How changes in income inequality affects growth in developed countries?

Abstract

As the academic field continues to be divided upon the direction of the relationship between growth and income inequality - some even finding no significant one at all - this research Thesis tries to contribute to the literature by estimating the effect on a set of 36 developed countries over a long time horizon of 53 years. The dynamic model set up is derived from a Human Capital Augmented Solow model with further variables added in line of the existing literature. The effect is estimated by both Pooled OLS, Least Squares Dummy Variables and with the Anderson-Hsiao first-differenced instrumental variable estimator. The first two estimation suffers from biases while the latter one corrects for them. The effect estimated by the Anderson-Hsiao estimator turns out to be positive and significant between income inequality and growth when the first is measured by the Gini Index - even if the effect is very small. To check for robustness, the model is re-estimated by different measures for income inequality - namely the top 1 and 10 percent pre-tax national income shares. The result of this new estimation shows the connection to be also significant, but negative and even smaller. From this we can only conclude that the measurement we choose for inequality matters a lot to its possible relationship to growth.