Inequality's Effect on Growth: An Empirical Study on Developing Countries and Emerging Markets

Abstract

This paper analyses inequality’s effect on economic growth in a sample of developing countries and emerging markets from 1960-2015. We use the Gini coefficient as the primary measure of inequality and GDP per capita growth as the primary measure for economic growth. Based on an augmented Solow model we set up a model to determine inequality’s causal effect on growth. Several panel data regression methods are considered and system GMM and fixed effects are chosen to carry out the analysis. We test several functional forms of inequality’s effect on growth. This paper’s main contribution to the inequality and growth literature, is the evidence of a non-linear hump-shaped effect of inequality on economic growth in developing countries and emerging markets. This result proves very robust throughout the analysis. We find no evidence of a simple linear effect in non-advanced countries. Further, we present results on a sample including advanced economies consistent with recent empirical studies. The results are to be interpreted on an overall level for developing countries and emerging markets. It is not possible to draw conclusions on a country specific level from this research. Instead, our paper provides a general guideline towards the effect of inequality on economic growth.