Income Inequality And Economic Growth
IncomeInequality andEconomic GrowthWhat relation does regional inequality have with localeconomic growth in US metropolitan areas?BACHELORTHESIS WITHIN: EconomicsNUMBER OF CREDITS: 15 ECTSPROGRAMME OF STUDY: InternationalEconomics and PolicyAUTHOR: Barbara Kandek and VeronikaKajlingJÖNKÖPING May 2017
Bachelor Thesis in EconomicsTitle:Income Inequality and Economic GrowthAuthors:Barbara Kandek and Veronika KajlingTutors:Charlotta Mellander and Emma LappiDate:May 2017Key terms: gini index, income inequality, economic growth, regional economics, united statesAbstractIncome inequality has been widely debated since the beginning of economic development. Thistopic is especially present in today’s economic world as the gap between the poor and rich onlyseem to widen, even in developed nations. Surprisingly, this is especially true for the UnitedStates where the top 1 percent own almost 50 percent of the nation’s income shares. Severalstudies have spoken on the impact inequality has on a nation, but few have commented on theeffect it may have on a nation’s economic growth. Therefore, this paper aims to examine whatrelationship exists between regional inequality and local economic growth in 357 metropolitancities in America. With the data gathered from the U.S. Census Bureau and several otherdatabases, between the years 2010 and 2015, a series of OLS regressions are run. It is importantto note research on the impact of income inequality on economic growth is few and far between,primarily on the city level due to data limitations. Thus, this disposition further contributeswithin the field of regional economics. The results in this paper, when regressing Gini to GDPPer Capita Growth and GDP Per Capita level, show Gini has a positive and significantrelationship with GDP Per Capita Growth versus a negative and insignificant relationship withGDP Per Capita level.i
Table of Contents1. Introduction .11.1 Purpose.21.2 Disposition .32. Theories and Concepts .32.1 Theories on Income Inequality: Does Harm Growth .32.2 Theories on Income Inequality: Does Not Harm Growth .52.3 Regional Inequality in the United States .72.4 What Causes Cities to Grow? .93.Hypotheses and Expected Results .114. Methodology and Data .124.1 Empirical Model .124.2 Variables .124.2.1 Dependent Variables .124.2.2 Independent Variables .144.3 Econometric Method .165. Empirical Results .165.1 Descriptive Statistics.165.2 Correlation Analysis .175.3 Regression Analysis .186.Analysis of Results .207.Conclusion .248.Bibliography .269.Appendix .28ii
TablesTable 1: Variables, Definitions, and Expected Signs .11Table 2: Descriptive Statistics .16Table 3: GDP Correlations.17Table 4: Regression Equations GDP Growth .18Table 5: Regression Equations Initial GDP .18Table 6: Standardized Beta Values Initial GDP .28Table 7: Standardized Beta Values GDP Growth .28Table 8: Correlation Matrix .29FiguresFigure 1: Scatterplot GDP Growth .13Figure 2: Scatterplot GDP Initial .14Figure 3: Histogram Standardized Residual GDP Initial .30Figure 4: Histogram Standardized Residual GDP Growth .30Figure 5: P-P Plot of Standardized Residuals GDP Initial .31Figure 6: P-P Plot of Regression Standardized Residual GDP Growth.31iii
1.IntroductionIncome inequality has been a pressing issue since the development of nations. Fromancient Greek philosophers to our now current politicians, income inequality and itsimpact has been widely debated. According to a report published by the IMF, “Wideningincome inequality is the defining challenge of our time. In advanced economies, the gapbetween the rich and poor is at its highest level in decades” (IMF 2015). Despite beinghighly developed, some Western nations have seen a steady increase in inequality in theirown backyards. This is especially evident in the United States. As Alesina and Glaeser(2004) have found, America is relatively unequal for a developed country. Piketty andSaez (2003) highlight this further by researching how wealthy the richest 1 percent trulyare in America; findings presented the 1 percent’s share of income rose by almost 14percent just between 1979 and 2007.In the next two years, from 2007 to 2009, the Great Recession took precedence over theUnited States. Americans experienced a long list of consequences due to the crash, fromhigh unemployment rates, plummeting housing prices, and a labor market downturn(Fairlie 2013). The average real income declined by almost 18 percent during this timeperiod (Saez 2013). For the top percentile, their average real income fell by 36.3%. Thebottom 99 percent experienced a smaller fall of 11.6 percent, although the drop more thanerased their 6.8 percent income gain from 2002 to 2007. After the recession, an unevenrecovery occurred among Americans. The top percentile grew at a steady 11.2 percentwhile the bottom percentile shrunk by 0.4 percent. Despite the fall of income in thebeginning of the crash, as households recovered, income inequality grew once againwhere in 2011, the top decile share equaled to 46.5%, the ‘highest ever since 1917’ (Saez2013).The recession highlighted the sharp inequality many Americans face today and how therecovery impacted households differently. Sampson (2016) argues inequality in Americacomes hand in hand with the ‘hollowing out of the middle class, stagnation of wages, andlack of upward mobility’. American individuals are now born and stuck in neighborhoodsthat are highly unequal, leading to a concentration of poverty, violence, and poor schoolquality at a regional level that, in the long term, creates a nationwide impact. Glaeser1
