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DP581 | Is Inequality Harmful for Growth? Theory and Evidence

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Is inequality harmful for growth? We suggest that it is. In a society where distributional conflict is important, political decisions are likely to produce economic policies that allow private individuals to appropriate less of the returns to activities which promote growth, such as the accumulation of capital and productive knowledge. In this paper we formulate a theoretical model that formally captures this idea. The model has a politico-economic equilibrium, which determines a sequence of growth rates depending on structural parameters, political institutions and initial conditions. We then confront the model's testable empirical implications with two sets of data. The first data set pools historical evidence - dating back to the mid-nineteenth century - from the US and eight European countries. A second data set contains post-war evidence from a broad cross-section of developed and less developed countries. In both samples we find a statistically significant and quantitatively important negative relation between inequality and growth. After a comprehensive sensitivity analysis, we conclude that our findings are not distorted by measurement error, reverse causation, hetroscedasticity or other econometric problems.