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Inequality and Growth in a Panel of Countries

Author: R Barro
Date: 2000
Size: 51 pages (104 KB)

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Summary

What is the effect of inequality on growth? This paper from Harvard University discusses recent theoretical analyses of the macroeconomic consequences of income inequality and applies a framework developed for the determinants of economic growth. It concludes that while there is little overall relation between income inequality and rates of growth and investment, higher inequality tends to retard growth in poor countries and encourage growth in richer places.

Many theories have been constructed to assess the macroeconomic relations between inequality and economic growth. They can be classed into four broad categories corresponding to the main feature stressed: credit-market imperfections, political economy, social unrest, and saving rates. The problem with these theories is that they tend to have offsetting effects, and the net effects on inequality and growth are ambiguous. However, the theoretical ambiguities do, in a sense, accord with empirical findings, which tend not to be robust.

Evidence from a broad panel of countries shows little overall relation between income inequality and rates of growth and investment.

• However, for growth, higher inequality tends to retard growth in poor countries and encourage growth in richer places.
• Growth tends to fall with greater inequality when per capita Gross Domestic Product (GDP) is below 2000 dollars (1985 U.S. dollars) and to rise with inequality when per capita GDP is above 2000 dollars.
• The Kuznets curve – whereby inequality first increases and later decreases during the process of economic development – emerges as a clear empirical regularity.
• However, this relation does not explain the bulk of variations in inequality across countries or over time.
• Income-equalising policies might be justified on growth-promotion grounds in poor countries. For richer countries, active income redistribution appears to involve a trade-off between the benefits of greater equality and a reduction in overall economic growth.

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Source: Barro, R. J., 2000, ‘Inequality and Growth in a Panel of Countries’, Journal of Economic Growth 5(1), pp. 5-32
Author: Harvard Department of Economics, http://www.economics.harvard.edu/