Income Distribution, Political Instability, and Investment

TLDR

Income inequality fuels social discontent, spurring sociopolitical instability that creates uncertainty and reduces investment, implying an inverse relationship between inequality and investment. The study tests hypotheses on 71 countries (1960–85) to demonstrate how income inequality inversely affects investment, a primary engine of growth. We measure socio‑political instability with indices of violent and non‑violent unrest and estimate a two‑equation model with investment and instability as endogenous variables. Results are robust to sensitivity analyses and remain unchanged under robust regression, confirming the hypothesized inverse link.

Abstract

This paper successfully tests on a sample of 71 countries for the period 1960–85 the following hypotheses. Income inequality, by fuelling social discontent, increases sociopolitical instability. The latter, by creating uncertainty in the politico-economic environment, reduces investment. As a consequence, income inequality and investment are inversely related. Since investment is a primary engine of growth, this paper identifies a channel for an inverse relationship between income inequality and growth. We measure socio-political instability with indices which capture the occurrence of more or less violent phenomena of political unrest and we test our hypotheses by estimating a two-equation model in which the endogenous variables are investment and an index of socio-political instability. Our results are robust to sensitivity analysis on the specification of the model and the measure of political instability, and are unchanged when the model is estimated using robust regression techniques.