Short-run and Long-run Dynamics of Growth,Inequality and Poverty in the Developing World

Growth, inequality, and poverty are central elements of the development process. However the mutual effects and directions of causality have been, and remain, one of the most controversial issues. After introducing a simple theoretical framework we derive some fundamental relations between growth, inequality and poverty. In the empirical part we test for unit roots and coin- tegration and apply GMM techniques on an error correction model (ECM) to estimate the pairwise short-run and long-run dynamics for income growth and changes in inequality and poverty in a panel of 114 developing countries and six regional subpanels for 1981 to 2005. The results confirm the relations of the theoretical framework; the evidence shows that in nearly all cases the vari- ables exhibit a short-run and long-run relationship. The findings reveal positive bidirectional causality between growth and inequality as well as between in- equality and poverty, and negative bidirectional causality between growth and poverty. Furthermore, the evidence shows that the level of development affects the poverty-reducing effect of growth, and that growth has benefited the poor regions far less. In summary, we show that growth, income distribution and poverty reduction are strongly inter-related, so a sucessful development strat- egy requires effective, country-specific combinations of growth and distribution policies.