the annual income levels, a greater allowance
should perhapsbe made for transient disturbancesin the distributions
for the underdeveloped than in those for the developed countries.
Whether such a correction would obliterate the differenceis a matter
on whichI have no relevantevidence.
Another considerationmight tend to support this qualification.Un-
derdevelopedcountries are characterizedby low average levels of in-
come per capita, low enough to raise the question how the populations
manageto survive. Let us assume that these countries representfairly
unified population groups, and exclude, for the moment, areas that
combine large native populations with small enclaves of nonnative,
privilegedminorities,e.g., Kenya and Rhodesia,where income inequal-
ity, because of the excessively high income shares of the privileged
minority, is appreciablywider than even in the underdevelopedcoun-
tries cited above.9On this assumption,one may infer that in countries
' For sources of these data see "Regional Economic Trends and Levels of Living," sub-
mitted at the Norman Waite Harris Foundation Institute of the University of Chicago in
November 1954 (in press in the volume of proceedings). This paper, and an earlier one,
"Underdeveloped Countries and the Pre-industrial Phases in the Advanced Countries: An
Attempt at Comparison," prepared for the World Population Meetings in Rome held in
September 1954 (in press) discuss issues raised in this section.
'In one year since the second world war, the non-African group in Southern Rhodesia,
which accounted for only 5 per cent of total population, received 57 per cent of total in-
come; in Kenya, the minority of only 2.9 per cent of total population, received 51 per cent
of total income; in Northern Rhodesia, the minority of only 1.4 per cent of total population,
received 45 per cent of total income. See United Nations, National Income and Its Dis-
tribution in Underdeveloped Cou4ntries, Statistical Paper, Ser. E, no. 3, 1951, Table 12, p.
19.

22 THEAMERICAN
ECONOMIC
REVIEW
with low averageincome, the secular level of incomein the lower brac-
kets could not be below a fairly sizable proportionof averageincome
otherwise, the groups could not survive. This means, to use a purely
hypothetical figure, that the secular level of the share of the lowest
decile could not fall far short of 6 or 7 per cent, i.e., the lowest decile
could not have a per capita income less than six- or seven-tenths of the
countrywideaverage. In more advancedcountries,with higheraverage
per capita incomes, even the secular share of the lowest bracket could
easily be a smaller fractionof the countrywideaverage,say as small as
2 or 3 per cent for the lowest decile, i.e., from a fifth to a third of the
countrywide average-without implying a materially impossible eco-
nomic position for that group. To be sure, there is in all countriescon-
tinuous pressure to raise the relative position of the bottom-income
groups; but the fact remains that the lower limit of the proportional
share in the secular income structure is higher when the real country-
widepercapitaincomeis low thanwhenit is high.
If the long-term share of the lower-incomegroups is larger in the
underdevelopedthan in the averagecountries,income inequality in the
former should be narrower,not wider as we have found. However, if
the lower brackets receivelarger shares, and at the same time the very
top brackets also receive larger shares-which would mean that the
intermediateincome classes would not show as greata progressionfrom
the bottom-the net effect may well be wider inequality. To illustrate,
let us compare the distributionsfor India and the United States. The
firstquintilein India receives8 per cent of total income,morethanthe 6
per cent share of the first quintile in the United States. But the second
quintile in India receives only 9 per cent, the third 11, and the fourth
16; whereas in the United States, the shares of these quintiles are 12,
16, and 22 respectively. This is a roughstatistical reflectionof a fairly
commonobservationrelating to income distributionsin underdeveloped
compared with developed countries. The former have no "middle"
classes: there is a sharp contrast between the preponderantproportion
of population whose average income is well below the generally low
countrywide average, and a small top group with a very large relative
income excess. The developedcountries,on the other hand, are charac-
terized by a much moregradualrise from low to high shares,with sub-
stantial groups receiving more than the high countrywide income
average,andthe top groupssecuringsmallersharesthanthe comparable
ordinalgroups in underdevelopedcountries.
It is, therefore,possible that even the distributionsof secularincome
levels would be more unequal in underdevelopedthan in developed
countries-not in the sense that the shares of the lowerbracketswould
be lowerin the formerthan in the latter, but in the sense that the shares

21 Most Influential Economic Papers Of All Time

21 Most Influential Economic Papers Of All Time

Recommended

Recommended

More Related Content

Similar to 21 Most Influential Economic Papers Of All Time

Similar to 21 Most Influential Economic Papers Of All Time (20)

More from Angela Shin

More from Angela Shin (20)

Recently uploaded

Recently uploaded (20)

21 Most Influential Economic Papers Of All Time