Income inequality changes between China/India and developed countries

This post goes over the concepts of the catch up curve, and how inequality between developing and developed countries is changing.  The key concept that we need to understand is that developing countries have more opportunities to develop their economies than developed countries do.  Incomes (or GDP per capita) can grow because of two things according to introductory macroeconomics.  These reasons are increases in capital, and increases in technology. 

Developing countries have an advantage in increasing incomes because a small increase in capital leads to a larger increase in output than in a developed country.  This is because of diminishing returns to capital.  Developed countries are already satiated with capital, so the same increase in a developed country will have a minor impact.  Also, technology can be acquired from developed countries much cheaper than researching and developing it on their own -- which is what developed countries must do.  For these reasons, we should expect developing countries to “catch up” to developed countries by growing quickly when “poor” and seeing slower growth as their incomes rise.

A common question asked in macroeconomic classes goes like this:

Incomes in China, India, and other developing countries are a small fraction of incomes in Canada, the United States, and other developed countries. But incomes in China and India are growing at more than twice the rate of those in Canada and the United States. With this going on, what can we say about changes in inequality between people in China and India and people in Canada and the United States?

Since incomes are increasing in the developing countries (China and India) faster than the developed countries, we will see a smaller difference between the two incomes. This will reduce inequality.  We will also see China and India’s income as a percent of the United States and Canada’s income increase, which also means that the incomes in the two countries are becoming more equal.

The ability to acquire capital and increase technology more easily means that developing countries will see higher rates of growth.  This coupled with the relatively small growth seen in developed countries means that the gap between the two categories of countries is becoming smaller. 

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