How does income Inequality impact growth?

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Question: 

Hi! I'm trying to do more reading on economics this summer as I consider applying to master's of economics programs after working in IT for 13 years. I came across a paper (linked at the bottom) on inequality. I only have an undergraduate level understanding of economics and statistics (think intermediate micro/macro and an introductory stats class I took around 2003) so I'm limited in my understanding.

I'm reading through this paper and while I can think of reasons why some of the conclusions might be true I don't get how empirically they are reaching their conclusions.

1) According to page 16 item #23 "The empirical results show that inequality has a negative impact on economic growth. The baseline results are reported in columns 1 to 4 of Table 1" and then goes on to explain its reasoning why inequality negative impacts growth and says "Based on the estimated coefficients in column 1, for example, lowering inequality by 1 Gini point would translate in an increase in cumulative growth of 0.8 percentage points in the following 5 years".
2) In item #29 (page 19) they go on to say "Taken together, these results suggest that inequality in disposable incomes is bad for growth, and that redistribution is, at worst, neutral to growth". Again while I can think of some reasons why this may be the case (and some reasons why it may not like if some of the wealth leaves the country so as not to get redistributed depending upon implementation) I'm not sure how they are coming to that conclusion empirically.
3) Then several times they estimate what the impact on growth would be for every % change in the Gini index but I'm not sure how they built that numerical assumption.

I came across the paper because I was trying to do some simple research into whether income inequality can lower the velocity of money (though so far I've just pulled some data from FRED on MZM and the Gini index and found like a -.46 correlation.

I'm hoping I could learn from someone to better understand how the tables this paper provides actually translates into the conclusions they claim; I don't know how to properly interpret the tables.

https://www.oecd-ilibrary.org/social-issues-migration-health/trends-in-i...

Thanks!

Christopher

Answer: 

1) According to page 16 item #23 "The empirical results show that inequality has a negative impact on economic growth. The baseline results are reported in columns 1 to 4 of Table 1" and then goes on to explain its reasoning why inequality negative impacts growth and says "Based on the estimated coefficients in column 1, for example, lowering inequality by 1 Gini point would translate in an increase in cumulative growth of 0.8 percentage points in the following 5 years".

 The first coefficient in table 1 column 1 is basically the coefficient of yesterday's inequality on today's income.  Then based on this you can using equation 1.a see the impact of inequality yesterday on income 5 years from now. Just iterating equation 1.a with the estimated coefficients.  You can apply to this the elasticity formula to see how much an increase o 1 point in the inequality impacts five years ahead income.

2) In item #29 (page 19) they go on to say "Taken together, these results suggest that inequality in disposable incomes is bad for growth, and that redistribution is, at worst, neutral to growth". Again while I can think of some reasons why this may be the case (and some reasons why it may not like if some of the wealth leaves the country so as not to get redistributed depending upon implementation) I'm not sure how they are coming to that conclusion empirically.

‚ÄčThis conclusion is drawn from the fact that when you control for both gross inequality and net inequality there is no effect of gross one. The only one that matters is the net one and has a NEGATIVE coefficient. So, this is evidence that redistributing ( that is, the difference between net inequality and gross) has a negative effect on growth. See the coefficient of gross inequality is non significant. That means that the coefficient of gross inequality is 0. So "redistribution" can be measure as the difference between net inequality and gross one. Given gross one is 0 we only get the coefficient on net inequality. Which is negative so redistribution affects negatively. They then claim that "at best" it is neutral. There is no statistical fundamental for this comment, they are just trying to make a point that redistribution is not positive affecting. 

3) Then several times they estimate what the impact on growth would be for every % change in the Gini index but I'm not sure how they built that numerical assumption.

Using the estimated coefficients you can apply the elasticity formula to equation 1.a or different variations of this equation where instead of the unknown parameters you replace them with the estimated ones. Then they can get elasticities in a straight forward way.  

For example if you have y = xb+e where b is unknown, and then you estimate it and get the estimated b is =1, then you have the fitted equation y=x. Then you can apply all the algebra and calculus you learn in economic theory to this. 

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Last updated on August 29, 2019