Review of Social, Economic & Business Studies, Vol.

7/8, 31-43

Forging a Link Between Human

Development and Income Inequality:
Cross-Country Evidence

Arzu ALVAN
Doctoral Researcher, Department of Economics, Eastern
Mediterranean University

Abstract
This study based on the evidence of ninety countries across
the globe and it examines the possible linkage between human
development and income inequality. Global inequalities in income
and living standards widened between nations as well as within
nations according to the latest annual United Nations Human
Development Report. Cross-country evidence on income inequality
and human developmet suggest that these two factors are
negatively correlated and causality runs in both directions. When
human development is improved (High Human Development),
income distribution tends to be fairer, also when income
distribution is more equal, human development tends to improve.
On the other hand, medium and low levels of human development
tend to increase income inequality.

1. Introduction
Human development is a process of enlarging people`s
choices increasing their freedom of choices. Enlarging people`s
choices is achieved by expanding human capabilities and
contestability. Increasing income level is one of the main means of
expanding choices and well-being (UNHDR, 2002). There are
several independent variables affecting income inequality. A few
of such critical variables are globalization, inflation, economic
growth, human development, economic policies and the nature of

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government. Most of the previous studies investigated the impact

of inflation on income inequality (Albanesi (2002); Al-Marhubi
(1997, 2000); Bulir (2001); Galli and Hoeven (2001)). Some of
them also studied the impact of globalization on income inequality
((Heshmati (2003); Mah (2002)) while some others concentrated
on the impact of growth on income inequality((Birdsall, Ross, and
Sabot (1995)).
Human development level is much higher in high-income
countries. This leads us to assume that there is a two-way causality
between income and human development. With higher income,
people and governments spend more on education, health,
sanitation, communication and so forth. People can be more
productive and gross national income will be higher when human
capabilities are improved (Todaro, Smith, 2002). Because of the
plausible relationship among all the variables adumbrated earlier,
our study has used some control variables to test the two-way
causality between human development and income inequality. In
the present study, we have used Gini index (G) as a proxy for
income inequality, GDP index (GI), gross national income per
capita (P), and human development index (HDI) .
The HDI1 attempts to rank all countries on the scale of 0
(lowest human development) to 1 (highest human development)
based on three goals or end products of development: longevity as
measured by life expectancy at birth, knowledge measured as a
weighted average of adult literacy (two-thirds) and mean years of
schooling (one-third), and standard of living as measured by real
per capita income adjusted for the differing purchasing power
parity (PPP) of each country`s currency to reflect cost of living
(UNHDR, 2000).
GNI per capita is often used to indicate a nation`s economic
well-being or command over resources. As such it is a key
component in the UNDP`s (United Development Programme)
human development index (HDI). However, since individual
incomes are uncertain and unequally distributed, GDP per capita
does not indicate the likelihood that any particular individual will
share the prosperity or the degree of anxiety and insecurity with
which individuals contemplate their futures (Ramos and Silber,
2002).

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On the other hand, although per capita income and Real

GDP growth are two of the basic necessary means of human
development ,they are not, however, sufficient. Economic growth
between every part of the society should be fairly equally
distributed, but it is not the case in developing and transitional
economies. Furthermore, the gap between lowest income quintile
and highest income quintile has widened since 1980s. In most of
the industrialized countries the share of expenditures and
investments to social means (education, health, sanitation,
communication etc.) in government budget has been declining
(Birdsall, Ross, and Sabot, 1995).
In the human development approach, income is the sole
determinant for improving the quality of people`s lives. (UNHDR,
1998).

2. Methodology and Data

To examine the human development-income inequality link,
we used a broad set of control variables: (i) human development
index as HDI, (ii) GNI per capita as P, (iii) GDP index as GI,and
(iv)income inequality as G (Gini index).
Cross-country studies of income inequality require a carefull
selection of the observations to be included in the sample, in order
to guarantee the comparability of data across countries and time.
For the present study, HDI, GI, and P are obtained from Human
Development Report 2002 (Tables 1-15) and World Bank, World
Development Indicators 1999, and from Penn World Tables
(PWT)2. Data for income inequality (Gini indices) have been
gathered from the World Income Inequality Database (WIID)
collected by the World Institute for Development Economics
Research (WIDER). We first selected data on Gini coefficient
covering the whole area (urban and rural) and population for 90
countries which include some developing and developed countries3.
We define a developing country as a country with a relatively low
Standard of living, undeveloped industrial base, and moderate to
low Human Development Index (HDI). On the other hand,
developed countries usually have economic systems based on
continuous, self sustaining economic growth and high standards of

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living. Gross national income per capita (P) is transformed into

logarithms. The logarithmic transformation of this variable is used
to avoid giving undue weight to the higher values in determining
the coefficient estimates of the regression.

