Inequality and Growth

Inequality and Growth: What Can the Data Say?
Author(s): Abhijit V. Banerjee and Esther Duflo

Source: Journal of Economic Growth, Vol. 8, No. 3 (Sep., 2003), pp. 267-299
Published by: Springer
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Inequalityand Growth:WhatCan theData Say?

ABHUIT V. BANERJEE
MIT
ofEconomics,
Department
ESTHER DUFUO
MITandNBER
ofEconomics,
Department
Thispaperdescribes thecorrelations
between inequality andthegrowth data.Usingnon-
ratesincross-country
parametricmethods, we showthatthegrowth U-shapedfunction
rateis an inverted ofnetchangesininequality:
changesin inequality areassociatedwithreducedgrowth
(in anydirection) in thenextperiod.The estimated
is robustto variations
relationship in controlvariablesand estimation methods.This inverted U-curveis
witha simplepolitical
consistent economy modelbutitcouldalsoreflect thenatureofmeasurement errors,
and,
ingeneral,efforts thisevidencecausallyrunintodifficult
tointerpret identification Weshowthatthis
problems.
toexplainwhyprevious
is sufficient
non-linearity estimates between
oftherelationship and
thelevelofinequality
growth areso differentfromoneanother.
Keywords:
inequality, cross-country
growth, regressions
Ol 1,O15
JEL classification:
1. Introduction
It is oftenthatthemostbasicquestions ineconomics turnouttobe thehardest to answer

andthemostprovocative answersendupbeingthebravest andthemostsuspect. Thusitis
withthe empiricalliterature on the effectof inequalityon growth.Manyhave felt
compelled totrytosaysomething aboutthisveryimportant braving
question, thelackof
reliabledataandtheobviousproblems Benabou(2000)lists12studies
withidentification:
on thisissueoverthepreviousdecade,basedon cross-sectional ordinaryleastsquares
(OLS) analysesofcross-country data.
Morerecently, boostfromtheimportant
receiveda substantial
theliterature workof
Deininger andSquire(1996), who puttogether a much largerand more comprehensive
cross-country thanwas hitherto
dataseton inequality available.Mostimportantly,their
datasethasa panelstructure withseveralconsecutivemeasures ofincomeinequality for
eachcountry. Thishas madeit possibleto use somewhat moreadvancedtechniques to
investigate theeffectof inequalityon growth:Benhabiband Spiegel(1998), Forbes
(2000),andLi andZou (1998) all lookat thisrelationship usingfixedeffectsestimates,
arguingthatthereare omitted country thatbias theOLS estimates.
specificeffects In
Wethank ForbesandRobert
Kristin Barroforsharing data,Alberto
their Alesina,OrianaBandiera, Robert
Barro,
MichaelKremer,
RolandBenabou,OlivierBlanchard, DebrajRay,andEmmanuel Saez forusefulconversations.

268 ABHIJITV. BANERJEEAND ESTHER DUFLO
contrast,Barro(2000) usesa three-stage leastsquares(3SLS) estimator whichtreatsthe

country-specific error terms as random, arguing that the differencing implicitin running
fixedeffects (orfixed effect-like)regressions exacerbates the biases due to measurement
errors.
Somewhat surprisingly, bothapproaches yieldnewresults. WhiletheOLS regressions
usingone cross-section typicallyfounda negativerelationship betweeninequality and
subsequentgrowth, the fixedeffectapproachyieldsa positiverelationship between
changesininequality andchangesinthegrowth rate,whichhasbeeninterpreted as saying
thatas longas onelookswithin thesamecountry, increases ininequality promote growth.1
Barro,bycontrast, finds norelationship between inequality andgrowth. However, hethen
breaksuphissampleintopoorandrichcountries andfinds a negative relationship between
inequality andgrowth in thesampleofpoorcountries anda positiverelationship in the
sampleofrichcountries.
It is notclearthatitis possibleto interpret anyofthisevidencecausally.Variations in
inequality arelikelytobe correlated witha rangeofunobservable factors associatedwith
growth. Moreover, as wearguelater,noneoftheunderlying theoriesgivestrong reasonsto
believethattheomitted variableproblem canbe solvedbyincluding a countryfixedeffect
in a linearspecification (as in Forbes,2000 andLi andZou, 1998).
Indeed,whenwe examinethedata without imposinga linearstructure, it quickly
becomesclearthatthedatadoes notsupport thelinearstructure thathas routinely been
imposedon it. In particular, we findthatchangesin inequality (in anydirection) are
associatedwithlowerfuture growth rates.Thereis also a non-linear relationship between
inequality andthemagnitude ofchangesininequality. Finally, thereseemstobea negative
relationship betweengrowth ratesand inequality laggedone period.Thesefactstaken
together, andinparticular thenon-linearities inthoserelationships (andnotdifferences in
thecontrol variables, thesample,andthelag structure), explainwhy differentvariants of
thebasiclinearmodel(OLS, fixedeffects, random effects) havegenerated verydifferent
conclusions: In manycases,itturnsoutthatthedifferences ariseoutofgivingdifferent
structural interpretations to thesamereduced-form evidence.
In theend,ourpaperis probablybestseen as a cautionary tale: Imposinga linear
structure wherethereis notheoretical support foritcanleadtoseriousmisinterpretations.
The remainder ofthispaperproceedsas follows.In Section2, we reviewtheexisting
empirical specifications oftherelationship between inequality andgrowth intheliterature.
In Section3, we discussthedifferent to the
approaches modelling relationship between
inequality andgrowth, andobservethatthereis littlesupport foranyofthespecifications
thathavebeenused.In Section4, we present ourempirical results.
In Section5, we show
thattheseresultshelpus to understand whydifferent methodsof estimating thesame
relationship ledto different results.We concludein Section6.
2. Specifications
in theLiterature
The standard
procedureforestimatingtherelationship
betweeninequality
andgrowthin
theliterature
is toassumea simplelinearrelationship
between
inequalityandsubsequent
growth:

INEQUALITYAND GROWTH:WHATCANTHE DATASAY? 269
(yu+a- yu)la = *y*+XitP+ ygu+ v,+ «*• 0)

As we notedin the introduction, and will elaborateon later,OLS estimationsof this
equationare likelyto be biased by a correlationbetweeninequalityand theerrorterm.If
this is indeed the real structureof the data, it is possible to solve some of these
problemsbyexploitingthepanel structure
identification of thedata.Essentially,takingout
periodaveragesof variableseliminatesthe (additive)countryfixedeffect,thusallowing
theinterpretationof theestimatedcoefficientsas thecausal effectofinequalityon growth,
undertheassumptionthatinnovationsin theerrortermare notcorrelatedwithchangesin
inequality.
Alternatively,one could firstdifferenceequation (1):
= XVit~ yu-a) + \Xit~ Xit-a)P

a a
+ y{git- git-a) + £|7- Zit-a' (2)
This is a relationshipbetweenchanges in the gini coefficient and changes in the growth
rate.As longas a = 0, theOLS estimateofthisrelationship gives an unbiasedmeasureofa
and is statistically
equivalentto the fixedeffectestimate of equation(1).
One problemis thatwhen a is not equal to zero, the presenceof lagged dependent
variableson theright-hand side biases the OLS estimateof the differenced equation (as
well as thefixedeffectestimateofequation(1)). The literature (notablyForbes,2000; and
Benhabib and Spiegel, 1998) has thereforefollowed the lead of Caselli, Esquivel and
Lefort(1996) in using a GMM estimatordeveloped by Arellanoand Bond (1991). The
idea is to multiplyequation (1) by a, to put yton the right-hand side, and to take first
differences of theresultingequation.This leads to the followingequation:
- y* = (fla+ l)(yu - yu-a) + <*(xu- xu-a)P
yu+a
+ Wig* - git- a) + ™it" <**U-a' (3)
An unbiasedestimateofy can be generatedifthisequationis estimatedusingyit_fl,Xit_fl,
git_a and all earlier lags available as instruments for (yit- yu-a)^ (xu~Xit-a) ^d
(git-git-a) -
Resultsof estimatingequation (1) withrandomeffects,fixedeffects,firstdifference,
and Arellanoand Bond estimatorsare presentedin Table 1, assumingthatthelengthof a
period is 5 years. We restrictthe data set to the Deiningerand Squire "high quality"
sample.2BoththeresultsforthesetofcontrolvariablesXitused in Perotti( 1996) (and used
by Fbrbes,2000), and the set of controlvariablesused in Barro (2000), which is much
larger,are presented.The resultsare veryconsistent.Random effectsare insignificant.
First differences,fixed effects,and Arellano and Bond coefficientsare positive and
significantin bothspecifications.This standsin sharpcontrastwiththe resultsobtained
whenestimatingthe same effectin a long cross-section.3 Forbes(2000) and Li and Zou
(1998), who firstmade thisobservation, have shown that thisresultis robustto a wide
of in
variety changes specifications.4 Li and Zou (1998) proposea theoreticalexplanation
based on a political economy model. Forbes (2000) rightlynotes that the estimated
coefficientindicatesa short-run positive relationshipbetween growthand inequality,
whichmightnotdirectlycontradictthelong-runnegativerelationship, and concludesthat

