On the Possibility of Combining Low Inequality with Growth - An Inquiry into the Effects of Income Inequality and Redistribution on Economic Growth in Affluent Democracies

Abstract

This study addresses the central question in political economy how growth and distribution of income are related to each other. Even though many studies have empirically investigated this relationship, few studies investigate whether the income distribution as such, or the redistributing public interventions put in place to equalise incomes affect economic growth. With a quantitative panel design covering 30 OECD countries between 1970 and 2009, this study aims to fill this gap.

This study does not find unequivocal evidence that income inequality affects economic growth. Nevertheless, under a number of restrictions, a robust positive relationship between income inequality and subsequent economic growth can be found. Yet, keeping in mind the data limitations, further analysis suggests that it is not so much the degree of income inequality, but the amount of redistribution that affects economic growth. A small but statistically significant and robust negative effect of redistribution is found, which provides evidence for the trade-off theory holding that redistribution can limit the financial incentives to gain wealth, leading to (marginally) lower output growth. Different types of social spending are not found to have a statistically significant effect on growth, which could point to the importance of tax systems or of other social policy fields, but analysis of their effects on growth are beyond the purview of the analysis here. This finding implies that developed societies have to prioritise values or aim for a certain balance between reaching economic growth and limiting income disparities.