Searching for prosperity

Abstract

Quah's [1993a] transition matrix analysis of world income distribution based on annual data suggests an ergodic distribution with twin peaks at the rich and poor end of the distribution. Since the ergodic distribution is a highly non-linear function of the underlying transition matrix, it is estimated extremely noisily. Estimates over the foreseeable future are more precise. However, the Markovian assumptions underlying the analysis are much better satisfied with an analysis based on five-year transitions than one-year transitions. Such an analysis yields an ergodic distribution with 72% of mass in the top income category, but a prolonged transition, during which some inequality measures increase.

The rosy ergodic forecast and prolonged transition arise because countries' relative incomes move both up and down at moderate levels, but once countries reach the highest income category, they rarely leave it. This is consistent with a model in which countries search among policies until they reach an income level at which further experimentation is too costly. If countries can learn from each other's experience, the future may be much brighter than would be predicted based on projecting forward the historical transition matrix.