Growth, inequality and poverty: A robust relationship?

An extensive literature on poverty traps suggests that high levels of poverty deter growth. However, a seemingly basic implication of the underlying theoretical models, namely that countries suffering from higher levels of poverty should grow less rapidly, has remained untested. A parallel literature has suggested a variety of mechanisms through which inequality may affect growth in opposing directions. Because inequality and poverty are different aspects of the income distribution, inequality can affect growth also through poverty, an indirect channel that has not been explicitly analyzed. This paper contributes to fill both gaps. Using a large cross-country panel dataset, we estimate a reduced-form growth equation adding both inequality and poverty to an otherwise standard set of growth determinants. Given inequality, the correlation of growth with poverty is consistently negative. In contrast, given poverty, the correlation of growth with inequality can be positive or negative, depending on the empirical specification and econometric approach used. Yet the indirect effect of inequality on growth through its correlation with poverty is robustly negative. Closer inspection shows that these results are driven by the sample observations featuring high (but not extremely high) poverty rates. Our empirical findings are consistent with the predictions from an analytical framework with learning-by-doing and knowledge spillovers, in which consumers cannot save and invest if their initial endowment is below a minimum consumption level.