Table1. Relationship
between andchangesinGini,linearspecifications.
growth
Variable:(y(t+ a) -y(i))la
Dependent
Perotti
Specification BarroSpecification
Random First Fixed Arellano Random First Fixed Arellano

Effects Difference Effect and Bond Effects Difference Effect andBond
(1) (2) (3) (4) (5) (6) (7) (8)
Gini(r) 0.021 0.298 0.297 0.56 -0.03 0.158 0.155 0.27

(0.09) (0.18) (0.16) (0.039) (0.043) (0.068) (0.063) (0.016)
N 128 128 128 128 98 98 98 98
Note:Standard a is equal to 5 (5-yearperiods).Controlvariables:Perotti

errorsin parentheses; specification:
log(GDP(/)),PPP I (r), male education(f), femaleeducation(t). Barro'sspecification: log(GDP(f- 1)),
log(GDP(/- 1)) squared,government consumption (f-1), secondary education(r), highereducation(t),
(r), (termof trade(/+ 1) - termsof trade(/)),ruleof law,democ(f),democt(r) squared,Spanish
fertility
or Portuguese colony,othercolony,investment share(t- 1).
herresults that"in theshortandmedium

suggest term, an increaseina country'slevelof
incomeinequalityhas a significantandpositiverelationship withsubsequent economic
growth."
Barro(2000) notesthattakingout fixedeffects exacerbatesthemeasurement error
problem,especiallyfora variablelikethegini coefficient,forwhich the variation
across
countries
is moreimportant thanthevariation overtime.Classicalmeasurement errors
alonecannot,however, explainwhythecoefficient of inequalityshouldchangesigns,
becomingpositiveand significant. Furthermore, theGMM estimator instruments first
differenceswith lagged levels, whichshould,in principle,attenuatethe classical
measurement errorproblem. Therefore,thereis probably moretothisreversalinsignthan
simple measurement error.
In theempiricalsection, we will this
investigate resultinmore
detail.We nowturnto thetheoretical foundation ofequation(1).
3. The Inequality-Growth
Relationship
Our goal in thissectionis to understand whatalternative theoriestell us aboutthe

choiceofspecifications
appropriate tobe usedwhendescribing thedataoninequality and
growth,andinparticularwhether thespecificationsin(1) and(3) caneasilybe generated.
Thereare essentiallytwoclasses of arguments in theliterature thatsuggesta causal
relation
betweeninequality andgrowth: Politicaleconomyarguments, andwealtheffect
arguments.Mostempirical studiesoftherelationship betweeninequalityandgrowth refer
tothesearguments,without their
alwaystaking preciseimplications To
seriously. thesewe
add a thirdargumentwhichis essentiallystatisticaland emphasizesthe role of
measurement errorin generatinga relation
betweeninequality andgrowth.

INEQUALITYAND GROWTH:WHATCANTHE DATASAY? 27 1
3.1. PoliticalEconomyArguments
Politicaleconomy models,intheirsimplest
version,startwiththepremise
thatinequality
leadstoredistribution
andthenitis arguedthatredistribution
hurts Sinceourgoal
growth.5
is to illustrate
whatcan happenin thisclass of models,we presenta versionof the
argument thatminimizes
institutional
detail.
3.1.1. A VerySimpleModelBased on ' 'Hold-up''
Consider an economyconstituted of twoclasses,A andB, whichfunction as competing

politicalgroups. Assume thatthe at
economy anypoint oftime is characterized bya single
number g which the
represents sharing rulefortheeconomy: A g
Group gets percent ofthe
output.
In eachperiod,thiseconomy is presented withan opportunity which,ifavailedof,can
lead to growth. Theseopportunities couldbe a newtechnology, a tradeagreement, an
internalreform, or a majorforeign investment. The potential growth generated by the
opportunity willbe denotedbyAy,whichis a randomvariablethatis independent over
timeandhas thedistribution F(Ay).
Thegrowth opportunity doesnot,however, automatically translate intogrowth. Some
structuralchanges need to be implemented in order tobenefitfrom theopportunity, and the
politicalsystem allowsforthepossibility thatthesechangeswouldbe blockedbyone of
thegroups. To keepmatters simple,assumethatineveryperiodoncethepotential growth
rateis known, oneofthegroups, chosenatrandom, getstoholduptherestoftheeconomy.
Morespecifically, assumethatthisgrouphastheoptionofeither acquiescing immediately
to thechanges,in whichcase thechangesaremadeandthefullgrowth opportunity is
or
realized, demanding a transferfrom theother group(i.e. an increase in its share) before
thechangescanbemade.Theother group,inturn, canagreetomakethetransfer orrefuse.
If itrefusesto makethetransfer, statusquo is maintained andthereis no growth. If it
agrees,thechangesaremadeandgrowth takesplace,butbynowa partof thegrowth
opportunity hasbeenlostandtheeconomy onlygrowsby(xIAy(aI< 1) where/= A,B is
the identity of the groupbeingheld up. a7 is a randomvariablewhichis drawn
independently from thedistribution G/(a7)ineveryperiod,andis knowntobothgroupsat
thebeginning oftheperiod(i.e. beforethehold-up"game" is played).
Theassumption thatthereis someefficiency loss intheprocessofbargaining (i.e. the
factthata7maybe lessthan1) playsan important roleinouranalysis.Delaymaybe one
reasonfortheloss: It is plausiblethattheprocessof getting all members of thelosing
grouptoagreetothetransfer wouldtakequitesometime.Makinga credible demandfora
transfertypically takestimeandresources - as we know,a groupmight havetoresort to
industrial action,streetprotests,and evencivilwar in ordertoestablish their claim. On the
other side,making a credible transfer mayrequire involving third parties(suchas thestate)
and/or changing the institutionalframework,6 which has potential costsof itsown.Finally,
therearethestandard arguments explaining why transferstend to be distortionary.7
To complete thedescription ofthemodel,we assumethatall agentsareeithershort-

livedorhaveshorthorizons.Whentheydecidewhether
or notto resist,
theyignorethe
itwillhaveon outputin future
effect periods.
3.1.2. ResultsandImplications
forEmpiricalWork
Let us assume,without lossofgenerality,thatin a givenperioditis groupB thathasthe

chancetoholduptherestoftheeconomy. Whether ornotitdoesdependsonhowmuchit
can extractfromgroupA. To figure thisout,we needto lookat thedecisionofgroupA
whenfacedwitha demandfortransfers worthAg.If theyacquiesceto thetransfer their
payoff willbe (g - Ag)(l + ocAAy)(thegrowth rateis ccAAybecausegroupB hasalready
demanded Iftheydo notacquiesce,theirpayoff
a transfer). willbe g, as therewillbe no
growth. Comparing thetwo,it is clearthatthemaximum transferthatcan be extracted
fromgroupA is givenby
which, tellsus thatAg < g,so thetransfer

reassuringly, is alwaysfeasible.
GroupB makes
itsdecisiontaking - itneverpaysforthemtodemandmoresincegroupAwill
thisas given
neveracquiesceandtherewillbe lessgrowth inthebargain.Theywilldemanda transfer
of size Ag ifandonlyif
(1 - g + Ag)(l + *AAy)> (1 - g)(l + Ay),
whichimplies
(1 - g)aAAy+ Ag(l + aAAy)> (1 - g)Ay.
Usingtheexpression
forAg fromabove,thisreducesto:
*a > 1 ~ g-
Then,ola> 1 - g is thecondition
underwhichgroupB alwaysdemandsa transfer
when
itgetsa chance.By a similarargument,
thecorrespondingcondition
forgroupA is
«*>g.
Thesetwoconditions oughttobe intuitive:
Theysaythateachgroupwillholduptherest
ofeconomy whenitsshareofoutput is low,whichis whentheyhavetheleaststakeinthe
growth oftheoveralleconomy. Thisis essentially
thesamereasonwhythepoorinAlesina
and Rodrik(1994), Perssonand Tabellini(1991) and Benhabiband Rustichini (1998)
choosehighlevelsofredistribution eventhough ithurtsgrowth.
Notealso thatbothoftheseconditions makeno mention ofAy.The potential growth
ratefortheeconomydoes notinfluence theprobabilityof growth-reducing bargaining/
conflict.
Thegrowth ratein oureconomyonlydependson whether thereis a hold-up:
If
thereis no hold-up, therateis Ay,whileifthereis a hold-upit is tyAy,
whereoijis the
expectation of a7. In the worldof thismodel,hold-upsonlyhappenwhenthereare

