Effects Of Income Inequality On Economic Growth

An empirical evaluation of the theoretical findings is done by applying a semi-parametric model on a sample of 55 low-income, lower-middle-income, upper-middle-income and high-income countries for the period 1980 to 2010. Results show that the relationship between income inequality and growth takes the form of an inverted-U shape in that income inequality initially has a positive impact on growth up to an average Gini coefficient threshold of 35.92 beyond which it negatively impacts on gr… Table 20 presents the impact of innovation on growth, the positive channel for UHC from column (1) to column (2a). Thus, income inequality in UHC promotes economic growth even if it does not positively affect innovation.

Cuts and reforms — Public services as we move into a new era

More generally, when individuals have unequal borrowing opportunities, the unjust income distribution under initial conditions will persist and continue for the next generations. According to this theory, which is analysed especially through the investments made in human capital, it will be inevitable that economic growth will be negatively affected since human capital is the basis for economic growth. According to the political economy approach, the second channel, a relationship is established between "inequality" and "income redistribution through taxes", and the effect of income inequality on economic growth is examined indirectly.

Long-term determinants of income inequality: evidence from panel data over 1870–2016

Thereby, tax compliance and the broadness of tax bases are similarly important issues, as well as the effectiveness of the public sector, which underpins all public sector actions. Since my focus is also on the income distribution implications of public spending and tax decisions, I look at labour taxes for different types of earners based on their income, family status and number of children (Fig. 6). The tax wedge is a measure of the taxes on labour sasol limited income (including social security contributions) paid by employees and employers, minus family benefits received, as a percentage of the labour costs of the employer. 6 compare the tax wedge for single persons without a child at 67 percent, 100 percent and 167 percent of average earnings, respectively. Among the six countries included on the chart, in 2019 the tax wedge was progressive in Belgium, France, Germany and Spain, it was almost flat in Poland and perfectly flat in Hungary.

Method and Dataset

The fourth section includes the analysis results and growth estimates on the channel variable of inequality. Who examined the relationship between inequality and aggregate output in the presence of credit market imperfections and indivisibilities in human capital investment. Galor and Zeira’s model predicts heterogeneity in the effects of inequality on aggregate output across countries’ initial income levels. Taking this prediction seriously, our econometric model included an interaction between measures of income inequality and countries’ initial level of GDP per capita.

Effects of income inequality on economic growth

• This finding supports many studies in the empirical literature, as stated in the section discussing the results for LLMC.
• Although the robustness of the results is controlled by using panel estimation techniques and different indicators, there are also some limitations of this study.
• Therefore, as stated by Demirguc-Kunt (2012), these countries primarily need stable macroeconomic policies and strong legal and information systems for the development of the financial system.
• If inequality becomes unacceptable for voters, they might insist on higher taxation and regulation, as well as mistrust businesses, reducing incentives to invest (Alesina – Rodrik 1994; Bertola 1993).

This study aims to explain whether the positive and negative channels expressed in the theory on the effect of income inequality on economic growth play a significant role in different income group countries. Therefore, https://www.investec.com/ the purpose of this study is to emphasise that income inequality might have an indirect effect on economic growth depending on the income level of countries, rather than identifying the direct effect of income inequality on economic growth. The first stage estimates how income inequality affects the proxies of channel variables, and the effects of these variables on economic growth are examined in the second stage. The study results indicate that the relationship between income inequality and economic growth is quite complex. Although there is evidence that greater inequality has detrimental effects on economic growth, it appears that this inference cannot be generalised when countries’ income levels are taken into account.

On the other hand, in high- and middle-income countries increases in income inequality reduce human capital. Finally, Table 7 shows https://www.easyequities.co.za/ the effect of inequality, a positive channel, on patent and saving rates. Contrary to the theory stated above, inequality has a significant adverse effect on the patent, similar to Braun et al. (2019) (except column 2).

However, control variables do not change in either the sign of the income inequality or the channel variables, so when the results are evaluated together with the reduced model, more correct inferences can be made by considering the bad control problem. The effect of inequality on political stability is significantly negative (except column 2), unlike LLMC, and these results are consistent with the theoretical view. Considering together with the results obtained for LLMC, it can be said that the relationship between income inequality and instability is not linear. Blanco and Grier (2009) stated that inequality can reduce political instability after a certain threshold. Considering that low-income countries have relatively high levels of inequality, it can be said that the results support Blanco and Grier (2009) study, as these countries may have exceeded this threshold.

Social mobility and inequality: New evidence from Imperial China

While many studies in the literature examine the direct relationship between relevant variables, some focus only on bilateral relationships such as income inequality-channel variable or channel variable-economic growth. Studies that determine whether the effect of income inequality on economic growth occurs through a channel focus mainly on some of the negative channels stated in theory. The primary purpose of this study is to test whether the positive and negative channels specified in theory are valid, rather than the direct effect of income inequality on economic growth. Thus, the study is expected to provide a more comprehensive explanation of how the relationship between income inequality and economic growth emerges.