Developing Countries and Economies in Transition: The Nexus between Economic Growth and Income Inequality

The relationship between economic growth and income inequality has been extensively investigated by previous studies. However, the studies have produced mixed evidences about the relationship. Previous studied have either exclusively focused on developed countries or on large panels with a larger share of developed than developing economies. In what we believe to be a first effort, in this study we have focused on low-income and high-income developing countries and the economies in transition to ascertain the relationship between economic growth and income inequality. The classification of the countries into the low-income and high-income developing countries and economies in transition are based on the classification of the World Bank as well as our own classification based on an income threshold that is endogenously estimated by our model. The classifications of countries according to their national incomes and stage of their development generate homogeneous samples leading to more robust inference about the relationship between economic growth and income inequality. We have used fixed-effects and dynamic panel technique such as system GMM estimation in our analysis to mitigate endogeneity problem. We have found strong evidence of a negative relationship between economic growth and income inequality in low-income developing countries and strong evidence of a positive relationship between economic growth and income inequality in high-income developing countries and in economies in transition.