Magazine article Business Review (Federal Reserve Bank of Philadelphia)

The Evolution of the World Income Distribution

Magazine article Business Review (Federal Reserve Bank of Philadelphia)

The Evolution of the World Income Distribution

Article excerpt

There is tremendous disparity in the levels of individuals' incomes across countries. Those fortunate enough to live in the richest countries have an average income that is about 30 times greater than the average income of residents of the world's poorest countries. Such a large disparity in income across countries implies large differences in living standards and well-being. A significant share of the world's population has a living standard well below that of the average U.S. citizen. Indeed, inhabitants of the world's poorest countries face daily hardships and deprivations that are so foreign to the citizens of rich countries as to be hard to believe.

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However, this large difference in per capita income across countries has not always existed. It wasn't until the early 19th century that countries began to experience significantly different growth rates in income as some countries were quicker to begin the process of industrialization. Consequently, before the late 1800s, there was relatively little income disparity across countries, at least by today's standards. But it doesn't take long for small differences in income growth rates to lead to wide divergence in per capita income levels. From the late 1800s until about the 1960s, there was a steady and rapid increase in inequality. Since then, the cross-country dispersion in per capita income has become somewhat more stable, while, at the same time, world poverty has been decreasing as countries with large populations, like China and India, begin to industrialize.

We'll investigate some facts about the evolution of per capita income across countries and review a simple model that broadly captures the observed evolution of the world income distribution since 1800. Given our analysis of what happened in the past, we'll discuss what predictions can be made about future cross-country distributions of income. We'll also discuss some policy prescriptions that follow from our understanding of the past and our predictions about the future.

EVOLUTION OF COUNTRY PER CAPITA INCOMES BEFORE 1800

Before 1800 and the onset of the Industrial Revolution, the distribution of world income looked very different than it does today. While cross-country data on incomes and population prior to 1800 are incomplete and challenging to piece together, the available information suggests that there was little, if any, growth in per capita incomes in any of the world's economies. Before the Industrial Revolution, economies were agricultural, and living standards were similar across countries and over time. People born before 1800 could expect to be about as well off as their parents, grandparents, and great-grandparents. In addition, they could expect their children to be about as well off as they were. Moving to a different country wouldn't have improved living standards much either--the agricultural technology across countries was about the same. This stands in stark contrast to today's world, in which living standards have increased rather consistently over time (at least in the developed countries) and vary greatly between poor and rich countries.

We will measure the standard of living, or economic well-being, of the typical resident of a country using real gross domestic product (GDP) per capita, which is real GDP divided by a measure of the population. Real GDP is all of the goods and services produced domestically by residents of a country. Higher real GDP means that a country produces more goods and services for its residents to consume and invest in. By itself, real GDP is not a particularly good measure of how rich a country is because a country with a large population is likely to produce more than a country with a small population. When we divide a country's real GDP by its population, we get a measure of goods and services produced per person: Rich countries will produce more per person than poor countries. …

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