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More evidence on income distribution and growth

  • Clarke, George R. G.

Inequality is often regarded as a necessary evil that has to be tolerated to allow growth, says the author. The view that inequality is necessary for the accumulation of wealth, and contains the seeds of eventual increases in everyone's income, is evident in trickle down economic theories, where societal acceptance of inequality allows the rich to earn a greater rate of return on their assets. Others argue that inequality slows growth - because increased inequality causes more conflict over distributional issues, thereby encouraging greater economic intervention and higher taxes. According to the author, the empirical evidence shows that: Inequality is negatively, and robustly, correlated with growth. This result is robust to many different assumptions about the exact form of the cross-country growth regression. Although statistically significant, the magnitude of the relationship between inequality and growth is relatively small. Decreasing inequality from one standard deviation above to one standard deviation below the mean increases the long-term growth rate by about 1.3 percentage points a year. Inequality has a similar effect in democracies and non-democracies. When an interaction term between the type of regime and inequality is included in the base regression, it is insignificant at conventional significance levels. The cross-country data on inequality follows Kuznets'inverted-U shape. Care should be taken in interpreting these results. Although inequality is negatively correlated with growth, this does not necessarily imply that soak-the-rich policies will improve long-term growth. First, theoretical work on inequality and growth stresses thatthis negative correlation is caused by high levels of inequality provoking high levels of government economic intervention. Soak-the-rich policies may be less necessary where there is less inequality. Second, although the partial correlation is robust, the direction of causality has not been determined and the effects of specific income distribution policies have not been tested. Finally, if policies designed to decrease inequality result in greater government consumption and the cost of increased government consumptions outweighs the benefits of greater equality, long-term growth may be harmed. But for certain: inequity is not a prerequisite for growth.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 1064.

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Date of creation: 31 Dec 1992
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Handle: RePEc:wbk:wbrwps:1064
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