Inequality does cause underdevelopment: Insights from a new instrument

Consistent with the provocative hypothesis of Engerman and Sokoloff [Engermann, Stanley and Kenneth Sokoloff (1997), “Factor Endowments, Institutions, and Differential Paths of Growth Among New World Economies: A View from Economic Historians of the United States,” in Stephen Haber, ed. How Latin America Fell Behind, Stanford CA: Stanford University Press., Sokoloff, Kenneth L. and Stanley L. Engerman (2000), Institutions, Factor Endowments, and Paths of Development in the New World, Journal of Economic Perspectives v14, n3, 217-32.], this paper confirms with cross-country data that agricultural endowments predict inequality and inequality predicts development. The use of agricultural endowments -specifically the abundance of land suitable for growing wheat relative to that suitable for growing sugarcane - as an instrument for inequality is this paper's approach to problems of measurement and endogeneity of inequality. The paper finds inequality also affects other development outcomes - institutions and schooling -which the literature has emphasized as mechanisms by which higher inequality lowers per capita income. It tests the inequality hypothesis for development, institutional quality and schooling against other recent hypotheses in the literature. While finding some evidence consistent with other development fundamentals, the paper finds high inequality to independently be a large and statistically significant barrier to prosperity, good quality institutions, and high schooling.