(2009) believes local inequality is important to study, for crime rates are higher in unequalAmerican cities and people are unhappier, leading to a higher possibility of political andsocial uprisings.Panizza (1999) joins the debate on income inequality by finding channels linkinginequality to economic growth. There exists many mixed theories and beliefs on how, ifat all, income inequality and economic growth relate. Nevertheless, Panizza argues thatpolitical instability, imperfect capital markets, and redistribution pressure could be areasoning behind a negative relationship. Nissan (2001) also studies the connectionbetween inequality and economic growth by researching U.S. states, labeling his theoryas ‘convergence’. This occurs when the income of regions approaches each other in thelong run, thus the gap between the poor and the rich would also decrease. Nissan findsper capita personal income has shown to diverge during the 1980s despite a long-termtendency of convergence. Introducing growth into the equation, Nissan (2001) theorizesa reason for this change could be towards the disparate growth rates due to some centralcities in the 1980s experiencing faster growth in their economies than others.From poverty, violence, and lack of opportunity, the socioeconomic impact of incomeinequality can be debilitating in the development of a nation and its people. As Chernicket al. (2011) argues, one fifth of Americans live in the 100 largest cities in the nation.Thus, the growth and prosperity of cities are the key to the economic prosperity of anation. This begins with furthering equality, so all Americans have the same opportunitiesand rights to better not only their situation, but the nation’s.1.1PurposeThe aim of this paper is to study what type of relationship exists between regional incomeinequality and local economic growth in 357 metropolitan cities in the United States. Thetime frame is a short-term of five years, specifically 2010 to 2015, which are also knownas the recovery years after the Great Recession.It is important to note there lacks specific research in this area, primarily when studyingat the regional metropolitan level. This is due to a collection of factors, one of them beinga limitation to data. Therefore, this paper contributes to the field of regional economics,2
by studying if there exists a positive, negative, or no relationship with regional incomeinequality and local economic growth.1.2DispositionThis paper is organized as follows, Section 2 reviews the previous theories and conceptsregarding income inequality. Section 3 shares the hypotheses tested in this paper. Section4 presents the data, variables, empirical models, and methods. The empirical results arepresented in Section 5, which are then analysed and discussed in section 6. Section 7concludes the paper and provides suggestions for future research regarding therelationship between regional income inequality and local economic growth.2.Theories and ConceptsIn this section, existing theories on income inequality and its relationship with economicgrowth will be discussed. Concepts on both regional income inequality and localeconomic growth will follow.2.1Theories on Income Inequality: Does Harm GrowthStiglitz (2012) argues inequality slows economic growth. According to Stiglitz, inequalityweakens aggregate demand for individuals at the bottom and thus they spend a biggerportion of their income than those at the top. This makes sense intuitively; the poor oftenneed to spend all their earnings simply to have the necessities to get by. Furthermore,Stiglitz argues the policy responses to fight weak demand can damage the economy. Ifmonetary authorities decrease the interest rates, this can fuel bubbles that, upon bursting,may lead to a recession. Inequality of outcomes is linked with inequality of opportunity,thereby preventing individuals from low socio-economic backgrounds to reach their fullpotential. This indicates that income inequality has a negative effect even on futureeconomic growth, putting families at risk of ending up in a poverty trap. Stiglitz points torent seeking, when the rich seek to increase their own wealth rather than creating newwealth, as another important factor on how inequality can harm growth.Much of the theoretical literature on inequality’s effect on growth presents imperfectcapital markets, pressure for redistribution, and socio-political instability as plausiblecauses for a negative association between income inequality and economic growth.3
