Inequality and Growth

Abstract

Using two unifying models and an empirical exercise, this paper presents and extends the main theories linking income distribution and growth, as well as the relevant empirical evidence. The first model integrates the political-economy and imperfect-capital-market theories. It allows for explicit departures from perfect democracy and embodies the tradeoff between the growth costs and benefits of redistribution through taxes, land reform, or public schooling: such policies simultaneously depress saving incentives and ameliorate the wealth constraints which impede investment by the poor. The second model is a growth version of the prisoner's dilemma which captures the essence of theories where sociopolitical conflict reduces the security of property rights, thereby discouraging accumulation. The economy's growth rate is shown to be a decreasing function of interest groups' rent-seeking abilities, as well as of the gap between rich and poor. It is not income inequality per se that matters, however, but inequality in the relative distribution of earning and political power. For each of the three channels of political economy, capital markets, and social conflict, the empirical evidence is surveyed and discussed in conjunction with the theoretical analysis. Finally, the possibility of multiple steady states leads the author to raise and take up a new empirical issue: are cross-country differences in inequality permanent, or gradually narrowing? Equivalently, is there convergence not only in first moments (GDP per capita), but in distribution?