Income Distribution, Political Instability, and Investment

This paper successfully tests on a sample of 64 countries for the period 1960-1985 the following hypotheses. Income inequality, by fueling social discontent, increases socio-political instability. The latter, by creating uncertainty in the politico-economic environment, reduces investment. As a consequence, income inequality and investment are inversely related. Since investment is a primary engine of growth, this paper identifies a channel for the frequently noticed inverse relation between income inequality and growth. We measure socio-political instability with a composite index which captures the occurrence of more or less violent phenomena of political unrest. We test our hypotheses by estimating a two-equation model in which the endogenous variables are investment and the index of socio-political instability. Our results are robust to sensitivity analysis on the specification of the model, and are unchanged when the model is estimated using robust regression techniques