Aghion et al. (1999) argues that inequality is harmful for growth in the presence ofimperfect capital markets. If a functioning credit market is lacking, investments willdepend on an individual’s own income and assets. The poor population may therefore notmake any or enough investments that will raise their human capital. This is evident in thelack of investment in education within poorer communities. These poor individuals havehigher marginal returns to investments than the wealthy. Hence, there is a potential forhigher return on investment through redistribution. Imperfect capital markets can preventthe poor from educating themselves and their children, start businesses and affordinsurances. These factors prevent the country itself from reaching the growth potential itmight have faced with a more equitable distribution.OECD (2014) finds a significant, negative relationship between inequality and economicgrowth in the OECD countries over a time span of 30 years. The gap between low incomehouseholds and the remaining population was shown to be of greatest importance, whileno evidence was found that the rich pulling away from the rest of the population harmsgrowth. Their study revealed that in unequal societies, the poor invested less in theireducation and skills, while it barely had any impact on human capital investments amongthe middle and upper class. Hence, this implies that inequality will create an increasingeducation and earnings gap. The study divided the population into three different groupsbased on parents’ educational background (high, medium, low) and looked at numeracyscores within the three groups based on the OECD’s Adult Skills Survey. In unequalsocieties, the individuals from low socioeconomic background scored worse than theydid in more equal societies. This can be considered economically inefficient, because amore skilled labour force can make greater contributions to the economy (Cingano, 2014).Persson & Tabellini (1994) discuss how conflict concerning the degree of distribution islikely to result in policies that impede growth. Economic growth takes place throughaccumulation of capital, human capital, and knowledge that is needed in production.Being able to appropriate the rewards of one’s efforts is important to incentiviseindividuals, thus redistribution policies risk distorting these motivations. Perotti (1996)refers to this as the fiscal policy approach with two different mechanisms. Equal societiesdemanding less redistribution (the political mechanism) results in lower levels of taxation,higher levels of investment, and growth (the economic mechanism). The fiscal policyapproach implies a distinction between democracies and non-democracies. In democratic4
societies, political outcomes are likely to reflect the wishes of the median voter. Ifinequality reaches high levels, the income of the median voter will be lower than the meanincome of the economy. This creates a pressure for distributional policy actions.However, in a country that lacks a majority voting system, the fiscal policy approach doesnot predict any direct relationship between income inequality and growth.Alesina & Perotti (1993) find that unequal societies are more politically unstable.Inequality causes social discontent, which in turn increases the degree of socio-politicalinstability in a society. This unstable political and economic environment is harmful foreconomic growth by reducing investment, threatening property rights, and causing alarger number of coups and revolutions. Kelly (2000) considers the relationship betweeninequality and crime using data from urban counties in the United States, showing thatinequality has an impact on violent crime. In a society with high inequality, the poor isfaced with higher pressure and incentives to commit crime. An individual is more likelyto turn to crime if they can expect a higher return from criminal activities than legalactivities. In addition, when the rich become increasingly richer, the return of burglary isexpected to increase (Chiu & Madden 1998).A report from IMF has focused on the medium and long-term, analysing the growth rateover five-year periods through panel growth regressions and the length of growth spells.Their results show, for a given level of redistribution, lower net inequality is associatedwith faster and more robust growth. Furthermore, their research found a mostly benigneffect of income distribution on growth. The IMF paper emphasises on the importantdistinction between market and net inequality. Net inequality is the inequality thatprevails after taxes and transfers has been taking place. Hence, the inequality indisposable income. This distinction is important to make, for most countries differ morein terms of net inequality due to their varying distributional policies. In fact, because ofthese policies, there is almost no overall correlation between market and net inequality inthe OECD countries (Ostry et al. 2014).2.2Theories on Income Inequality: Does Not Harm GrowthIn neoclassical economics, there exists a trade-off between equality and efficiency. Thisis discussed by Okun (1975), he exemplifies transfers from rich to the poor as a “leakybucket” were some money will be lost as it carried in the leaky bucket. Equality is5
