Is Inequality Harmful for Growth? Theory and Evidence

TLDR

In societies where distributional conflict dominates, political decisions tend to reduce private appropriation of returns to growth‑promoting activities such as capital accumulation and knowledge production. The study investigates whether inequality harms economic growth, arguing that it does. The authors develop a politico‑economic model linking inequality to growth rates and test its predictions using historical data from the US and eight European countries and post‑war data from many developed and developing nations. Both historical and post‑war data reveal a statistically significant, quantitatively important negative relationship between inequality and growth, robust to extensive sensitivity checks.

Abstract

Is inequality harmful for growth? We suggest that it is. To summarize our main argument: in a society where distributional conflict is more important, political decisions are more likely to produce economic policies that allow private individuals to appropriate less of the returns to growth promoting activities, such as accumulation of capital and productive knowledge. In the paper we first 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 testable empirical implications with two sets of data. A first data set pools historical evidence-which goes back to the mid 19th 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, hetroskedasticity, or other econometric problems.