Table 1: The Correlation Matrix

HHDI HDI LHDI MHDI P G GI
HHDI 1.00
HDI 0.72 1.00
LHDI -0.39 -0.83 1.00
MHDI -0.63 -0.05 -0.40 1.00
P 0.80 0.93 -0.67 -0.26 1.00
G -0.48 -0.43 0.21 0.30 -0.39 1.00
GI 0.81 0.94 -0.71 -0.24 0.98 -0.44 1.00

To examine the relationship between human development

and income inequality, first, we have categorized HDI in three
ranks such as high human development (HHDI), medium human
development (MHDI), and low human development (LHDI) to see
the seperate impacts of them on Gini coefficient (G) in the first
regression analysis. These classifications are adopted from the
Human Development Report of the UNDP4 .
Since two-way causality is assumed to exist between human
development and income inequality, we have used (first) Gini
index (G) as a dependent variable, and HDI, GI, P, HHDI, MHDI,
and LHDI as independent variables. We have used six different
models, and the regression results are given in Table 2. Second, in
another case, the HDI is taken as a dependent variable and G, GI,
and P have been used as independent variables. The regression
results are shown in Table 3. The effects of these three
independent variables are tested in three different models.

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Table 2. Cross-Country Gini Regressions

Independents Model 1 Model 2 Model Model 4 Model 5 Model 6

3

C 57.54 58.27 83.7 46.2 56.5 36.7

(13.7) (14.1) (8.7) (20.04) (13.2) (18.1)

P -21.2
(-4.98a)

HDI -24.8
(-5.4a)

HHDIi -11.7
(-5.8a)

MHDIii 5.8
(2.87a)

LHDIiii 5.64
(2.32b)

GI -25.9 -24.7
(-5.7a) (-5.3a)

R2 0.21 0.23 0.18 0.29 0.30 0.06

Adj. R2 0.19 0.21 0.16 0.27 0.28 0.04

F-Stat 10.65 12.1 9.04 16.5 11.7 2.43

Prob. 0.00008 0.00003 0.0003 0.000001 0.000002 0.09

(F-Stat)

Notes: Figures in parentheses are t-statistics, a Denotes 1% significance, b Denotes

5% significance
(i) Dummy variable: 1 if HDI is greater than and equal to 0.80, 0 otherwise
(ii) Dummy variable: 1 if HDI is greater than 0.50 and less than 0.80, 0 otherwise
(iii) Dummy variable: 1 if HDI is less than and equal to 0.50, 0 otherwise

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3. The Cross Country Empirical Evidence

Table 1 reports the correlation matrix of G, GI, P, HDI,
HHDI, MHDI, and LHDI. Owing to multicollinearity, some
variables, which are highly correlated, are not used simultaneously
in the models given in Tables 2 and 3. While HHDI, HDI, GI, and
P are negatively correlated with G; MHDI and LHDI are positively
correlated with G. This means that Gini index (G) tends to decrease
with the improvement of HDI, HHDI and with the increase in P
and GI; and it tends to increase with MHDI and LHDI (positive
correlation).
In the same way, GI and P are highly positively correlated
with HDI, HHDI, MHDI, and LHDI. When GI and P rise, HDI,
HHDI, MHDI and LHDI tend to improve (Table 1). The same
Table also reveals that GI and P are highly positively correlated
with each other. Since there is a high correlation among these six
variables, they were tested under six different models in the first
regression analysis (Table 2). These six different models are
formulated on the basis of combinations of different variables.
The OLS results of the estimation are reported in Tables 2
and 3. However, the cross-country data which include the figures
of developed, developing, and transitional economies at the same
time reveal heterogeneity in the variances. To avoid this problem,
all t-statistics are based on the White’s Heteroskedasticity-
consistent Covariance Matrix.

