Threshold Effects of Inequality on the Process of Economic Growth

This paper explores the relationship between inequality and growth in the context of a unified empirical approach suggested by the theoretical model of Galor and Moav (2004). Based on the model’s prediction, we construct a measure of human capital-to-physical capital ratio in order to investigate the threshold effects of inequality on economic growth. Using data of 82 countries for the period 1965–2003, our results are twofold: first, there exist significant thresholds of human-to-physical capital ratio below which the effect of inequality on growth is positive, whereas it is negative above it; second, human capital drives growth only when the human-to-physical capital ratio is above its threshold level. Our results are generally robust to using different measures of human capital and different data on inequality. These results are consistent with the predictions of Galor and Moav (2004).