Inequality and Growth in the United States: Why Physical and Human Capital Matter

Abstract

We investigate the relationship between economic growth and top income inequality under the influence of human and physical capital accumulation, using an annual panel of U.S. state‐level data. Our analysis is based upon the “unified” framework offered by Galor and Moav (2004) while the empirics account for cross‐section dependence, parameter heterogeneity, and endogeneity, in nonstationary series. We conclude that changes in inequality do not influence growth, neither in the short run nor in the long run in the United States as a whole in the 1929–2013 period. Our findings are robust to the inclusion of overall income inequality measures. These findings provide support for the theoretical prediction of the unified theory of inequality and growth, according to which the growth effect of inequality becomes insignificant in the latest stages of economic development that the United States experiences during our period of investigation. Therefore, future policies aiming at moderating the concentration at the upper end of income distribution are not likely to have adverse growth consequences in developed countries such as the United States. (JEL I21, O47, C23)

Does Finance Alter the Relation Between Inequality and Growth?

“…The theory developed by Galor and Moav () proposes a positive effect of inequality on the process of development in the early stages of industrialization when physical capital accumulation was the prime engine of economic growth but it proposes a negative effect in later stages of development when human capital accumulation becomes a prime engine of economic growth and credit constraints are largely binding. Benos and Karagiannis () provide support for the theoretical prediction of the unified theory of inequality and growth that was developed by Galor and Moav (). Banerjee and Newman () and Aghion and Bolton () suggest that equality positively affects the investment opportunities of individuals, not only in human capital but also in physical capital…”

Managing the impact of globalization and technology on inequality

“…In that regard, inequality is negatively correlated with the level of economic development. Galor and Moav (2004) theoretical model has been empirically verified by Chambers and Krause (2010) and Benos and Karagiannis (2018). In our empirical model, we use GDP per capita as a threshold variable to differentiate between development levels.…”

Literature review on income inequality and economic growth

“…In addition, several studies have yielded inconclusive findings, with most reporting that the relationship is positive in high-income and negative in low-income countries (see, for example, [13 , 20 , 25 , 27] ). A few studies found no relationship between inequality and growth (see [15 , 44] ).…”

“…The findings confirmed that economic growth reduced poverty, but had no effect on income inequality, which implies that there was no relationship between income inequality and economic growth. Benos and Karagiannis [15] examined the relationship between top income inequality and growth under the influence of physical and human capital accumulation in the U.S. By using 2SLS and GMM on the annual panel of U.S. state-level data during 1929 to 2013, they concluded that changes in inequality do not have an impact on growth. Table 1 shows the summary of empirical studies discussed in this section.…”

“… [32] 106 countries, 1965–2005 Gini coefficient System GMM First-difference GMM Short-run: + Long-run: - Ostry et al. [45] 90 countries, 1960–2010 Gini coefficient System GMM Early stage: + Mature stage: - Brueckner and Lederman [20] 144 countries, 1970 to 2010 Gini coefficient 2SLS GMM Low income countries: + High income countries: - No relationship Niyimbanira [44] Mpumalanga 18 municipalities, 1996–2014 Gini coefficient FE Pooled regression 0 Benos and Karagiannis [15] US state level data, 1929 to 2013 Gini coefficient 2SLS GMM 0 Note: - denotes negative; + denotes positive; 0 denotes no relationship …”