redistributive transfersthatresultfromthehold-up.Therefore, we have thefollowing

result.
Result1. As longas aj and a^ are less thanone,theexpectedgrowth ratein this
in
economy anyperiodfollowing a distributional
change is lower thanwhen thereis no
conflict.
Inorder tointerpret thevariableg as a measure ofinequality, weneedtoassumethatone
ofthegroups(saygroupA) is substantially richerthantheotherin termsof percapita
income(inotherwords,groupB hasa muchlargershareofthepopulation thangroupA).
In thiscase,an increaseing inourmodelwouldcorrespond toan increaseininequality.8
The relationship betweendistributional changesandexpectedgrowth impliedbythe
aboveresult is,however, highly discontinuous. This is because our model clearlymakesan
excessively strong distinction
between thecase where there are no distributional
changes
andthecase wheretherearesomedistributional changes.A smoother relationship could
be derivedifwe assumedinsteadthatthehold-upproblem onlydetermines theplanned
transfer,whereas theactualtransfer is determinedex postbyaddinga random shocktothe
plannedtransfer. Thisallowsthepossibility thattherewillbe somesmalldistributional
changesevenwhenthereis no conflict. Combinedwiththeassumption thatgrowth is
higher whentheplannedtransfer is zero,thiswouldgiveus a smooth inverted U-shaped
relationbetween expectedgrowth and actualchangesin inequality.
If we wereprepared to takethismodelliterally, itwouldallowus to estimate a (non-
linear)causal relationshipbetween and in
growth changes inequality. There are,however,
manyreasonswhythismodelis special:Mostimportantly perhaps, growth heredoesnot
haveanydirect effect.
distributional Ifmoregrowth leadstomoreredistribution, thenthe
anticipation of a largegrowth shockcouldraisethelikelihoodthatthereis a hold-up
problem.More redistribution could thenbe associatedwithhighergrowthand the
relationship wouldno longerbe U-shaped.Moreimportantly, therewouldbe reverse
- from to
growth anticipatory changes in the - makingit
distribution
causality running
to the
impossible interpret relationship between growth and distributionalchanges
causally.A possiblesourceofreverse comesfrom
causality theideathatthelackofgrowth
opportunities makes the environment more conflictual(say, because people feel
frustrated),and conflicts lead to changesin inequality.9 We therefore onlyofferthis
modelas a possiblewayto interpret thedata.
Thediscussion abovesuggests that,at leastin termsofdatadescription, ifnotcausal
interpretation, we shouldestimate a relationshipof the form:
iyit^~yit) =
ay, + XJ + k(git- git.a) + v,.+ sin (5)
whereyitrepresentsthelogarithm ofGDP incountry i atdatetya is thelength ofthetime

-
periodwe choose,5 or 10 yearsin theexampleswe will consider((yit+a yit)/ais
thereforethegrowth rate),Xitis a setof controlvariables,gitis thegini in
coefficient
country • At
i at datef,and k( ) is a genericfunction. thispoint we do notimposeany
structureon theshapeof thek{• ) function. The errortermis modelledas a country-
timeinvariant
specific effect(v,) anda timevaryingerror term(eit).yitis included
among
thecontrolsinordertocapture convergence and
effects, Xitcontrolsforpossible of
sources
spuriouscorrelation.

However, thepoliticaleconomy hasnottakenthisroute.Instead,

literature theapproach
hasbeentoderivea relationshipbetween thelevelofinequalityandchangesininequality,
which,combined witha relationshipbetweengrowth andchangesin inequality(suchas
theonejustderived),generatesa between
relation growth and thelevelof We
inequality.10
couldalso takea similarapproach here.To do this,observethatinourmodelchangesin
arecausallyrelated
inequality tothelevelofinequality. Theexpectedincreaseintheshare
ofgroupA
is obviously decreasingin g, whichtellsus thefollowingresult.

Result2. The relationbetweenthelevel of inequality and theexpectedchangein
inequality in ourmodelis broadlynegative.
Thissuggests estimatingthefollowing relationship:
8it+ a - Sit= Wit+ XJ + h\(Sit-a) + Vf. + £ir (6)
Whatmattersforgrowth inourmodel,however,is nottheactualchangeininequality
buttheabsolutevalue of thatchange(as bothpositiveand negativechangesreduce
whichis givenby:
growth),
As g goesup,thefirst goesdownbutthesecondgoesup,making
termofthisexpression it
difficultto predict the sign of the relationship.However, as long as
maxja^} + max{a#}< 1, there exist values of g satisfyingmax{afl}< g < 1
- max{a,4},and forsuch intermediatevalues of g, thereare no plannedchangesin
There
inequality. are in
plannedchanges inequality forg < aB,to theextent
of
and,as is apparent fromthisexpression, thesechangesarebiggerthecloserg is to 0.

Likewise,inequality falls
when g biggerthan1 - max{aA},anditfallsfaster
is wheng is
closerto 1. We statetheseconclusions as thefollowingresult.
Result3. The relationbetweenthelevelof inequality and theexpectedvalueofthe
absolutechangesin inequalityfor the economyin our model is U-shapedwhen
max{ocA} + max{aB} < 1. The (expected)absolutevalueofchangesininequality is first
decreasing withinequality, thenflatovera rangeandthenincreasing withinequality.
Thistellsus thatplannedchangesin inequality, andtherefore becomemore
hold-ups,
commonas we movetowardsthetwo extremes of completeequalityand maximum
Moreover,
inequality. thethreshold levelofa7atwhichpeoplearewilling toholdtheother
side up, goes downas we approacheitherextreme, withtheimplicationthatas we
approacheitherextreme, hold-upsbecomemorecostly(in termsof lostgrowth)on
average.Thenetresultis thefollowing.

Result4. The relationbetweenthe level of inequalityand futuregrowthforthe

economy inourmodelis inverted U-shapedwhenmax{aA}+ max{aB} < 1,i.e. thereis
lessgrowth wheninequality is eitherveryhighorverylow.
Whathappenswhenmax{aA}+ max{aB} > 1 is less straightforward. However,one
special case that is easily understood is where both vla and olb are constants, with
ola-\-clb> \.In this case, there is rangeof values of g between 1 - and
vla olb where both
sidesaregoingto tryto holdtheothersideup.Thishas theconsequence thatthereare
moreholdups in themiddlethanat eitherextreme. Changesin inequality are more
common inthemiddleandthegrowth rateis lowestforintermediate valuesofinequality,
generating a U-shapedrather thanan inverted U-shapedrelation betweeninequality and
growth.
Another interesting specialcase is whereolaand(xBareconstants andccA <olb = 1. This
is thecase wheretherichcancostlessly holdup thepoor,withtheconsequence thatthey
do so whenever are
they given a chance.However, since itis costly to hold up rich,the
the
poor only initiate a hold up when their share is low enough. Therefore,
thefrequency of hold-ups(and distributional changes)goes up as inequality rises,and
thegrowth ratefalls.This givesus a monotonic relationship betweeninequality and
growth, whichcouldjustify estimating something like(1) oritsdifferenced version,(3).
Thisis consistent withthefactthatestimating (1) is oftenjustified in termsof a model
whereredistribution towards therichtakesplacethrough a taxcut,anditis assumedthat
taxcutscreateno upheavalsand therefore haveno efficiency costs(in facttheyraise
efficiency),which is very much in thespiritof our assumption that olb= I.11
In general, however, thereseemsto be no grounds forthepresumption thattheright
equationto estimateis linear.Takingour modelseriouslywouldsuggestestimating
equation(5) as wellas thefollowing flexiblespecifications thatcorrespond broadlytoour
Results3 and4. The first relationship relatesthe square(or,alternatively, theabsolute
level)ofchangesin inequality to thelevelof inequality:
(**+« " 8u)2= Wit+ *uP + h2(git-a)+ v,+ £l7. (7)

is a "reduced-form
The secondrelationship whichrelatesthelevel of
relationship,"
(laggedoneperiod)tothegrowth
inequality rate:
(y*+«- yu)/«= *y*+ x*P + *(&>-«) + v<+ «*> (8)

