Equality, Participation, Transition: Essays in Honour of Branko Horvat

50 Determinants of Income Inequality
terms of economic structure, political institutions, socio-cultural heritage,
or whatever) play an important part in determining exactly
what level of inequality is to be found at any particular level of
modernization.
No comprehensive alternative hypothesis regarding determinants of
income inequality has so far been suggested, however.
It is worth pointing out, in light of the alternative hypothesis proposed
here, that the Kuznets hypothesis puts at centre stage the role of economic
factors, that is, the supply of, and demand for, various factors of
production. 5 The forces of economic development determine the shape
of income distribution. Societies do not choose the income distribution
that they would like to have. The process is led by inexorable economic
forces, and deviations from the income distribution that a country must
have at a certain level of development are small and non-systematic.
4.3 A new hypothesis
Here I propose an ‘augmented’ Kuznets’ hypothesis. I argue that
income-size distribution is determined (1) by a factor that is in the
short-run, from the point of view of policy makers or society as a whole,
‘given’; and (2) by social (or public policy) choice. The given factor is
the level of development measured by income (GDP) per capita. The
public policy factors are (1) the percentage of workers employed in the
state and para-statal sectors; and (2) the extent of government transfers,
measured as a share of a country’s GDP. These two factors are the
products of political decisions, both current and past (for example, a
country might have a large state sector because of a strong past influence
of socialist parties). In the empirical section that follows, I will
address two key questions: (1) Are social choice factors statistically significant
‘explanators’ of cross-country income inequality; and (2) if so,
how large is their influence?
Our hypothesis says that, once income is ‘accounted for’, there is still
sizeable discretion regarding income inequality. Income distribution is
viewed also as the product of social choices mediated through elections,
lobbying of various social groups, societal preferences or historical
developments. Thus, some countries may have a greater proportion
of state-sector workers because socialist or Communist parties were historically
stronger; or the population may have a high preference for
eradicating poverty and redistributing income through transfers; or
the middle classes which decisively determine the size of transfers in