“Tracking positive and negative effects of inequality on long-run growth”

Despite extensive research, there is still controversy on the effects of income inequality on economic growth. The literature proposes several transmission channels through which these effects may take place, and even the existence of two different forms of inequality. However, empirical studies have generally not distinguished between these channels, nor have their analyses included a consideration of the two forms of inequality and their separate effects on growth. In this paper we review the theory and the evidence on the different transmission channels through which inequality influences growth. We contribute to the literature by using a system of recursive equations, following a control function approach, to empirically assess the relevance of these channels and to differentiate between two forms of inequality. In this way we have captured in a single model not only a negative effect, but also a positive effect of inequality on long-run economic growth.