whereonceagainh{ • ) maybe non-monotonic.
Itis worthnotingthatestimating theserelationshipsusingcross-country dataintroduces
a number of additional problems. Av
First, and thedistributionsof ola and olbmaybe
differentfordifferentcountriesandtheinitiallevelofinequality maybe correlated with
these(unobserved) differences in Ay,olaandocB.Second,theshapeoftherelationships
mayvaryacrosscountries: Theymaybe U-shapedin someand thereversein others.
Finally,thevalueofmeasured inequalitythatcorresponds tog = \mayvaryfrom country
tocountry, andtherefore therelationshipmaypeak(and bottom out)atdifferent pointsin
different Forall ofthesereasons,
countries. theserelationships
interpreting from
estimated
cross-country data is, at best,a perilousundertaking. It remains,however, thatthe
correspondence between Results 3 and 4 shouldhold even when these countriesare

heterogenous.In otherwords,as long as our basic modelis correct,it is alwaysa

ofourmodelthatourestimates
prediction ofthefunctions h{ • ) andh2{• ) inequations
(8)
and(7) shouldhavetheoppositeshape.
Theright oftimelagsforestimating
structure thismodelis also an issue.Forexample,
in ourmodelhighinequalityis badforgrowth becauseitcreatesincentives forholdups,
intended Buttheresulting
toreduceinequality. reductionininequality makesitlesslikely
thatinthesubsequentperiodtherewillbe a holdupandtherefore theexpected growthrate
in thatperiodwillbe higherthanwhatit wouldhavebeen,absentthecostlychangein
intheprevious
inequality period.Averaged overthetwoperiods, theneteffectongrowth
comingfromtheinitialreductionininequality is obviously
muchsmallerthantheimpact
effect,andwe can clearlyhaveshocksto inequality thatarecostlyin theshortrunbut
overa longerhorizon.
beneficial
3.2. WealthEffectArguments
32.1. A Model
Wealtheffect arguments forwhyinequality shouldhaveaneffect ongrowth startwiththe

premisethatthereis some relationbetweenwealthnow (wt) and futurewealth
(wt+i) : wt+i =f(wtiP)*wherep is a vectorof market prices,whichincludethewage
rateand therateof interest.12 It is reasonableto assumethat/^is positive, butto say
anything robustabouttheeffectof inequality we also needto know/MTM,. If we assume
/^ < 0, itimmediately follows(since/isconcaveinw) thatifGft(w) is a meanpreserving
of
spread Gt(w)y the current distribution of wealth,aggregatefuture wealthunderG,,
Jf{wiP)dGt(w), willbe than
greater aggregate futurewealthunder GJ,//(w,p)JGJ(w).
In otherwords,a moreequal economygrowsfaster thana less equal one.The problem
withthisformulation is thatthe/ function telescopesa numberof separateeconomic
decisions,includingthoseaboutsavings,investment andbequests.To understand whatis
reasonable toassumeabouttheshapeofthe/function weneedto"unpack"the/function.
One simpleformulation is to considera modelwhereeveryoneis identicalin all
in
respectsexceptpossibly wealth,and thereis onlyintergenerational transmission of
wealth.Letcapitalbe theonlymarketed factorofproduction.
Assumepeopleliveforone
period.Assumein addition, thatcapitalmarkets areimperfect andas a resultindividuals
canonlyborrow up toXtimestheirwealth,whereAis a function ofr,,thecurrent rateof
interest
(A' < 0).13Finally,assumethatcorresponding toeachindividual, there is a strictly
concaveproduction function h(k),whichtellsus theamount ofincomehegenerates when
histotalinvestment is k.u
Ifwe assumethateachindividual startswitha certain
bequestfrom hisparent, invests it
duringhis lifetimeand dies at theend ofthe periodafterconsuming a fraction 1 - J5 ofhis
end-of-periodwealthandbequeathing theresttohischild,thismodelturns outtogiveusa
verysimple/function. Atthecurrent rateofinterest,
peoplewillwanttoinvestanamount
£*,whichis givenbytheusualmarginal conditionh'{k*)= rt.Therefore, thosewhostart

Diagram1 A+l
withenoughwealth,i.e. (A+ l)wt> k*,willinvest&*,whiletherestwillinvestall that

theycan,i.e. (k + l)wr.Theywillearna netincomeof:
min{A(**)+ (w,- k*)rnh((X + l)w,) - Aw,r*}.
Outofthisincome,a fraction whichgivesus w,+1,the
/?willbe leftto theirchildren,
of wealth
beginning period forthenext period.
3.2.2. ResultsandImplications
forEmpiricalWork
Themapfromcurrent wealthto future wealthgeneratedbythismodelis representedin

Diagram1 andis indeedconcave.Thisimmediately givesus thefollowingresult.
Result5. An exogenousmean-preserving spreadin thewealthdistributionin this
economy willreducefuturewealth and the
byimplication growth rate.
Theextent to whichinequalityis costlywilldepend,however,on themeanwealthin
thiseconomy:The mapin Diagram1 is linearforwealthlevelsabove&*/(/. + 1) and
therefore willhavenoeffect
inequality as longas no onehaswealthlessthank*/(A+1).
Moreintuitively,oncetheeconomyis richenoughthateveryone can affordtheoptimal
levelof investment,inequalityshouldnotmatter. The estimated between
relationship
inequalityandgrowth shouldtherefore allowforan interaction
termbetweeninequality
andmeanincome.
Notethatthesamediagram alsotellsus something aboutthedynamics ofthiseconomy.
On the assumption thatthe rateof interest does not varyover time,the diagram
summarizes theprocessof evolutionof the wealthof a dynasty. As is evident,this

economyembodiesa verystrongconvergence property: Everyone'swealtheventually

converges to a steadystateat thepointmarkedw*byimplying thatthelong-run average
wealthis independent ofinitialconditions.We statethisas thefollowing result.
Result6. Starting withanyinitialdistribution
ofwealth, bothinequality andthegrowth
ratemust,onaverage,go downovertime,withtheconsequence thatinthelongrunthere
is no inequality andno growth.
Thishastwoimplications fortheestimationoftheinequality-growth relationship.First,
thefactthattheeconomy becomesmoreequalas itgrowstendstogenerate a mechanical
positiverelation between growth bothinthecross-section
andinequality, andinthetime
series.As a result,boththecross-sectional and thefirstdifferenced (or fixedeffects)
estimates of theeffectof inequality on growth runtheriskof beingbiasedupwards,
compared to the truenegative relationthatwe mighthave foundif we had compared
economiesat thesamemeanwealthlevels.Moreover, considera variant of themodel
wherethereareoccasionalshocksthatincreaseinequality. Sincethenatural tendency of
theeconomyis towardsconvergence, we shouldexpectto see twotypesof changesin
inequality: Exogenousshocksthatincreaseinequality andtherefore reducegrowth, and
endogenous reductionsininequalitythatarealso associatedwitha fallinthegrowth rate.
In otherwords,measured changesininequality ineither directionwillbe associatedwith
a fall in growth, suggesting thattherightequation to estimateis theone in (5), or the
following more generalspecificationthatnests both a directeffect of the level of
inequality andan effect ofchangesin inequality:
^"-^
+XJ + k(git- git_a)+ h{git)+ v,+ £,-,.
= ocyit (9)
This of courseassumesthatwe have not eliminatedthe convergence effectby
adequately controllingfor mean wealth (or mean income). In fact most that
specifications
are estimated do tryto controlfortheconvergence effect, as is standard in growth
regressions, byincluding a linearfunction ofthemeanlevelofincomeatthebeginning of
theperiod(as inequations (1) and(9)). In first onecontrols
differences, forpastgrowth (as
inequation(3)). Formostfunctions/(wnp) however, theconvergence term doesnotenter
linearly.Moreover, itseemsplausiblethatdifferent economieswillhavedifferent Asand
thereforewillconverge atdifferent rates.Therefore, controlling linearlyforpastlevel(in
thelevelequation)orpastgrowth (in thefirstdifferences equation)willnotnecessarily
in the of
help solving non-monotonicity relationshipthe between growth andchangesin
inequality.
Themodelalso tellsus thatwhileinitialdistribution matters forthegrowth rate,itonly
matters in theshortrun.Overa longenoughperiod,twoeconomiesstarting at thesame
meanwealthlevelwillexhibit thesameaveragegrowth rate,sincetheybothwouldhave
gonefrom theinitialmeanwealthtoa meanwealthofw*.In otherwords, thelength ofthe
timeperiodoverwhichgrowth is measuredwillaffectthestrength of therelationship
betweeninequality andgrowth.15
Notethatall thisis stillinthecontext ofwhatis,moreorless,thebest-behaved model
wecouldcomeupwith.Thereis,forexample, noverygoodreasontoassumethath(k)y the
production function intheaboveexample,is globallyconcave - mostmachines, forone,
comeina fewdiscrete sizes.16Consider a simplevariantofthemodelabovewherethere is

