Inequality, Growth, and Investment

Abstract

A substantial literature analyzes the effects of income inequality on macroeconomic performance, as reflected in rates of economic growth and investment.Much of this analysis is empirical, using data on the performance of a broad group of countries.This paper contributes to this literature by using a framework for the determinants of economic growth that I have developed and used in previous studies.To motivate the extension of this framework to income inequality, I begin by discussing recent theoretical analyses of the macroeconomic consequences of income inequality.Then I develop the applied framework and describe the new empirical findings. I. Theoretical Effects of Inequality on Growth and InvestmentMany theories have been constructed to assess the macroeconomic relations between inequality and economic growth. 1 These theories can be classed into four broad categories corresponding to the main feature stressed: credit-market imperfections, political economy, social unrest, and saving rates. A. Credit-Market ImperfectionsIn models with imperfect credit markets, the limited ability to borrow means that rates of return on investment opportunities are not necessarily equated at the margin.2 The credit-market imperfections typically reflect asymmetric information and limitations of 1 Recent surveys of these theories include Benabou (1996) and Aghion, Caroli and Garcia-Penalosa (1998). 2 For models of the economic effects of inequality with imperfect credit markets, see Loury (1981), Galor and Zeira (1993), and Piketty (1997), among others.

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