Most economic studies on growth use income inequality in the study because it is far more easily and accurately measured. There were a number recently that did find a statistically significant negative correlation between income inequality and growth. But I had to be me and wondered (for nearly two whole years): how valid is this correlation really?
So I searched for literature, preferably peer-reviewed (as scandalous as they may be), on this topic. Rather scarce it seems. Searching Google for “income inequality economic growth” returned 3,370,000 results in 0.56 seconds while “wealth inequality economic growth” returned 1,260,000 results in 0.50 seconds. The aversion to studying wealth leaves me puzzled.
At any rate, one paper to catch my attention was “Does Wealth Inequality Matter for Growth? The Effect of Billionaire Wealth, Income Distribution, and Poverty” by Sutirtha Bagchi and Jan Svejnar (IZA Discussion Paper No. 7733).
I will quote some text from the introduction here (you can skip to under this if you wish):
Our first finding is that wealth inequality has a negative, statistically significant effect on economic growth, while the effect of income inequality is insignificant or only borderline significant, and the effect of poverty is statistically insignificant in all specifications. Hence, using an encompassing model, we show that in the head-on comparison it is wealth inequality, rather than income inequality or poverty that has a significant effect on economic growth.
Our second set of results comes from specifications in which we control for the fact that some billionaires acquired wealth through the use of political connections or cronyism, while others obtained it in a relatively standard legal environment. This estimation is based on a categorization of billionaires that is somewhat subjective. We are conservative about classifying someone as being politically connected and are also fully up-front about how we carry out the classification. Using the classification, we find that the effect of politically connected wealth inequality on growth is negative, while the effects of politically unconnected wealth inequality, income inequality, and initial poverty are statistically insignificant. The second set of results hence suggests that one needs to pay attention to the sources and nature of wealth inequality.
Our third set of results shows that our estimates are robust to a number of alternative specifications…
- Wealth inequality is found to have a statistically significant, negative relationship with growth while income inequality has a negligible relationship when both are included in the model.
- Politically connected growth of wealth inequality (cronyism) has a statistically significant, negative relationship with growth while politically unconnected wealth inequality has an insignificant relationship.
- The relationships were found to be valid using various specifications of the model.
Let’s focus on the second point. If inequality grows because of political connections, the growth of such inequality is negatively correlated to overall economic growth.
Bangladesh was perceived as the most corrupt country for 5 years in a row a little under a decade back and yet the growth projection for Bangladesh is expected to top 6% for the coming decade and has been touted as one of the most promising economies of the world.
This is the scenario:
- Bangladesh is very export dependent, and most of its export markets are fighting debt deflation.
- There is no denying that political and economic power are both becoming further entrenched among a certain section of the socioeconomic class, which means that the domestic economy will be facing an increasing drag on growth.
- A recent news item reports that BDT 76,000 crore was funneled out of Bangladesh in 2013 (source; in Bangla). The budget for FY 2015-2016 is around BDT 300,000 crore (source). Capital worth close to a fourth of the national budget was removed from the country’s economy two years ago. The effects should be greater because that much money can be used many times for many transactions.
With such strong downward pressures on economic growth, where will the advertised growth come from? Given this scenario, I see one route to growth: Increasing the debt load of the economy, whether it will be public or private will depend on how each sector positions itself. That does not always bode well for the economy in the long run (especially with worsening inequality).