Urbanization can help reduce income inequality

Income inequality is a major global challenge, particularly acute in developing countries, especially LDCs. Traditional fiscal measures, such as taxation and redistribution, are shown to be ineffective in reducing inequality in these contexts due to factors like informality, limited tax bases, and weak institutions. The paper highlights that the urban-rural gap is a significant contributor to overall income inequality, a factor often overlooked. The authors introduce the concept of well-managed urbanization as a potential solution, emphasizing its potential to narrow the urban-rural gap and improve income distribution. The introduction underscores the urgent need for a re-evaluation of existing strategies to tackle income inequality in developing economies, and suggests that a focus on urbanization may offer a more feasible and effective alternative.

The paper reviews the limitations of relying solely on fiscal transfers to address income inequality, referencing the work of Thomas Piketty (2014). It highlights the inadequacy of fiscal measures even in developed countries and argues that these limitations are even more pronounced in LDCs due to factors like informality and weak governance. The paper also draws on prior research by Shorrocks and Wan (2005) and Wan (2013), focusing on the urban-rural income gap as a key driver of national inequality, a component largely neglected by previous studies, including Kuznets (1955). The review establishes the need for a new approach that considers the urban-rural dynamic and moves beyond traditional fiscal solutions.

The study uses the Theil index to decompose income inequality into its components: within-rural inequality, within-urban inequality, and the urban-rural gap. The authors develop a method to estimate the urban-rural gap, utilizing data from sources like the IMF GFS Database and the World Bank's WDI Database. They analyze the impact of urbanization on income inequality using a regression model that incorporates urbanization rate, GDP per capita, and a dummy variable for urbanization policy stance (pro- or anti-urbanization). The model controls for variables such as economic generosity, government interventions, and redistribution policies. The authors also use equation (2) to measure the impacts of urbanization on the urban-rural gap in 90 economies. Data on Gini estimates are sourced from the Standardized World Income Inequality Database (SWIID v. 7.1). The methodology emphasizes the importance of considering the urban-rural gap as a critical component of national income inequality, moving beyond a simplistic focus on urban and rural inequality in isolation. The study also incorporates a nuanced understanding of urbanization policies, considering their diverse effects on income distribution.

The paper's key findings include the demonstration of the infeasibility of relying on fiscal measures to significantly reduce income inequality in LDCs. Figures 1 and 2 visually illustrate the limitations of social protection expenditure and the minimal impact of fiscal transfers on income inequality in lower-income countries. Figure 3 reveals the substantial contribution of the urban-rural gap to national income inequality (30% or more, exceeding 50% in China). Figure 4 and Figure 5 demonstrate the beneficial impact of urbanization on the urban-rural gap, especially after an urbanization rate of approximately 30% is reached. Figure 6 shows that the positive impact of urbanization is more pronounced in rapidly urbanizing countries. Figures 7 and 8 highlight the contrast between the inverted U-curve relationship of GDP per capita and within-urban/rural inequality versus the decreasing relationship between GDP per capita and the urban-rural gap. Figure 9 shows that pro-urbanization policies amplify the positive effect of urbanization on income inequality. The analysis contradicts the Kuznets hypothesis by showing that urbanization's positive impact on income distribution is overlooked when the urban-rural gap isn't considered. The study emphasizes that for the majority of countries, with GDP per capita above USD 2000, promoting urbanization can be an effective strategy to reduce income inequality.

The findings challenge the conventional wisdom surrounding urbanization and income inequality. The research shows that well-managed urbanization can be a powerful tool for reducing income inequality, particularly in developing countries where fiscal measures are limited in their effectiveness. By focusing on the urban-rural gap, the study offers a new perspective on the relationship between urbanization and inequality. The positive effects of urbanization are more pronounced in countries with pro-urbanization policies, highlighting the importance of policy choices in shaping income distribution outcomes. The results have significant implications for policymakers in developing countries, who should reconsider anti-urbanization policies and adopt strategies that promote inclusive and sustainable urbanization.

This paper significantly advances our understanding of the urbanization-inequality relationship. It demonstrates the limitations of fiscal solutions and highlights the positive role of well-managed urbanization in reducing income inequality, specifically by narrowing the urban-rural gap. The authors strongly advocate for a policy shift away from anti-urbanization practices. Future research could focus on understanding how urbanization might lead to rising within-city inequality and explore mechanisms to prevent slum formation and promote inclusive urban development.

The study's limitations include potential data limitations in accurately capturing income inequality and urbanization rates across all countries. The methodology relies on specific data sources and assumptions, which may affect the generalizability of the findings. Future research should strive to expand data coverage and refine the estimation of urban-rural income gaps for a more robust and comprehensive analysis.