A Reassessment of the Relationship Between Inequality and Growth

Abstract

This paper challenges the current belief that income inequality has a negative relationship with economic growth. It uses an improved data set on income inequality which not only reduces measurement error, but also allows estimation via a panel technique. Panel estimation makes it possible to control for time-invariant country-specific effects, therefore eliminating a potential source of omitted-variable bias. Results suggest that in the short and medium term, an increase in a country's level of income inequality has a significant positive relationship with subsequent economic growth. This relationship is highly robust across samples, variable definitions, and model specifications. (JEL O40, O15, E25)

Global Interpersonal Inequality: Trends and Measurement

“…4 A review by Benabou (1996:13) …nds that 'These regressions, run over a variety of datasets and periods with many di¤erent measures of income distribution, deliver a consistent message: initial inequality is detrimental to long-run growth. ' In contrast, Forbes (2000) found that in the short and medium term, an increase in a country's level of income inequality has a signi…cant positive relationship with subsequent economic growth. Still other studies have found more nuanced relations between inequality and growth.…”

Institutions, inequality, and long-term development: a perspective from Brazilian regions

“…However, as argued by Forbes (2000), although most of these works focus on the theories establishing a negative effect of inequality on growth, a careful reading of this literature suggests that this negative relationship is far less definitive than is generally believed. In many models, the negative relationship depends on exogenous factors, such as aggregate wealth, political institutions, or the level of development.…”

“…Moreover, some studies made during this time (Saint-Paul and Verdier 1993;Galor and Tsiddon 1997a;Benabou 1996) found a positive theoretical relationship between inequality and growth. According to Forbes (2000), these papers received less attention because of the empirical negative relationship +reported at the time.…”

“…Soon after, new studies cast doubt on the robustness of these previous results: studies, such as those by Barro (2000), Forbes (2000), and Banerjee and Duflo (2003), make use of new data and strategies, and find either a positive relation or no relation between inequality and development indicators.…”

“…Using new data and panel techniques, Forbes (2000) finds a positive relationship between economic inequality and growth. Barro (2000) and Banerjee and Duflo (2003) also present evidence against such a clear-cut negative relationship.…”