Effects of Income Inequality on Economic Growth

Economic growth reflects the change in the overall well-being of a country and the standard of living of its population. It is important to understand what factors affect economic growth. This thesis hypothesizes that income inequality negatively affects growth. A country-level data set of 114 countries for 2000 and 2005 is used to estimate a growth model. The dependent variable, the five year average of economic growth per capita, is regressed on a set of standard factors (human capital, investment, and technology), institutional factors (political stability, corruption, and property rights), income inequality, and demographic factors (gender equality and racial diversity). The model also includes lag of per capita income to capture convergence. Regression results indicate that income inequality hurts economic growth, and that countries in Latin America and the Caribbean, the Middle East and North Africa, and Sub-Saharan Africa perform poorly compared to East Asia and Pacific. To reduce inequality and promote growth, countries could improve education and make taxes more progressive. Country-specific case study reveals that the Chinese government attempts to solve income inequality between rural and urban populations largely through taxes and subsidies. Argentina, on the other hand, still struggles to reduce its high level of income inequality