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Table 3: Cross-Country HDI Regressions

Independents Model 1 Model 2 Model 3

C 1.10 (16.6) 0.045 (1.3) -0.87 (-11.6)

P 0.79 (22.6a)

GI 0.95 (25.6a)

G -0.008 (-4.6a)

I -0.03 (-2.91a) 0.02 (3.5a)

R2 0.25 0.90 0.87

Adj. R2 0.23 0.90 0.87

F-Stat 13.3 405.6 577.8

Prob. (F-Stat) 0.00001 0 0

Notes: Figures in parentheses are t-statistics, a Denotes 1% significance, b Denotes

5% significance

The results in Table 2 consider various alternative

specifications. In Table 2, G is expressed as the dependent
variable, and the effects of independent variables on it are tested
under six different models. In model 1, because of the negative
correlation between HDI and G, HDI`s estimated coefficient is (-
24.8) and significant at 1% level. This means that if HDI improves
by 1 point, G tends to decrease by 24.8 points. HDI has a very
pronounced effect on G. In model 2, GI has also very strong effect
on inequality (G) such that if GI increases by 1 point, inequality
tends to decrease by 25.9 points. In model 3, per capita income (P)
also has a very remarkable effect on G. Because of the negative
correlation between P and G, P`s estimated coefficient is (-21.2)
and significant at 1% level. In models 4, 5, and 6, high, medium,
and low levels of HDI were tested on G. While HHDI is affecting
G negatively by the estimated coefficient of (-11.7) which is
significant at 1% level; MHDI and LHDI are affecting G positively

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by the estimated coefficients of ( 5.8) and (5.64 ) which are

significant at 1% and 2.5% levels respectively. While MHDI and
LHDI are increasing by 1 point, G is increasing by the amount of
their coefficients.

LOESS Fit (degree = 1, span = 0.3000)

1.0

0.9

0.8

0.7
HDI

0.6

0.5

0.4

0.3

0.2
10 20 30 40 50 60 70

Figure 1 - HDI and G

LOESS Fit (degree = 1, span = 0.3000)

2.4
2.3
2.2
2.1
2.0
P

1.9
1.8
1.7
1.6

1.5
0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0

HDI

Figure 2- HDI and P

Based on the empirical analysis above, we can presume that

in an economy, income distribution tends be more fair if HDI is

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greater than and equal to 0.80 (HHDI) together with high levels of
GDP and per capita income. On the other hand, medium HDI
(between 0.50 and 0.80), and low levels of human development
(HDI is less than and equal to 0.50) have positive impacts on
income inequality. Thus, if a country is interested in reducing
income inequality, it should strive to improve human development
through capability expansion.
LOESS Fit (degree = 1, span = 0.3000)
2.4
2.3
2.2
2.1
2.0
P

1.9
1.8
1.7
1.6

1.5
0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0

GI

Figure 3 - G and P

LOESS Fit (degree = 1, span = 0.3000)

1.0

0.9

0.8

0.7
GI

0.6

0.5

0.4

0.3

0.2
10 20 30 40 50 60 70

Figure 4 - G and GI

To examine whether income inequality (G), GDP index (GI)

and per capita income (P) are affecting HDI or not, regression
analysis was conducted by taking HDI as dependent variable. The

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results are shown in Table 3. Because of the high correlation and

multicollinearity problem among G, GI, and P, the effects of these
variables on HDI were tested separately under three models in
Table 3. In model 1, estimated coefficient of G is (-0.008) and
significant at 1% level. There is a two-way causality between G
and HDI. In models 2 and 3, estimated coefficients of GI and P are
(0.95) and (0.79) respectively with 1% level of significance. These
variables are affecting HDI positively. Hence, we can conclude
that higher levels of GDP and per capita income lead to an
improvement of HDI.
LOESS Fit (degree = 1, span = 0.3000)
1.0

