Inequality Overhang

Abstract

The linearity of the relationship between income inequality and economic development has been long questioned. While theory provides arguments for which the shape of relationship may be positive for low levels of inequality and negative for high ones, most of the empirical literature assumes a linear specification finding conflicting results. Employing an innovative empirical approach robust to endogeneity, we find pervasive evidence of nonlinearities. In particular, similar to the debt overhang literature, we identify an inequality overhang level in that the slope of the relationship between income inequality and economic development switches from positive to negative at a net Gini of about 27 percent. We also find that in an environment characterized by widespread financial inclusion and high income concentration, rising income inequality has a larger negative impact on economic development because banks may curtail credit to customers at the lower end of the income distribution. On the positive side, a sufficiently high female labor participation can act as a shock absorber reducing such negative impact, possibly through a more efficient allocation of resources.

The Role of Inequality for Poverty Reduction

“…context specific relationship between inequality and growth (Duflo and Banerjee, 2003;Grigoli et al, 2016;and Grigoli and Robles, 2017). 7 Second, our analysis sheds no light on how observed changes in inequality or growth came about, and, thus, sheds no light on policy makers' ability to influence these two variables.…”

Norway: Selected Issues

“…Female labor force participation can compensate for the negative impact of higher inequality on growth. Grigoli and Robles (2017) find that inequality reduces growth for countries with Gini coefficients higher than 28. Higher-than-average female labor force participation can increase this threshold and thus help avoid that inequality retards growth.…”

Great Expectations: Is the IMF turning words into action on inequality?

“…The most recent IMF research finds that there is in fact an 'inequality overhang', whereby any positive relationship between inequality and growth begins to diminish at a net Gini ratio of around 27 percent. 16 To put this in perspective, in 2014 only eight out of 35 OECD countries had Gini coefficients below 27. 17 Among those, the lowest score was 24.6 (Iceland).…”