Inequality-growth nexus along the development process

Abstract The paper examines whether the effect of inequality on growth varies with the level of economic development. Using a comprehensive panel of annual data for the 48 contiguous US states over the period 1945–2004, we find overwhelming evidence in support of threshold effects in the relationship between inequality and growth. Our analysis shows that while the effect of inequality on growth is significantly negative at lower levels of development, this effect diminishes along the growth process and then turns significantly positive at higher levels of development. Quantitatively, the coefficient estimates imply that when real income per capita is below the threshold of $12,140 (2004 US dollar), a one standard deviation increase in the share of income held by the top 1% of the population reduces the growth rate of real per capita income by 0.6479 percentage points. In contrast, when income per capita is above the threshold of $21,065 (2004 US dollar), a one standard deviation increase in the top percentile income share raises the rate of growth of real per capita income by 0.2561 percentage points.