expected to affect incentives, and politicians must make a choice in whether to prioritizeequity or economic efficiency. Kaldor’s (1955) reasoning for this trade-off is that the richhave a higher marginal propensity to save than the poor do. If one assumes that GDPgrowth has a direct relationship with the savings rate, this implies that unequal economieswill experience faster growth. Furthermore, it implies that income redistribution, such asprogressive taxation, will reduce the savings rate of the whole economy.Another argument for how income inequality can be growth-enhancing, concerns thelarge costs involved in making investments, such as setting up new industries andimplementing innovations. If wealth is more concentrated, at least some individuals havethe sufficient resources to bring forward new investments (Aghion, et al. 1999). Mirrlees(1971) discusses the incentives concerning inequality and growth. In his model, output isdependent on unobservable effort borne by agents. If these agents are all rewarded withthe same wage level, which is independent of their output, this will discourage anindividual from putting in any additional effort. Hence, some inequality may be anecessity to foster growth and encourage productivity. Galor & Tsiddon (1997) claim thatrising levels of inequality is observed during time periods characterized by majortechnological inventions. By improved mobility and a concentration of high-skilledworkers in high-tech sectors, greater technological progress and growth will follow.Forbes (2000) finds a positive relationship between income inequality and growth in theshort and medium run. This suggests that a trade-off between reducing inequality andimproving a country’s growth pe
growth will be discussed. Concepts on both regional income inequality and local economic growth will follow. 2.1 Theories on Income Inequality: Does Harm Growth Stiglitz (2012) argues inequality slows economic growth. According to Stiglitz, inequality weakens aggregate demand f
of its income inequality (Lu and Chen, 2005). Innovation not only plays a role in the economic development of developing countries, but can also impact income inequality. While there is ample literature studying income inequality in China, there is less concern about the impact of the innovation level on income inequality.
World Income Inequality Databases: an assessment of WIID and SWIID Stephen P. Jenkins (London School of Economics, University of Essex, and IZA) 27 May 2015 Abstract This article assesses two secondary data compilations about income inequality – the World Income Inequality Database (WIIDv2c), and the Standardized World Income Inequality
World Income Inequality Databases: an assessment of WIID and SWIID. This paper assesses two secondary data compilations about income inequality – the World Income Inequality Database (WIIDv2c), and the Standardized World Income Inequality Database (SWIIDv4.0) which is based on WIID but with all observations multiply-imputed.
economic growth on income inequality. The first argument is that inadequate redistributive policies and the increase in inequality that accompany economic growth lessen the potential benefits of economic growth to the
Income inequality and economic growth 1545 Years 1940 1960 1980 2000 8.0 8.5 9.0 9.5 0.15 0.10 0.05 0.00 0.05 0.10 0.15 ab Fig. 1 State-level average of real income per capita and real income per capita growth: 1930–2005. a Average log of real per capita income. b Real per capita income growt
Measuring economic inequality Summary Economics 448: Lecture 12 Measures of Inequality October 11, 2012 Lecture 12. Outline Introduction What is economic inequality? Measuring economic inequality . Inequality is the fundamental disparity that permits one individual certain
that increasing income inequality has reached a level that is becoming a brake on growth. For this reason, there is no fundamental contradiction between state-led income redistribution and economic growth. The reduction of income inequality should not be limited to a pure redistribution
in advanced mathematics used in US universities are also popular in Australian universities for students studying engineering and some areas of applied sciences. However, the advanced mathematics .