0.9

0.8

0.7
HDI

0.6

0.5

0.4

0.3

0.2
0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0

GI

Figure 5 - HDI and GI

4. Concluding Remarks
This study provides empirical evidence of a negative
correlation between high human development and income
inequality as well as a positive correlation between medium and
low levels of human development and income inequality using the
most recent and reliable data on control variables (G, HDI, P, GI).
There exists a two-way causality between human development and
income inequality. Because of the existence of several other
independent variables affecting income inequality, our result does
not seem to be universally applicable, but given the framework and
the data (ninety countries) of the study, we can conclude that
human development is very critical in the matter of reduction in
income inequality. To reach higher levels of GDP and per capita
income, and lower level of inequality, human development should

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be given top priority in the development programs particularly in

those countries where economic growth is low and income
inequality is high. High human development has positive impact on
income distribution. Our study also concludes that the linkage
between human development and income inequality becomes
meaningful with the inclusion of some standard control variables in
a framework that studies human development in a cross-country
perspective.

Endnotes
1
HDI= 1/3* (GDP index) + 1/3* (life expectancy index) + 1/3*
(education index)
2
Alan Heston, Robert Summers and Bettina Aten, Penn World
Table Version 6.1, Center for International Comparisons at the
University of Pennsylvania (CICUP), October 2002, (1950-2001)
3
Argentina (ARG), Armenia (ARM), Australia (AUS), Austria
(AUT), Belarus (BEL), Bangladesh (BGD), Burkina Faso (BFA),
Bulgaria (BGR), Canada (CAN), Brazil (BRA), Barbados (BRB),
Chile (CHL), China (CHN), Cote`dlovoire (CIV), Colombia
(COL), Costa Rica (CRI), Czech Republic (CZE), Denmark
(DNK), Dominican Republic (DOM), Ecuador (ECU), Spain
(ESP), Estonia (EST), Finland (FIN), France (FRA), United
Kingdom (GBR), Germany (GER), Ghana (GHA), Guinea (GIN),
Gambia (GMB), Guinea Bissau (GNB), Georgia (GEO), Greece
(GRC), Guatemala (GTM), Guyana (GUY), Hong Kong (HKG),
Hungary (HUN), Indonesia (IDN), India (IND), Ireland (IRL),
Israel (ISR), Italy (ITA), Jamaica (JAM), Jordan (JOR), Japan
(JPN), Cambodia (KHM), Sri Lanka (LKA), Luxembourg (LUX),
Latvia (LVA), Morocco (MAR), Macedonia (MDA), Madagascar
(MDG), Mexico (MEX), Mauritania (MRT), Mali (MLI), Mauritus
(MUS), Malaysia (MYS), Nigeria (NER), Netherlands (NLD),
Norway (NOR), Nepal (NPL), New Zealand (NZL), Pakistan
(PAK), Panama (PAN), Peru (PER), Philippines (PHL), Poland
(POL), Portugal (PRT), Paraguay (PRY), Romania (ROM),
Singapore (SGP), Slovak Republic (SVK), Slovenia (SVN),
Sweden (SWE), Thailand (THA), Trinidad & Tobago (TTO),
Tunisia (TUN), Turkey (TUR), Uganda (UGA), Ukraine (UKR),

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Uruguay (URY), USA (USA), Venezuela (VEN), Yemen (YEM),

Zambia (ZMB), Zimbabwe (ZWE)
4
HHD (HDI≥0.80): ARG, AUS, BEL, CAN, BRB, CHL, CRI,
CZE, DNK, ESP, EST, FIN, FRA, UK, GER, GRC, HKG, HUN,
IRL, ISR, ITA, JPN, LUX, LVA, NLD, NOR, NZL, POL, PRT,
SGP, SVK, SVN, SWE, TTO, UGY, USA; MHD
(0.50<HDI<0.80): BEL, BGR, BRA, CHN, COL, DOM, ECU,
GHA, GEO, GTM, GUY, IDN, IND, JAM, JOR, LKA, PAN,
PER, PHL, PRY, ROM, THA, TUN, TUR, UKR, VEN, ZWE;
LHD (HDI≤0.50): ARM, BRD, BGD, BFA, CIV, GIN, GMB,
GNB, KHM, MDG, MRT, MLI, NGA, NER, NPL, PAK, UGA,
YEM, ZMB

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