Inverted-U Hypothesis:

It was argued by Simon Kuznets (1955) that a country's industrialization process  in he initial phases could  lead to higher income inequalities. The process gets reversed as the level of industrialization goes up. Kuznets gave empirical examples  from developed countries to prove his argument. He hypothesized  that the relationship between the level of economic development and  income inequality takes the form of an  inverted U-curve. This hypothesis is  commonly  referred  to  as the  inverted-U hypothesis and the curve is called the Kuznets' curve. In particular,  Kuznets postulated  that the  itersectoral  shifts which  occur  in,the early stages of economic development accentuate inequality. However, after reaching certain threshold  level of development, inequality attains its peak and then declines in  later stages. The Kuznets  curve  is  based  on  empirical  findings.  Usually Gini  coeffecient is taken as the measure of inequality. When  Gini coefficient. it is plotted against a quadratic function of per capita income we obtain the Kuzets curve. In Fig. we show a hypothettical  Kuznets' curve. The possible reason behind Kuznets curve is that in  early stages of development, when  investment in  physical capital  is the main  engine of economic growth, inequality spurs growth by  directing resources towards those who save and  invest the most.  In more mature economies, on the other hand,  human  capital accumulation takes the place of physical  capital accumulation as the main  source of growth. Moreover,  inequality impedes growth by  hurting education because poor people cannot fully finance their education.

The  Kuznets' curve  is  extended  to other areas  including environment. The environmental  Kuznets  curve  is  a  hypothesized  relationship  between  various indicators of environmental degradation and  income per capita. In the early stages of economic growth there is an  increase in  environmental degradation and pollution, but beyond  some level of income per capita (which will vary for different indicators) the trend  reverses. Consequently,  at  high-income  levels economic  growth  leads  to environmental  imprc~vement  and  there  is  decline  in  the  level  of  environmental degradation.  This  implies  that the  e~ivironmental  impact  on an  indicator  is  an inverted  U-shaped  function  of  income  per  capita. Typically  the  logarithm of  the indicator is modeled as a quadratic function of the logarithm of income.

Many studies have shown  the implications of inverted-U  hypothesis. First,  high income inequality may increase absolute  poverty which may,  in turn, adversely affect the quality of health, education, nutrition, etc. resulting in poor quality of human  capital. Second, rising inequality in favor of a small minority of  the population may heighten social and political tension and  threaten a country's  long- run development prospects. With the interaction of economic and political forces, policy makers  may  not  formulate correct policies to enable long  term income redistribution.