^ - I- r1
- It*- h 'h- 5r
^. ^ w*-Aw2 w - w*+Aw,
Diagram 2 ^+1
a secondtechnology requiring a minimum investment ofk > (A+ l)w*butyielding a far

higher returnthan the •
h( ) technology.
Assuming theyieldsfromthisnewtechnology aresufficientlyhighthatthosewhocan
afford itwanttoinvestinit,theresultingmapfrom wttowt+xis represented inDiagram2.
It is clearthatthemapis no longerconcave,andwhileitis notconvexitbehaveslikea
convexfunction overcertainranges(and like a concavefunction overothers).17 In
particular, startingwithan economywhereeveryoneis at w*,a small increasein
inequality, showninDiagram2 by[- Awx,Ah^],leadstoa fallinthegrowth rate(i.e. the
meanwealthshrinks).18 But a largerincrease,shownby [- Aw2,Aw2], will actually
increasethegrowth rate,becausethosewhogainfromtheincreasein inequality willbe
abletotakeadvantage oftheveryrewarding secondtechnology. Evenlargerincreases in
inequality, shownby [- Aw3,Aw3],may,however, be counterproductive.
The relationbetweeninequality and growth deliveredby thismodelis clearlynon-
monotonic. Moreover,thestrong convergence propertythatholdsinthesimpler modelis
nowonlytrueifeveryone witha wealthlessthankj{k-hi). Anyonewhostarts
starts with
morewealththan&/(&+1), thatis, morewealththanhe needsto be able to investan
amount £,willconvergetoa differentsteadystate,representedbyw**inDiagram2.19In
otherwords,thegrowth rateofwealthmiljumpup at wt= k/(A+ 1), withtheobvious

280 ABHurrv. banerjee and Esther duflo
implicationthateconomies with highermean wealth will not necessarilygrow more

slowly.In otherwords,theeffectof mean wealth,thatis theso-calledconvergenceeffect,
may not be monotonicin thiseconomy.Linearlycontrollingformean wealththerefore
does notguaranteethatwe will get thecorrectestimateof theeffectof inequality.20
It is
worthnotingthatthiseconomywill have a connectedcontinuumof steadystates.This
means thataftera shock the economywill nottypicallyreturnto the same steadystate.
However,since itdoes convergeto a nearbysteadystatethisis notan additionalsourceof
non-linearity.
So far,we have assumed thatthe evolutionof the economy leaves the interestrate
unchanged. Making the interestrate endogenous complicates matterssubstantially:
Variantsof the simple concave economymay no longerconverge,even in the weaker
sense of thelong-runmean wealthbeingindependentof theinitialdistribution of wealth.
Intuitively,pooreconomieswill tendto have highinterest rates,and thisin turnwill make
capitalaccumulationdifficult (notethatk1< 0) and tendto keep theeconomypoor.21This
effectreinforcesthe claim made above that inequalitymattersmost in the poorest
economies.22This economy can have a numberof distinctsteadystatesthatare each
locally isolated. This means thatsmall changes in inequalitycan cause the economyto
move towardsa different and further away steadystate,makingit more likelythatthe
relationship will be non-linear.
Even ifwe could agreeon a specification thatis worthestimating, itis notclear how we
can use cross-country data to estimateit. Countries,like individuals,are different from
each other.Even in a worldof perfectcapital markets,countriescan have verydifferent
distributionsof wealth because, for example, they have differentinstitutionsor
distributions of ability.In this case, we run the risk of misinterpreting a purelynon-
causal associationbetweeninequalityand growthas a causal relationship:For example,
culturalstructures (such as a caste system)mayrestrict occupationalchoices and therefore
may not allow individuals to make proper use of their talents,causing both higher
inequalityand lowergrowth.Conversely,ifcountriesuse technologiesthatare differently
intensivein skilled labor,those countriesusing the more skill-intensive technologycan
have bothmoreinequalityand fastergrowth.
Countriesmayalso have different kindsof financialinstitutions,
implyingdifferences in
theA's in ourmodel.Ourbasic model wouldpredictthatthecountrywiththebettercapital
marketsis likelybothto be moreequal and to growfaster(at leastonce we controlforthe
mean level of income).The correlationbetweeninequalityand growthwill therefore be a
downwardsbiased estimateof thecausal parameter,ifthequalityof financialinstitutions
differsacross countries.23Changes in inequalitymay also be systematically relatedto
changesin growthrates:Forexample,skill-biasedtechnologicalprogresswill lead bothto
a changein inequalityand a changein growthrates,causinga spuriouspositivecorrelation
betweenthetwo. To make mattersworse,we have to recognizethefactthatk itself(and
therefore theeffectof inequalityon growthat a givenpointin time)maybe varyingover
time as a result of monetarypolicies or financialdevelopment,and may itself be
endogenousto the growthprocess.24
The moregeneralpointthatcomes outof thediscussionabove is thatunlesswe assume
capital marketsare extremelyefficient (which,in anycase, removesone of theimportant
sourcesof the effectof inequality),changes in inequalitywill be partlyendogenousand

relatedto country
characteristics
whicharethemselves relatedto changesin thegrowth
rate.Even in thesimplestmodel,controlling forconvergence effectslinearlyis not
and
adequate, relationships such as equations(1) and (3) cannotbe derivedfromthe
model. In particular,
one would expect strongnon-monotonicity in the observed
relationshipbetween (and changes inequality) growtheven if the
inequality in and
underlying mechanism a
implies negative betweeninequality
relationship andgrowth.
ErrorArguments
3.3. Measurement
Inequalityis noteasytomeasure, andwhiletheDeininger andSquire(1996)highquality

data set is a considerable improvement over the data that was previously available,
substantialscopeforerror remains. Atkinson andBrandolini (2001) carefully discussthe
Deininger andSquiredatafortheOECD countries, andfindthatithasimportant problems.
Mostworrisome is thefactthedatamaybe especiallyill-suited forcomparison overtime
andwithin countries.Forexample, theDeininger andSquiredataforFranceshowsa sharp
dropininequality from1975to 1980.As Atkinson andBrandolini (2001)show,thisis due
toa rupture intheseriesrather thantoa genuinechangein theunderlying inequality.As
showninTable2, severalcountries wheretheDeininger andSquirehighqualitydataset
showa largeincrease ininequality overa 5-yearperiodseemtoalsohavea largedecrease
ininequality overthefollowing ortheprevious 5-yearperiod,whichseemsunlikely inthe
absenceofmeasurement error.25
To seewhythismatters, assumethatall apparent changesininequality ariseoutofmis-
measurement by thestatistical agency. Assume also that the statisticalagencyis more
likelytomis-measure when thesocietyas a whole is under stress,because ofaneconomic
ora political or
crisis, a war. These arealso times when the growth rateis likelytofall.We
will therefore expect an inverted U-shaped relation between measured changesin
and
inequality changes in the growth rate - measured changes in inequality in any
direction willbe associatedwitha subsequent fallin thegrowth rate.
3.4. Summary
Thissectionmakesthecase thatthereis no reasonto expectthatwe can learnaboutthe

betweeninequality
relationship andgrowth byrunning linearcross-country
regressions.
Thereareno strong grounds forthinkingthattheright wouldbe monotonic,
specification
noneofthetheories
letalonelinear.Finally, giveus anyconfidence willbe
thattheeffect
properly In
identified. theremainderofthispaper,we focuson thefunctionalformissue,
toshowthatthisissueenoughis sufficienttocastdoubtonthevalidity inthe
oftheresults
previous as
literature, wellas toreconcile
the results
different thathavebeen with
obtained
different
specifications.

