Inequality of opportunity and growth

Abstract

Theoretical models and empirical studies exploring the relationship between income inequality and growth reach a disappointing inconclusive answer. We postulate in this paper that one reason for this inconclusive result is that income inequality consist at least in two different sorts of inequality, inequality of opportunity and effort. These two types of inequality would affect growth through opposite channels. As a result, the relationship between income inequality and growth could be positive or negative depending on which kind of inequality is more relevant. We test this proposal using depurated data of the PSID database for 24 US states from 1980 to 2000. We estimate regressions that relate growth with overall income inequality, inequality of opportunity and other widespread used control variables. We find robust support for a negative relationship between inequality of opportunity and growth and a positive relationship between growth and income inequality.JEL Classification: D63, H00.Key Words: income inequality; inequality of opportunity; economic growth. INTRODUC TIONAn upsurge literature on income inequality and growth has emerged over the last two decades. The development of endogenous growth theory has provided the tools to handle the relationships between income inequality and economic growth within a dynamic equilibrium setting. Relaxing the representative-agent assumption raises two main questions. The first concerns the effects of income and wealth inequality on growth. The second addresses the reverse causation from growth to inequality, and disputes about the Kuznets (1955) hypothesis, according to which development and growth should eventually reduce income inequality.We concentrate on the first channel of influence, that is, on the effects of income inequality on growth. In this respect, two sets of growth models have been proposed in the literature: models where inequality is necessary for growth and models where inequality is harmful for growth. As it will become clear in the next section, the prevalence of a positive or negative relationship between income inequality and growth from a theoretical perspective is not possible since income inequality may affect economic growth in both directions through many different channels. For example, wealth and human capital heterogeneity across individuals produces a negative relationship between income inequality and growth because capital markets are imperfect. Meanwhile, income inequality may courage people s effort and, therefore, economic growth. In this manner, opposite forces give rise to a confusing picture of the relationship between economic growth and inequality. Worst still, the empirical evidence on the link from initial income inequality to future growth is mixed. Thus, there is a general inconclusiveness of cross-sectional and panel data studies of the relationship between income inequality and growth. In this respect, Ehrhart (2009) acknowledges in a recent survey on this topic that the overall rather disappointing econometric ...

Inequality of Opportunity and Economic Growth: A Cross-Country Analysis

“…While this weak finding is neither robust to changes in specification nor to switching to the DHS data set, it is nonetheless inconsistent with a positive association such as the one found by Forbes (2000) and Li and Zou (1998). Furthermore, we find no evidence in support of our original hypothesis, which found some support in a data set of 26 U.S. states (Marrero and Rodríguez, 2013): there is no apparent relationship between either component of inequality and growth in either of our two data sets.…”

“…Table A3 confirms these null findings when the instrument set is restricted further using the pca option. These findings are clearly not supportive of the hypothesis that there might be a negative association between inequality of opportunity and growth (and a positive one between the residual inequality and growth) à la Marrero and Rodríguez (2013).…”

“…The OLS and FE estimators are presented in columns (1) and (2) in Tables 3-6. For comparison with other studies on inequality and growth, such as Marrero and Rodríguez (2013), we also estimate a ten-year OLS, which regresses growth during the latest 10-year period we have in each country on initial conditions at the beginning of that period, excluding the time dummies. 23 These estimates are presented in column (3) of each regression table.…”

Tracking positive and negative effects of inequality on long-run growth

“…However, the paper acknowledges that its empirical analysis "is not very informative regarding the different channels through which inequality might affect income." 8 The closest study we found is Marrero and Rodriguez (2010). In line with our results, they find opposing effects for inequality of opportunities and for inequality of returns.…”

A Public Finance Perspective on Climate Policy: Six Interactions That May Enhance Welfare

“…In contrast, inequality of returns to efforts gives incentives to households to work harder. The conventional view is correct with respect to inequality of returns to efforts as it increases an economy's growth rate; however inequality of opportunities decreases it (Marrero and Rodríguez, 2013). High levels of inequality of opportunity are usually coupled to low social mobility, a fact which is also known as the 'Great Gatsby Curve' (Corak, 2013).…”