Essays on the relationship between income inequality and economic growth

Abstract

This doctoral dissertation studies the relationship between income inequality and economic growth. It adds to the literature by incorporating the division of income between capital and labor into the analysis, by evaluating the role of financial conditions, by acknowledging country-specificity, by closely examining popular estimation techniques, and by adopting multiple measures of inequality. The dissertation comprises an introductory chapter and five studies. The first four are empirical, while the fifth contains both empirical and theoretical analyses. The first essay documents how results on the association between income inequality and subsequent per capita GDP growth depend on estimation technique. Specifically, accounting for country-specific unobservable characteristics explains many of the negative associations obtained using techniques that ignore them. It is also found that GMM techniques are not effective in disentangling causation from correlation. The second essay tests the prevalence of financial development as a determinant of the inequality-growth relationship. A multi-dimensional measure of financial development is adopted, and the results imply that promoting the development of financial markets may alleviate the adverse effects of income inequality on economic growth in under-developed countries. Unlike the first two essays, which rely on cross-country panel data, the third focuses on individual countries. Clear differences between countries are documented, and evidence is found for the proposition that economic growth responds asymmetrically to fluctuations in inequality. The fourth essay introduces data on capital shares and shows that shares are integrated between countries. In all sample countries, changes in capital shares are mainly driven by a single latent factor. In most of the countries, the factor is correlated with both trade openness and total factor productivity. The fifth essay shows that, as a matter of both empirics and theory, the association between top income shares and growth is positive when the capital share of income is low and negative when the capital share of income is high. The empirical regularity emerges from historical data. The theoretical analysis stresses the importance of precautionary saving motives and consumption smoothing.