This study has investigated the impact of macroeconomic instability on income inequality in Pakistan over the period of 1980 to 2015. A comprehensive macroeconomic instability index has been constructed by incorporating inflation rate, unemployment rate, trade deficit and budget deficit. Stationarity of data is checked with the help of the Augmented Dickey-Fuller (ADF), Phillips-Perron (PP) and Dickey-Fuller Generalized Least Squares (DF-GLS) unit root tests.
Autoregressive Distributed Lag (ARDL) model has been used for examining the co-integration among the variables of the model and Vector Error-Correction model has been used for short run dynamics of the model. The empirical results of the study confirm the existence of co-integration between macroeconomic instability and income inequality in Pakistan. The results of the study show that macroeconomic instability has a deep-rooted impact on income inequality in the case of Pakistan. Hence, for achieving the desired level of income distribution, Pakistan should make its macroeconomic environment stable.
Keywords: Macroeconomic instability, Income inequality, Pakistan, Co-integration
Better quality of life is the aim of all types of sciences. Following this objective, economists treat economics as a science. Smith (1784) mentions that no society can be happy and flourished if the greater part of its population is miserable and poor. Hartwell (1972) claims that the spirit of economics to study poverty. But a historical overview of economic thoughts shows that the nature of economic activities changed over the time. Bigsten (1983), Atkinson (1997) and Ferran (1997) place income distribution in the center of their thoughts when they claim that political economy should determine the laws and rules of income distribution. Thus, the fairer income distribution is the prime objective of economics, but this prime objective lost elsewhere as economic thoughts move forward. After Smith and Ricardo, the literature before 1950’s shows that the objective of fair distribution of income is absent in economic theories and policies (Atkinson, 1997).
Generally, income inequality gives a concise picture of society that show who receives what. Following theoretical and empirical literature, functional distribution and personal distribution or size of income distribution are two main concepts of income distribution. The functional distribution reveals what the share of income is received by individual factor of production. Whereas the size of income distribution reveals that how many households get how much? The final results of the entire economic process are the distribution of income (Bigsten, 1983). From 1970’s much concern of the developed world is the quality of life and harmful consequences of economic growth, such as the depletion of natural resources and pollution. But the developing world is still confused between relationship of economic growth and distribution of income. Moreover, developing countries are experiencing high rates of economic growth with increasing income inequality (Todaro, 1994).
How macroeconomic environment impacts income distribution? This is a critical topic of discussion among the economists and policymakers since the days of Kuznets. But after millennium development goals of United Nations reducing income discrepancies and macroeconomic instability are the main objectives of United Nations member countries. Macroeconomic instability is not only a natural policy target of governments, but it can also be viewed as an important factor affecting income distribution. Moreover, there are number of normative and positive questions are associated with the relationship of macroeconomic instability and income distribution. So, uncovering the direction of this relationship gives much understanding to policymakers for targeted policy issues. Demery and Tony (1987) mention that rising inflation, deficit in balance of payment and budget deficit create distributional issues.
Due to political pressure the rising government spending arises domestic demand, which has no concerns with employment and real output. Hence the ultimate impact of macroeconomic instability may create the distributional issues among different households and sectors. Lewis (1954) points out that rising overall national income may increase income inequality because that boom has minimal impact on overall employment and other socioeconomic structure of the economy. For last few decades the poverty rate declined at national and global level due to high economic growth in developing countries. However, income inequality also rises as the profits and wages of skilled labor to move upward in market-oriented and open economies. As the economies move towards for getting higher economic growth they have to face higher inflation, unemployment and income inequality.
Blinder and Howard (1978) and Blank and Alan (1985) mention that there is a positive and significant relationship between inflation, unemployment and income inequality in the USA. Nolan (1987) studies those macroeconomic factors which have a very influential impact on income distribution. Pasinetti (1989) argues that it is the budget deficit, which decides the propensity to consume of wage and non-wage income.
The objective of this study is to find the impact of macroeconomic instability on income inequality in Pakistan. Income inequality is most studied topic in development economics but there are few studies how link macroeconomic factors with income inequality. The existing studies use inflation or GDP fluctuations as macroeconomic instability, but these two separate variables are not enough for representing the macroeconomic situation. So, this study uses a comprehensive macroeconomic instability index for measuring macroeconomic situation. There are a number of studies which focus on determinants of income inequality, but there is hardly any study which investigates the impact of macroeconomic instability on income inequality in the case of Pakistan, so this study is a healthy contribution to respective literature.
Historically, the basic objective of development economics is to improve the standard of living by reducing poverty. In the last few years, the economists are much worried about rising income inequality and income gap within and among nations. Some of the most prominent and important studies are presented here as a review of literature. Gibrat (1931) gives an empirical and theoretical framework for income distribution. This model has supposed that individual income is subject to random proportionate changes. Kalecki (1945) modifies the Gibrat (1931) original model and he claims that negative shocks in income worsen the level of income inequality. He mentions that the rising level of income inequality puts pressure on low income communities rather than high income communities. Rutherford (1955) expands Gibrat (1931) model by introducing birth and death rate considerations.
He concludes that income inequality has greater impact on birth and death rate. There is a negative relationship between income and longevity of life, whereas death and birth rates have a positive relationship with income inequality. Atkinson (1970) establishes a theoretical background for social welfare function by using Lorenz Curve. Kakawani (1977) extents the model of Atkinson (1970) and finds the relationship between income distribution and macroeconomic variables. This model is also known as Generalized Lorenz Curves.
Jeetun (1978) examines the trends of economic growth and income inequality both rural and urban areas of Pakistan from 1963-64 to 1971-72. Coefficient of variation, Kuznets measures and GINI coefficient are used for measuring tendencies of income inequalities. The estimated results of the study show that income inequality by all measures deteriorates in selected time period. He concludes that the fruits of agricultural development and high output concentrated in a few hands of the urban aristocracy which widely disturb the income distribution in Pakistan.
Chaudhry (1982) investigates the impact of Green Revolution on income inequality in rural areas of Pakistan. On the basis of empirical results, it is concluded that Green Revolution reduces income inequality among large farms and small farms and among farms and non-farms rural population. The study recommends the necessity of Green Revolution in developing countries like Pakistan. Knight and Sabot (1983) mention that human capital and income inequality has a very complex relationship in case of the dual economy. It is the wage compression, which decides investment in human capital. The upward rising wages reduce the risk on education as educated workers have high rate of expected return which lower income inequality. On the basis of estimated results, they conclude that there is negative relationship between education and income inequality.
Afridi et al., (1984) analyze the relationship between inflation and income inequality in the case of Pakistan. They evaluate the gap between rich and poor over the time. The results of the study show that inflation has a very influential role on income inequality in Pakistan. They conclude that inflation puts a negative impact on the purchasing power of poor and poor class suffer from inflation but the case is reverse for rich. Kruijk and Leewan (1985) examine different indices of income inequality and poverty in Pakistan with the help of decomposition techniques during 1970s. In this study standard deviation, coefficient of variation and GINI coefficient are used for measuring income inequality in Pakistan. The results of the study show that income inequality increases in both rural and urban areas of Pakistan during the selected time period.
They conclude that remittances have a negative and significant impact of reducing inside and outside household income inequality in Pakistan...