The first two essays of this dissertation rely on survey-based panel data and stan-dard panel regression techniques. The first essay contributes to the previous lit-erature on inequality and growth by providing further evidence on the proper-ties of the widely-used estimation techniques. Furthermore, it summarizes the choices an empirical researcher studying the topic necessarily faces, and docu-ments how these choices affect the conclusions. The second essay tests the sig-nificance of financial development as a potential determinant of the inequality-growth relationship. The results imply that promoting the development of finan-cial markets may alleviate the adverse effects of income inequality on economic growth in under-developed countries.
The findings of the first essay also suggest that the relationship between inequality and growth is characterized by cross-country heterogeneity – the re-sults depend on whether unobservable country-specific traits are considered. The third essay addresses country-specificity explicitly by focusing on individual coun-tries. Evidence of differences between countries is found. Moreover, positive and negative changes in income inequality are disentangled, and economic growth is found to respond asymmetrically to changes in inequality in France, India and the United States.
The contribution of the fourth essay lies in showing that the changes in the division of income between capital and labor, that is, the functional income distri-bution, are driven by the same underlying factors in different countries. The find-ing helps to put together country-specific evidence on the drivers of the changes in functional income distributions. More broadly, it shows how macroeconomic inter-dependencies can be examined beyond cross-country correlations and time series graphs by borrowing statistical methods from the financial literature.
To my interpretation, the main academic contribution of this dissertation is the central finding of the fifth essay. My co-authors and I show how account-ing for functional income distribution determines whether changes in income in-equality are associated positively or negatively with subsequent economic growth.
Our explanation (precautionary saving motives, consumption smoothing and set-ting our focus on the accumulation of capital) of the observed empirical regular-ity is potentially one of many, and we hope that our study will spark an active discussion on the empirical finding, which is both novel and robust. We believe that potential complementary mechanisms may be discovered by focusing on the composition of income in different income brackets, the accumulation of human capital, the potential role that new innovations play, and the labor supply deci-sions of households, to name some of the ones that we have thought but not yet formally analyzed.
Even though the question of whether inequality boosts or dampens growth is intriguing politically, clear recommendations stemming from either theoretical or empirical economic literature cannot be given. Theoretically, there are valid arguments on both sides. As far as the empirical evidence is concerned, there
are at least three fundamental issues. First, it has proven to be extremely diffi-cult – perhaps impossible – to establish a causal interpretation to the empirical findings. Second, constrained by data availability, the results typically rely on information from multiple years and from multiple countries. It is problematic to interpret findings associated with such structure of the data in terms of an indi-vidual country, where policy-makers operate. Third, bypassing the two previous notions, inequality can be affected through specific policies. Thus, it is perhaps more fruitful to focus on the evaluation of feasible reforms when county-specific policies are discussed. Moreover, the efficiency-equity trade-off is a second order issue in the political process, whose chief concern should be with individuals’
views about justice.
Studies on inequality and growth can still be of use, beyond satisfying the hunger of the academics dedicated to the topic, despite them being ill-suited for country-specific policy discussions. Complemented with other evidence on how our societies fare, carefully documented statistical associations interpreted in terms of applicable conceptual frameworks can help us to get "the big picture right". To me, problems arise if evidence on such large-scale patterns are taken to argue for specific issues.
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DIFFERENT PANEL ESTIMATORS AND VARIOUS MEASURES OF INCOME INEQUALITY
Abstract*
This study re-examines the much-studied inequality-growth relationship. An empirical analysis that covers over a hundred countries finds no clear evidence that inequality boosts or dampens the growth of per capita GDP. Furthermore, evidence is found that inequality promotes growth through physical investments and that it hurts economic development via lower accumulation of human capi-tal. These two mechanisms seem to balance each other out. The conclusions are based on a thorough investigation using the World Income Inequality Database maintained by UNU-WIDER and considering different measures of inequality, various estimation techniques, different specifications of the growth regression, allowing for non-linearities in the relationship and separating the OECD mem-bers from the non-OECD countries. The properties of the much-used system GMM estimator are investigated in detail. Even though its use is motivated by a desire to disentangle causality from correlation, the technique is found to suffer from weak instrument variables and sensitivity to small changes in the economet-ric specification. The results from simpler panel techniques follow a predictable pattern, where the use of cross-country (time) variation is associated with nega-tive (posinega-tive) estimates. More profoundly, a strong result that stems from a data set that combines information from several countries would be of limited use for policy purposes because the actions to curb or promote income inequality are within the purview of national policy-makers.
* I wish to thank my supervisors Kari Heimonen and Juha Junttila for their encouragement and the numerous reads, Malin Gardberg for comments on the first draft at the 41st An-nual Meeting of the Finnish Economic Association, Olli Ropponen and Tuomas Takalo for an instructive chat during the 2019 Summer Seminar of Finnish Economists in Jyväskylä, and François Bourguignon, Denis Cogneau and other participants in the Paris School of Economics Development Summer School 2019 for the highly stimulating discussions. The work was supported financially by the Finnish Cultural Foundation under Grant 12181963 and by the OP Group Research Foundation under Grant 20190078.
Keywords:Economic growth, Income inequality, Panel data, GMM