Inequality-Driven Growth: Unveiling Aggregation Effects in Growth Equations

Abstract

This paper presents a simple Cass-Koopmans-Ramsey AK growth model with heterogeneity that explains how policies that increase income inequality may temporarily boost a country’s income growth rate. Briefly put, a change in policy that reduces redistributive transfers will free up resources to the households with the highest productivities, resulting in an aggregate growth rate increase that will endure until new limits to differentiated accumulation are found. The unambiguous effect takes place in poor and rich countries alike, arising from productivity heterogeneity and redistribution (although it could also arise from other sources of heterogeneity). The effect is explicitly captured in the aggregate growth equation by the changes of the mean logarithmic deviation (MLD or Theil’s second measure) of the income. The model supports the empirical results found in Forbes (AER, 2000). The accelerated growth episodes observed in Brazil from 1968 to 1973 and in China recently are shown to be empirically consistent with the model. If the model predictions are correct, Chinese growth rates may eventually fall, following a pattern that, even if not presenting the same magnitude, could resemble the one observed during the Brazilian slowdownInequality, Growth, Income Distribution, Redistribution, Heterogeneity, AK Model, Brazil, China