282 ABHurrv. banerjee and Esther duflo
Table2. Countries
withlargechangesin ginicoefficients.
Decreasein ginicoefficient
largerthan Increasein ginicoefficient
largerthan
3 percentagepoints 3 percentagepoints
Beginning Changein Gini Beginning Changein Gini

ofPeriod (Percentage of Period (Percentage
Country Period Gini(in %) Points) Country Period Gini(in %) Points)
(1) (2) (3) (4) (5) (6) (7) (8)
Bangladesh 65-70 37.3 -3.1 Australia 85-90 37.6 4.1

Bulgaria 70-75 21.5 -3.7 Bulgaria 75-80 17.8 7.2
Brazil 75-80 61.9 -4.2 Brazil 80-85 57.8 4.0
Canada 85-90 32.8 -5.3 Brazil 70-75 57.6 4.3
Colombia 70-75 52.0 -6.0 Chile 75-80 46.0 7.2
Spain 75-80 37.1 -3.7 China 85-90 31.4 3.2
Finland 70-75 31.8 -4.8 Colombia 75-80 46.0 8.5
Finland 85-90 30.8 -4.7 Germany 65-70 28.1 5.4
France 75-80 43.0 -8.1 Dominican 85-90 43.3 7.2
Republic
HongKong 85-90 45.2 -3.2 Finland 75-80 27.0 3.9
Hungary 65-70 25.9 -3.0 United 85-90 27.1 5.2
Kingdom
Indonesia 80-85 42.2 -3.2 HongKong 80-85 37.3 7.9
Ireland 75-80 38.7 -3.0 SriLanka 75-80 35.3 6.7
Italy 75-80 39.0 -4.7 SriLanka 80-85 42.0 3.3
Korea,Republic 80-85 38.6 -4.1 Mexico 85-90 50.6 4.4
Sri Lanka 85-90 45.3 -8.6 NewZealand 85-90 35.8 4.4
Sri Lanka 65-70 47.0 -9.3 NewZealand 75-80 30.0 4.8
Mexico 75-80 57.9 -7.9 Sweden 75-80 27.3 5.1
Norway 75-80 37.5 -6.3 Thailand 85-90 43.1 5.7
Portugal 75-80 40.6 -3.8 Venezuela 80-85 39.4 3.4
Sweden 70-75 0.4 -6.1 Venezuela 85-90 42.8 11.0
Trinidadand 75-80 51.0 -4.9
Tobago
Trinidadand 80-85 46.1 -4.4
Tobago
Turkey 70-75 56.0 -5.0
Venezuela 75-80 47.7 -8.2
Source:Deininger
andSquire(highqualitysample).

4. Estimation
and Results
estimatesof equations(5)-(9). Afterhaving

In thissection,we startby presenting
established
the importance we turnto theirconsequencesforthe
of non-linearities,
of
interpretationequations(1) and(3).
4.1. Data and Variables
Our mainfocusin thispaperis on thepotentially non-linear effectsof distributional

changes, and therefore we have chosen to sidestepa number of important and natural
questions. the
First, question of what should be the right set of controlvariables. The
choiceof thesevariablesis clearlycritical,sincea centralconcernfortheempirical
literature
is thattheginicoefficient couldproxyforomitted variables. Forexample, Barro
(2000) criticizesearlierstudieson theirchoice of controlvariablesand shows,in
particular,thattheirresults aresensitivetotheinclusion offertility intheregression. But
thechoiceofthevariables entailsmaking judgements aboutcausality thatarenoteasyto
defend.We therefore avoidtakinga positionon thissubject.Instead,we present all the
resultsfor the set of controlvariablesXit used in Perotti (1996) and theset of control
variablesused in Barro(2000). These specifications are usefulbenchmarks fortwo
reasons.First,thePerotti has
specification been used by most subsequent studies.Second,
theyrepresent twoextremes: ThePerottispecification usesthesmallest number ofcontrol
variablesandtheBarrospecification thelargest.The listof variablesincludedin both
specificationsis includedas a noteto Table 1. The Perotti specificationexcludesmost
variables(inparticular, investment andgovernment spending) through whichtheinfluence
of inequality couldbe channelled. The onlyvariablesincludedare male and female
education andthepurchasing powerparity ofinvestment goods,a measureofdistortion.
Barro, on the other hand, includes investment share of GDP, fertility, education, and
government spending, which areplausible channels through which inequalitycould affect
growth.26 The interpretation of thecoefficient of inequality in thetworegressions is
thereforedifferent.
Second,thequestionof whattherightdefinition of inequality (interquartilerange,
measure ofpoverty, etc.)oughttobe.Therearereasonstodoubtthattheginicoefficient is
theappropriate of
measure inequality from the point of view of growthregressions.
However, mostempirical workon growth andinequality focuseson theginicoefficient.
Therefore, ourfocusinthispaperis also on therelationship betweentheginicoefficient
andeconomicgrowth.
A distinct butrelatedquestionconcernsthereliability of themeasureof the gini
coefficient.A newdataset,compiledbyDeininger andSquire(1996),has substantially
improved thereliability andthecomparability ofavailablemeasures ofinequality. They
havecompiledan extensive a
datasetfor largepanel of countries. Theyalso identify a
sub-setof theirdataas a "highquality"dataset.27Mostrecentstudieshaveusedthis
newhighqualitydataset(or itsextended version).Therefore, despitetheproblems we
notedabovewiththisdataset,we willpresent mostresultsin theDeininger andSquire
highqualitydatasetrestricted to countries withat leasttwoconsecutive observations.28

It should be noted that,dependingon the data source,the data referseitherto ex post

inequality(i.e. to incomemeasurednetof redistribution, or to expenditureinequality)or
to gross inequality.The distinctionis less strongthan it appears, however,since a
substantialfractionof the redistribution does not occur throughthe tax systembut
through other mechanisms (minimum wages, labor laws, inflation,etc.). An additional
drawback is that the "high quality" data set is small, and includes very few poor
countries,especially when it is limitedto countrieswhereat least two observationsare
available.29
Finally thereis the question of the relevanttime period (the choice of a). As we
emphasizedin theprevioussection,thetheorypredictsdifferent effectsoverdifferent lags.
The firstset of empiricalpapers studiedgrowthover a long timeperiod (25-30 years).
Subsequentpapers have exploitedtherichnessof the Deiningerand Squire data set and
have chosen shorterlags (5 or 10 years)in an attemptto increasethenumberof available
observations.Since using longer lags substantiallyreduces the numberof changes in
inequalityin our data set,we will focus on 5-yearlag periods.
42. Basic Results
Table 3 presentstheresultsfromestimatingvariousversionsof equations(5) and (9).30In

columns (1) and (5), we regressgrowthon the change in inequalityand the change in
inequalitysquared.Past variationin inequalityis relatedto subsequentgrowth,in a very
non-linearway: While the lineartermis insignificant, thequadratictermis negativeand
significant withbothsets of controlvariables.
We thenintroducethelevel of thegini coefficient intotheregression(columns(2) and
(6)). The coefficientsof -
(git git-a) and -
(git git-a)2 are notaffectedbytheintroduction
of the gini coefficient.31To explorethenon-linearity we use a kernelregression,
further,
and we "partial out" the linearpartof the model (i.e., yit,gitand Xit) using a method
analogous to thatdeveloped by Robinson (1988) and applied in Hausman and Newey
(1995).32 The resultsare shown in Figures 1 (withPerottivariables) and 2 (withBarro
variables). The kernelregressionline is shown as a solid line. This relationshiphas the
shape of an invertedU, witha maximumaround0 and a relativelyflatsectionat thetop.
Changes in inequality,in any direction,are associatedwithreducedgrowthin inequality,
and largerchangesare associated withlargerdecline in growth.
This resultis striking,and we investigatedits significanceusinga varietyof methods.
First,we estimatedthe relationshipusing series estimation.In Figure 1, we show the
predictedvalue using a quarticspecificationforthe functionh( • ). This polynomialis
maximized when the value of lagged change in inequality is 0.012 (using Perotti
variables), which is very close to 0. To test whetherthe non-linearity is statistically
significant, we presentin columns(4) and (8) theF-testforthejoint significanceof the
non-lineartermsin the partiallylinear model. Linearityis rejected in both cases, at
3 percentin thePerottispecificationand 12 percentin the Barro specification.Given the
limitedamountof data (128 and 98 observations,respectively)and thefactthatit is very
noisy,thisresultis a surprisinglystrongrejectionof linearity.
Finally,we estimatea piece-
wise linear specificationfor/*(•) (columns (3) and (7)), wherewe treatthe effectsof

Table3. Relationship
between andchangesin inequality
inequality andgrowth.
Variable:(y(t)-y(t-a))/a
Dependent
Perotti
Specification BarroSpecification
(1) (2) (3) (4) (5) (6) (7) (8)
gini(r) 0.05 0.064 0.094 -0.042 -0.039

