Is there a Nonlinear Relationship between Economic Growth and Inequality? Theory and Lessons from ASEAN, People Republic of China and India

In view of rising inequality in fast growing Asian developing countries, it is important to study the relationship between economic growth and income inequity. We develop a simple model to establish that economic growth and inequality can bear a complex and non-linear relationship if policy makers try to impact on one (say, inequality) by influencing the other (economic growth). Our findings for the Associations of Southeast Asian Nations (ASEAN), People Republic of China and India (ACI) economies are two-fold: first, we observed that for low values of economic growth, inequality and growth bear an inverted U-shaped function. This function becomes U-shaped for values of economic growth lying between two critical values. As a result, the relationship between growth and inequality can take the form of a wave. Secondly, we examine the issue of the existence of threshold effects of foreign direct investment (FDI) in the relationship between growth and inequality by applying the standard methodology of endogenous sample splitting. We confirm that the relationship between growth and inequality in ACI economies is significantly influenced by a single threshold in FDI: for FDIi>ô, economic growth and inequality can have an inverse relationship while for FDIi<ô this relationship becomes direct. We also note various other interesting elements in the relationship between growth and inequality which has profound policy implications for the ACI Economies.