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Kuznets curve is the graphical representation of Simon Kuznets's theory ('Kuznets hypothesis') that economic inequality increases over time, then at a critical point begins to decrease.

One theory as to why this happens, in early stages of development, when investment in physical capital is the main mechanism of economic growth, inequality encourages growth by allocating resources towards those who save and invest the most. Whereas in mature economies human capital accrual, or an estimate of cost that has been incurred but not yet paid, takes the place of physical capital accrual as the main source of growth, and inequality slows growth by lowering education standards because poor people lack finance for their education in imperfect credit markets. Kuznets curve diagrams show an inverted U curve, although variables along the axes are often mixed and matched, with inequality or the Gini coefficent on the Y axis and economic development, time or per capita incomes on the X axis.

KUZNETS RATIO is a measurement of the proportion of income going to the highest earnings (20%), dividing it by the poorest proportion of the society. A value of 1 would mean perfect equality and absolute inequality.

Kuznets had two similar explanations for this historical phenomenon:

• workers migrated from agriculture to industry,
• rural workers moved to urban jobs.

In both explanations, inequality will decrease after 50% of the work force switches over to the higher paying sector. Economic historians have since used skill gap theories and the theories of capital concentration in early economies from classical economists and Marxists to further explain the Kuznets curve.

Interpretation of Kuznets Curve

Kuznets Curve can be interpreted as follows. Transition from agrarian sector to urban industrialization, in which we see a growth in income inequality as income in agriculture is relatively low compare to income earned in city. With this opening up of inequality, we also see that the level of income people earn in rural areas is similar to one another, whereas we see wide range of income level in industrialized city, which further opens up inequality. What then generates decline in Kuznets Curve? First, a rise of mass education movement may opened up opportunity for all and reduce gap in income inequality. Second, social policy put forth by the government as a country becomes rich may explain decline in inequality as government provide transfers, welfare, retirement pension, health care, as an effort to redistribute income throughout different level of income earning groups.

In case of the United States, we can model income inequality through Kuznets Curve with underlying mechanisms such as education and government redistribution which seem to generate up and down concave shaped curve. We can see from the sources presented by Alice Hansen Jones (1775); Edward Wolff (1915-1995) the share of wealth held by top 1% from 1775 to 1995. Around 1775, the top 1% owned about 15% of the wealth, then 30% by 1855 according to U.S Census. The data presented shows inequality to peak around 1935, with the top 1% owning 45% of the share of wealth in the United States and then begin a decline toward civil-war era levels from the World War II years to the 1970s. This period of decline occurred during Kuznets' lifetime and appear to be consistent with his theory regarding inequality. However, there has since been a steady increase in the share of wealth held by the top 1%. By the 1990s, inequality had climbed back to late-1930s levels. One possible explanation for this divergence from the Kuznets' curve is the impact of American social mobility on wealth distribution. Kuznets believed that as a country grew richer, its government would make a greater effort towards social spending. But in the U.S., high social mobility fostered a belief in the rewards of "hard work," which, in turn, may have resulted in more employer-provided social programs (welfare capitalism) and less of a welfare state.

Kuznets' conclusion that inequality must increase before decreasing, however, rests on shaky ground, because he used cross-sectional data of many countries during the same time period, rather than time series data that showed the progression of individual countries' development. The U-shape in the curve comes not from progression in the development of individual countries, but rather from historical differences between countries. In his data set, many of the middle income countries were in Latin America, a region with historically high levels of inequality. When controlling for this variable, the U-shape of the curve tends to disappear.

Another situation where Kuznets type curves appear is the environment. It is claimed that many environmental health indicators, such as water and air pollution, show the inverted U-shape: in the beginning of economic development, little weight is given to environmental concerns, raising pollution along with industrialization. After a threshold, when basic physical needs are met, interest in a clean environment rises, reversing the trend. Now society has the funds, as well as willingness to spend to reduce pollution. This relation holds most clearly true for a few pollutants, such as sulfur dioxide and nitrogen oxide, but there is little evidence that the relationship holds true for other pollutants, especially those with non-local effects (e.g., greenhouse gases), or for the environment in general.

For example, energy, land and resource use (sometimes called the "ecological footprint") do not fall with rising income. While the ratio of energy per real GDP has fallen, total energy use is still rising in most developed countries. In addition, the status of many key "ecosystem services" provided by ecosystems, such as freshwater provision and regulation, soil fertility, and fisheries, have continued to decline in developed countries. In general, Kuznets curves have been found for some environmental health concerns (such as air pollution) but not for others (such as landfills and biodiversity). However, it is important to note that this does not necessarily invalidate the theory - the scale of the Kuznets curves may differ for different environmental impacts. We may still be on the 'upward' leg of energy use Kuznets curve and have to get even richer still before we see a decline. Against this must be considered that much of the environmental damage associated with economic growth, such as extinct species and loss of wilderness, is irreversible.

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