(0.10) (0.099) (0.11) (0.045) (0.043)
gini(/) 0.065 0.36 0.053 0.073

-gini(f-a) (0.16) (0.17) (0.063) (0.066)
(gini(/) -5.09 -5.37 -2.47 -2.33

-gini(/-a))2 (2.95) (3.06) (1.16) (1.17)
gini(r) 0.63 0.27

-gini(f-o)* (0.30) (0.10)
l(gini(r)
- gini(f- a)) < 0
gini(f) -0.59 -0.11

-gini(/-a)* (0.33) (0.13)
l(gini(r)
-gini(/-a))>0
F-testfor 9.02 5.72

(gini(r) (0.029) (0.12)
-gini(f-o))2,
(gini(r)
- gini(r- o))3,
(gini(r)
-gini(/-fl))4
(p valuein
parentheses)
Numberof 128 128 128 128 98 98 98 98

observations
obtainedusingrandom
Note:Coefficient effect specifications.
errors
Standard in parentheses;a is equalto 5 (5-yearperiods).
variables:see noteto Table 1.
Control

between
Figure1. Relationship andlaggedginigrowth:
incomegrowth linearmodel(Perotti
partially variables).
increases and decreases in inequality separately.The coefficientsof decreases and

increasesin inequalityare positiveand negative,respectively.The positivecoefficient in
the decreasingrange is significantin bothspecifications.The negativecoefficient in the
increasingrangeis significant(at the 10 percentlevel) only in Perotti'sspecification.We
Figure2. Relationship
between
incomegrowth
andlaggedginigrowth: linearmodel(Barrovariables).
partially

alsoranthesespecifications
usingtheBarroexpanded dataset,and10-yearlagsinsteadof
5-yearlags,and we findthesameinverted U-shapedrelationshipbetweenchangesin
andgrowth,
inequality albeitestimated whichis notsurprising
withlessprecision, given
thatwe areleftwithonly78 observations not
(results reported).
Onbalance,thereis nostrong ofinequality
evidenceofa directcorrelation ongrowth in
theshortrun(overa 5-yearlag period),butthereseemsto be an associationbetween
changesin inequalityand growth. Changesin inequality,
whatever are
theirdirection,
associatedwithlowergrowth in thenextperiod.We discussat theend of thissection
whether anycausalinterpretation butbeforethatwe report
canbe giventothisresult, the
fromourreducedformestimates.
results
43. TheEffectofLaggedInequality
In Table4 (columns(l)-(6)), wepresent theresults oftheestimation ofequation(8). The

difference betweenthespecifications estimated in thistableandthefirst columnin the
previous table is that theindependent variable is not the beginning-of-period level of
inequality but thelagged levelof inequality -
(g(t a)).
(g(t))
The coefficient ofg(t- a) entered linearly is nownegative(around- 4 percent), but
stillinsignificant in bothPerotti's and Barro'sspecifications (Table4, columns(1) and
(4)). Columns(3) and(6) showtheresultsobtainedwhenwe lag theotherregressors by
oneperiodas well,which, as we showbelow,is similar tothereducedformofthemodels
ofBarro(2000)andForbes(2000).Thecoefficient oflaggedinequality is similarinthese
specifications. It is significant with the Barro control variables. In the quadratic
the
specification, squared term is negative, though non-significant (Table 4, columns(2)
and(5)). Thecorresponding Kernelregression (showninFigure4) is indeeda U-shaped
relationship,withthecorrelation betweenlaggedinequality on growth turningpositive
whentheginicoefficient is largerthan0.45.
In columns(7H10) of Table 4, we estimatetherelationship betweenchangesin
inequality andpastinequality described byequations(6) and (7). boththePerotti
In and
Barrospecifications, in are
changes inequality strongly negatively correlated with past
inequality, whilethesquareofthechangeininequality is positivelyrelatedto inequality.
The kernelregression corresponding to equation(7) is shownin Figure3. The
relationship between inequality and squared changesin inequality is non-linear witha
peakaround0.45.Theshapeis verysimilar ifwereplacethesquareofthechangewithits
absolutevalue.
Interestingly,thenon-parametric partialrelationships betweengrowth and inequality,
on theone and in
hand, change inequality growth, and on theother hand, appeartobe
do
mirror images of each other,with a peak at about the same level. This corresponds fairly
closely tothe prediction of the politicaleconomy model, although given the identification
problems we discussed, we stopshortofcommitting tothisexplanation oftheresults.

288 ABHijrrv. banerjee and Esther duflo
Table4. Estimation
ofthereducedformmodel.
Variable:(y{t+ a) -y(t))/a
Dependent
Perotti Barro
(1) (2) (3) (4) (5) (6)
g(t-a) -0.047 0.77 -0.033 -0.043 -0.21 -0.10

(0.076) (0.66) (0.082) (0.039) (0.21) (0.043)
g(t-af -0.94 0.26
(0.81) (0.27)
Control
variables X(t) X(t) X{t-a) X(t) X(t) X{t-a)
Variable:Changein GiniCoefficient
Dependent
Perotti Barro
g(t) - g(t- a) (g(t) - g(t - a))2 g(t) - g(t- a) (g(t) - g(t- a))2
(7) (8) (9) (10)
g{t-a) -0.087 0.0067 -0.25 0.0076

(0.038) (0.0025) (0.066) (0.0038)
Controlvariables X(t-a) X{t-a) X(t-a) X(t-a)
Note:Coefficientobtainedusingrandomeffect specifications.
Standarderrorsin parentheses;
a is equal to 5 (5-yearperiods).
Controlvariables: X{t) standsforcontrolvariablenotlagged.
X(t- a) standsforcontrol variableslaggedone period(5 years).
Fora listof control
variablessee noteto Table 1.

between
giniandsquareofginichanges.
Figure4. Reducedform,
withPerotti
variables.

290 ABHDIT V. BANERJEEAND ESTHER DUFLO
withtheLiterature
5. Relationship
Regardlessof how we interpret theseresults,it is clear thattheyhave important

for
implications how we read theexistingresultsin theliterature.
In particular,
we will
results
showthatthestriking obtainedbythosewhohaveestimated thegrowth-inequality
withfixedeffects
relationship arisefromgivinga different andmisleadinginterpretation
to thesamereduced-formevidencethatis presented here.
5.1. Non-linearity
As we notedinSection2,all theapproachesbasedondifferencingthedatarelyheavilyon
thelinearityofequation(1) andtheexclusionofthedifferenced term.If eitherofthese
conditionsare violated,thefixedeffectand first
differenceestimatesof y willnotbe
andbothwillbe different
identical, fromtheOLS estimate ofequation(1) evenifall the
otherconditions oftheOLS estimate
forthevalidity Itwillthenbe important
aresatisfied.
eachofthesecoefficients.
to be verycarefulin interpreting
The resultsin theprevioussectionsuggestthatchangesin inequality
werenegatively
correlatedwithsubsequentgrowth.Assumingthe relationship betweenthe level of
inequalityand growthis indeedlinear(h(g)= yg),and differencing equation(9), one
obtains:
yu+a- y« = (<*a+ i)Gto- yu-a) + <*(Xu- xit_a)p

+ MBit ~ git-a) + ak(Zit~ git-a)) + <*Kgti-a~ git-2a))
+ aeit-aeit_a,
or
yu+a- y*= ifl*+ i)(y* - yu-a) + a(xu - xu-a)P

+ afigi,- git-a)) + Kgit-a - git-2a))+ aeit~ ™it-a, (10)
where<t>(x)= k(x) + yx.
Inprinciple,thisequationcouldbe estimated.Usingmethods similartothosederived in
Porter(1996),onecouldalsorecover •
k( ) and7, butthe datarequirement would make the
exercisesenselessinthepresentcontext (therearetoofewcountries withthreesuccessive
measuresofinequality).
However,if equation(10) is indeedthe correctway to represent the relationship
between changesininequality andgrowth inthefirst
differenced equation, itsuggests
that
theinterpretation
ofthefixedeffects, first
differenceandGMM estimates ofequation(1)
could be verymisleading.In orderto investigate thispointwithout relyingon our
biased)estimates
(potentially ofequation(9), we estimate a modified versionofequation
(3), whichdoesnotrestrict
thecoefficientofthedifference git- git_atobe linear.Inother
words,we estimate therelationship

between andlaggedGinigrowth:
incomegrowth linearmodel.
partially
- - -
yit+a y» = (*<*+ i)(y* ?*-„) + <*(** x»-a)P
- 8u-a) + <«* - ^a-m
+ <><t>(git 0 *)
where(f)(• ) is a functionthatwe wantto estimateflexibly.Underthehypothesisthatthe

model in equation(1) is thecorrectmodel,we shouldnotbe able to rejectthelinearityof
We use kernelregression,and we ' 'partialout" the linearpartof the model usingthe

same methodologywe used before.The resultsare presentedin Figure5 forthe Perotti
variables(we obtaina verysimilargraphswhenwe use theBarrovariables).The linearity
seems,once again,to be rejected.To further explorethis,we used thesame specifications
as in Section3. We presentthemin Table 5. To testwhetherthenon-linearity is statistically
significant, we presentin panel C ofTable 5 theF-testforthejointsignificanceofthenon-
lineartermsinthepartiallylinearmodel(columns(1) and (2)). Linearityis rejectedin both
cases, at the9 percentand 3 percentlevels ofconfidence,respectively. Panel D presentsthe
resultsof estimatinga quadraticspecificationfor</>(•)•Finally,we estimatea piece-wise
• (in of decreases and increasesin
linearspecificationfor</>( ) panel B). The coefficients
inequality are positive and negative, respectively.The positive coefficientin the
decreasingrangeis significant. The negativecoefficientin the increasingrangeis smaller
in absolutevalue and insignificant.
To ensurethatthenon-linearity of therelationshipbetweeninequalityand growththat
we are findinghere is not drivenby some mis-specification in our estimationof the
partially linearmodel,33 we then testforlinearityunderthe assumptionthatthemodel in
theliteraturewe are critiquingwas actuallycorrectlyestimated.

