Is Inequality Harmful for Growth?

T. Persson and G. Tabellini (AER - 1994)

October 3, 2012

T. Persson and G. Tabellini (AER - 1994) () Is Inequality Harmful for Growth? October 3, 2012 1 / 18
 1 Introduction

2 The Model

3 Empirical Evidence

4 Conclusions

T. Persson and G. Tabellini (AER - 1994) () Is Inequality Harmful for Growth? October 3, 2012 2 / 18
 Introduction

The Motivation

The literature on endogenous growth has clarified the importance of

policy for growth.
The work on endogenous policy has shown the importance of
distribution for policy.
Can we draw a direct link between distribution (inequality) and
growth?
Opposite approach relative to the one of economic development
literature (Kuznets curve).
Alesina and Rodrik (1993) study the determination of tax policy in
the political equilibrium of an endogenous-growth model, finding a
negative empirical link between inequality and growth.

T. Persson and G. Tabellini (AER - 1994) () Is Inequality Harmful for Growth? October 3, 2012 3 / 18
 Introduction

The Idea of this Paper

Economic growth is determined by accumulation of productive factors.

The incentives to accumulate depend on tax policies and regulation.
We expect a society with more inequality to implement policies that
allow less private appropriation (taxation on investment) =⇒ less
accumulation =⇒ less growth!

T. Persson and G. Tabellini (AER - 1994) () Is Inequality Harmful for Growth? October 3, 2012 4 / 18
 The Model

The Model(1/2)

OLG model, heterogeneous agents that act as consumers and voters.

The problem of generation born at t − 1 is to maximize (1) s.t. (2)
and (3):

vti = U (cit−1 , dit ) (1)

cit−1 + kti = yt−1
i
(2)
dit = r[(1 − θt )kti + θt kt ] (3)
c is consumption when young, d is consumption when old, k i and k
are individual and average accumulation of an asset, r exogenous rate
of return, θ is the policy variable.
U (.) is concave, well-behaved and homothetic.

T. Persson and G. Tabellini (AER - 1994) () Is Inequality Harmful for Growth? October 3, 2012 5 / 18
 The Model

The Model(2/2)

The accumulation of k (physical capital/human capital) has spillover

effects on the income of the next young generation:
i
yt−1 = (w + ei )kt−1 (4)

w and ei exogenous average and invidual endowment of skills.

Purely redistributive policy (capital taxation, property rights).
Average national income: (w + r)k.

T. Persson and G. Tabellini (AER - 1994) () Is Inequality Harmful for Growth? October 3, 2012 6 / 18
 The Model

Timing and Definition of Equilibrium

At the beginning of time t − 1 electors (young) choose θt .

Investors choose kti .

Politico-economic Equilibrium
A politico-economic equilibrium is a policy and a set of private economic
decisions such that:
1 The economic decisions of all citizens are optimal, given the policy,
and markets clear;
2 The policy cannot be defeated by any alternative in a majority vote
among the citizens in the enfranchised section of the population.

T. Persson and G. Tabellini (AER - 1994) () Is Inequality Harmful for Growth? October 3, 2012 7 / 18
 The Model

Characterization of Economic Equilibrium

dit
Due to homotheticity, cit−1
= D(r, θt ), Dr > 0, Dθ < 0.
i
rD(r, θt )[(1 − θt )yt−1 + θt kt ]
dit = (5)
D(r, θt ) + r(1 − θt )
i
r[(1 − θy )yt−1 + θt k t ]
cit−1 = (6)
D(r, θt ) + r(1 − θt )
kt wD(r, θt )
gt = G(w, r, θt ) = −1= −1 (7)
kt−1 r + D(r, θt )

gt denotes the growth rate of the economy. Gw > 0, Gθ < 0, Gr ≷ 0.

T. Persson and G. Tabellini (AER - 1994) () Is Inequality Harmful for Growth? October 3, 2012 8 / 18
 The Model

Characterization of Political Equilibrium

Individual preferences are captured by:

∂vti ∂kt
= Ud (.)[(kt − kti ) + θt ]r (8)
∂θt ∂θt
Furthermore, individual preferences can be ranked:

−D(.)kt−1
kt − kti = ei (9)
D(.) + r(1 − θt ) t−1

The equilibrium policy θ∗ (w, r, em ) solves implicitly:

D(r, θ)em wr
− + θDθ (r, θ) =0 (10)
D(r, θ) + r(1 − θ) r + D(r, θ)

T. Persson and G. Tabellini (AER - 1994) () Is Inequality Harmful for Growth? October 3, 2012 9 / 18
 The Model

Equilibrium Results

From equation (10):

θ∗ ≷ 0 as em ≶ 0.
θe∗ < 0
∗ ≶ 0 as em ≶ 0.
θw
Combining the two pieces of equilibrium:

g ∗ = G(w, r, θ∗ (w, r, em ))

∂g ∗
= Gθ θe > 0
∂em
∂g ∗
= Gw + G θ θw > 0 if em < 0
∂w
Equality increases growth. The effect of average level of skills depends on
the median voter’s endowment.

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 Empirical Evidence

Historical Data (Raw Data)

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 Empirical Evidence

Historical Evidence (Regression Results)

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 Empirical Evidence

Historical Evidence (Sensitivity Analysis)

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 Empirical Evidence

Postwar Data (Raw Data)

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 Empirical Evidence

Postwar Evidence (Regression Results)

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 Empirical Evidence

Postwar Evidence (Sensitivity Analysis)

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 Empirical Evidence

Discussion of the Results

Empirical evidence statistically significant: higher inequality implies

less growth.
In the postwar database, this remains true for democracies.
Only the reduced model has been estimated, what about the specific
channels?
The results are weakly confirmed. Further Evidence

T. Persson and G. Tabellini (AER - 1994) () Is Inequality Harmful for Growth? October 3, 2012 17 / 18
 Conclusions

Final Remarks

A model that relates equilibrium growth to income inequality and

political institutions.
Main finding: inequality is harmful for growth, because it leads to
policies that do not protect property rights.
Further research:
Theoretical side: endogenize growth and income distribution in a
dynamic political equilibrium.
Empirical side: more extensively investigate the channel between
inequality and growth.

T. Persson and G. Tabellini (AER - 1994) () Is Inequality Harmful for Growth? October 3, 2012 18 / 18
 Appendix - Estimation of the ”structural” channels (1/2)

T. Persson and G. Tabellini (AER - 1994) () Is Inequality Harmful for Growth? October 3, 2012 1/2
 Appendix - Estimation of the ”structural” channels (2/2)

T. Persson and G. Tabellini (AER - 1994) () Is Inequality Harmful for Growth? October 3, 2012 2/2