Introduction

Nicholas Kaldor, one of the leading post-Keynesian economists, developed a modern theory of functional income distribution in the 1950s. His approach was a significant departure from classical and neoclassical theories, which focused on marginal productivity. Instead, Kaldor’s theory, rooted in the Keynesian tradition, emphasized aggregate savings behavior, investment, and the macroeconomic stability of income shares. His two-class model—capitalists and workers—provides a powerful tool to explain how income distribution changes with changes in investment and saving rates. This theory is crucial for Paper 1 of the UPSC Economics optional syllabus.

1. Context of Kaldor’s Theory

Kaldor’s model emerged during a time when empirical observations showed stable shares of labor and capital in national income despite economic growth. This contradicted the neoclassical belief that distribution was solely a result of marginal productivities. Kaldor introduced a theory where the savings behavior of income classes played a central role in determining the profit and wage shares.

2. Assumptions of the Model

• The economy is always at full employment.
• There are only two classes: capitalists and workers.
• Capitalists save a large portion (possibly all) of their income.
• Workers save very little or none of their income.
• Total investment is exogenously determined and fixed in the short run.

3. Key Concepts and Equations

Kaldor defines:

• Y = National Income
• W = Wages
• P = Profits
• S_k = Savings by capitalists
• S_w = Savings by workers
• I = Investment

Total savings = S_k · P + S_w · W

Since total savings must equal investment: I = S_k · P + S_w · W

Rewriting the equation, Kaldor derives the share of profits in national income (P/Y):

P/Y = [I/Y – S_w]/[S_k – S_w]

This formula shows that as investment increases, the share of profits must also rise (assuming S_k > S_w).

4. Interpretation

The key insight is:

• Higher investment → greater income share for capitalists (profits)
• Lower investment → relatively higher wage share

This model links income distribution to macroeconomic variables like savings and investment rather than marginal productivity.

5. Diagrammatic Representation

The graphical presentation plots the relationship between the profit share and the investment-output ratio. A higher investment-output ratio results in a higher profit share.

6. Infographic

Kaldor Distribution Theory Infographic

7. Mind Map

Kaldor_Distribution_Theory_MindMap

8. Implications of Kaldor’s Theory

• Explains stable functional income shares during economic growth
• Emphasizes the role of savings behavior in distribution
• Suggests policy interventions through investment to affect profit shares
• Supports Keynesian emphasis on aggregate demand

9. Criticisms of Kaldor’s Model

• Ignores inflation and price dynamics
• Assumes static full employment – unrealistic in developing economies
• No role for government expenditure or taxes
• Simplistic two-class framework overlooks middle class, financial capital
• Assumes fixed savings rates and rigid behavior

10. Relevance in Today’s Context

• Useful in explaining how inequality changes with investment booms
• Still applicable in Keynesian growth models and income policy design
• Reinforces the idea of class-based savings behavior in policymaking

11. Previous Year Questions (UPSC Economics Optional)

• UPSC 2022: Explain how savings behavior affects income distribution in Kaldor’s model.
• UPSC 2019: Critically examine the assumptions of Kaldor’s theory of functional distribution.
• UPSC 2015: Compare Kaldor’s theory with the neoclassical marginal productivity theory.

12. Probable Questions for UPSC Prelims & Mains

• Mains: “Kaldor’s theory of distribution is investment-led and savings-driven.” Elaborate.
• Mains: “How does Kaldor’s model challenge the neoclassical notion of distribution?”
• Prelims: “In Kaldor’s model, income distribution depends primarily on…”
• Prelims: “Which assumption is central to Kaldor’s two-class model?”

13. Conclusion

Kaldor’s theory of distribution offers a dynamic and macroeconomic approach to functional income distribution. It replaces micro-level marginal analysis with savings-investment behavior and class-based outcomes. Despite its limitations, it remains an influential tool in understanding income inequality, macroeconomic stability, and growth dynamics. For UPSC aspirants, this theory is a must-study component of Paper 1 in the Economics optional syllabus.