Table5. Non-linearity
oftherelationship changeinginiandgrowth
between inmodelsbasedonfirst
differences.
Variable
Dependent
(y(t+ g)-y(t))/a + a)-y(GDP(t)Y)

(\/a*\y(t
Perotti Barro Perotti Barro
ControlVariables (1) (2) (3) (4)
A. Linearassumption: of (gini(f)- gini(f- a))

OLS coefficient
gini(r)-gini(r-a) 0.298 0.158 0.36 0.17
(0.18) (0.068) (0.18) (0.07)
B. Piecewiselinearassumption:
OLS coefficients
of (gini(/)-gini(/-a))
if gini(0-gini(/-a)<0 0.79 0.39 0.69 0.4
(0.30) (0.13) (0.38) (0.13)
if (gini(0-gini(/-a))>0 -0.3 -0.13 -0.49 -0.11
(0.35) (0.11) (0.38) (0.14)
C. Quarticspecification
F-testfornon-linearterms
jointlysignificant 2.21 3.37 2.55 3.3
(0.09) (0.02) (0.059) (0.02)
D. Quadraticspecification
gini(/)-gini(r-fl) 0.23 0.13 0.311 0.15
(0.18) (0.067) (0.19) (0.66)
(gini(f)- gini(r- a))2 -5.88 -3.24 -5.94 -3.28
(3.39) (1.26) (3.43) (1.23)
Numberofobservations 128 98 128 98
Note:Standard errorsin parentheses;

a is equal to 5 (5-yearperiods).Fora listof controlvariablessee note
to Table 1. Fora definition
ofresidualgrowth,see thetext
To do so, we estimatethemainequation(1) usingtheArellanoand Bond method,and

thencompute:
- y*)* = - -
(yu+a y»+a y» («« + 1)0^ - yu-a) - <*{*» - **-*)& (12)
wherea and ftare the values of a and /?obtainedby estimatingequation (1) using the
Arellanoand Bond estimator.If theassumptionsnecessaryforthevalidityof each method
are satisfied,a and P will be estimatedconsistently.
Then,accordingto equation(3), the
relationshipbetween(yit+a- yit)*and git- git_ashouldbe linear.
The next step is to make sure that the estimates of y obtained if we regress
-
(yit+a yu)*la linearlyon thedifference git- git_aare similarto thoseobtainedusinga
fixed-effectstype estimator.OLS estimatesare presentedin panel A of Table 5. They are
alternativeestimatesof y, consistentif equation (3) is correctlyspecifiedand if the
innovationin inequalityis notcorrelatedwiththe innovationin theerrorterm.They are
not identicalto the estimateof y reportedin Table 1, since theyuse different estimation
methods.However,theyare also positiveand significant, and theirmagnitudeis similarto
thatof the fixedeffectand Arellano and Bond estimates.In otherwords,as long as we
impose linearity, theresultsare verysimilarto whattheliterature finds.

between
incomegrowth
andlaggedGinigrowth:
usingArellanoandBondcoefficients.
Finally,we testthe linearityassumption.We startby allowingthe coefficientto vary

withthe sign of thedifference git- git_a.The resultsindicatethatthereis a sharpnon-
As
linearity. before,we findthatbothincreasesand decreasesin inequalityare associated
withlower subsequentgrowth(panel B). This suggeststhatthe conclusionsof Forbes
(2000), and Li and Zou (1998) are not warranted:There is no evidence in the data that
increasesin inequalityare good forgrowth.In fact,thebulk of the evidence goes in the
oppositedirection.
In Figure 6, we presenta kernelregressionof l/a*(yu+a ~yuY on me difference
git- Su-a f°r me Perotticontrolvariables. The shape of the curve is similar across
specifications,and similarto whatwe had foundwhen we estimatedthe partiallylinear
model.We have experimented witha varietyofotherspecificationswhichwe do notreport
here (Barro control variables, differentlags, differentway to estimate the other
coefficientsin the regression,etc.). The results are always similar. In panel C of
Table 5, we reporttheF-statisticof the significanceof the non-lineartermsin a quartic
regressionof\/a*(yit+a- yit)*on git- git__a.Here also, thedata clearlyrejectslinearity
in almostall specifications.
5.2. Consequencesfor EstimatedCoefficients
5.2.1. RandomEffectsand Fixed Effects
The resultssuggestthatequation(1) is mis-specified.

Non-lineartermsin pastchangesare
omittedin the regression.Since currentlevels and past changes are correlated,this

introducesa bias in thecoefficient of inequalitywhenequation(1) is estimated using

randomeffects.
Thismis-specificationis accentuated whentheequationis estimated infirst
differences
or usingfixedeffects.The fixedeffectestimation imposes a linearstructure on the
between
relationship the deviation of thegrowth rate from its averageacross all the
periodsandthedeviation of theginicoefficient fromitsaverage.Sincetherelationship
betweengrowthand inequalityis not monotonic in firstdifferences,it is also not
monotonic whenperiodaveragesaretakenout.The fixedeffect estimatoris, ineffect,a
weightedaverageofnegative andpositive coefficients,whichcanbe positive iftheweight
givento positivecoefficients is larger.As it turnsout,thereare moredecreasesthan
increasesof inequalityin thedata.The majority of thedatapointsare therefore in the
regionwhere are
changes positively correlatedwith growth,which means thatthe positive
coefficient
getsmoreweight.
UsingtheArellanoandBondTechnique
5.2.2. Estimation
The Arellanoand Bond estimator to instrument

uses laggedlevels of inequality for
in with
changes inequality lags. Ignoring
longerlags,thereduced formequationimplicitly
whenusingtheArellanoandBondtechnique
estimated has theform:
+ a - ytt)la= tyit-a+Xit-aK+ S8it-a+ Vi+ 6r
(yit 03)
Thisreducedformis verysimilarto theequationwe hadestimated in Section3. The
onlydifference is thatincomelevelsandthecontrolvariablesarelaggedoneperiod.In
columns(3) and (6) ofTable4, we present thecoefficientofgit_ain thisspecification.
As before, we finda negative, butinsignificant,
coefficient.
TheArellanoandBondGMMestimator ineffecttakestheratioofthisnegative reduced
formcoefficient and thenegativecoefficient fromestimating theeffectof thelevelof
inequality on changesin inequality. Thisnaturallyleadsto thepositivecoefficientinthe
"structural" equation.Forexample,dividing- 0.033 (column(3), Table4) by - 0.087
(column(7), Table4) leadsto 0.38,close to theArellanoand Bondcoefficient of 0.58
reportedincolumn(4) inTable1.Therefore, theseemingly dramatic differenceinresults
obtained whenweusetheArellano andBondmethod areinfacta different
interpretationof
thesamereducedformevidencepresented inthispaperorin,forexample, Barro(2000).
Thisinterpretation of thereducedformis clearlymisleading, becauseequation(3) is
mis-specified. The effectof changesin inequalityis not constant. Thereis also an
asymmetry betweenincreases ininequalityanddecreasesininequality: Whenwe regress
reductions in inequality on laggedinequality,thecoefficientis negative( - 0.083) and
verysignificant, indicating thathigherinequality is associatedwithlargerdeclinesin
inequality.However, when we repeatthisexercisewithincreasesininequality,thecontrast
is striking:
Increasesininequality arenotcorrelatedwithlaggedlevels(thecoefficient is
- 0.011 and is insignificant).As a result,theArellanoand Bondestimator more
gives
weight totheeffect ofdecreasesininequality, whicharepositively relatedtogrowth, and
thereforefindsa positiveeffect on average.

Appendix
TableAl. Descriptive
statistics in thesample.
andcountries
in theSample
Countries
Australia Japan
Bangladesh Korea,Republicof
Belgium Malaysia
Brazil Mexico
Bulgaria Netherlands
Canada NewZealand
Chile Norway
China Pakistan
Colombia Peru
CostaRica Philippines
Denmark Poland
Dominican Republic Portugal
Finland Singapore
France Spain
Germany Sri Lanka
Greece Sweden
HongKong Thailand
Hungary TrinidadandTobago
India Tunisia
Indonesia Turkey
Ireland UnitedKingdom
Italy UnitedStates
Venezuela
Means(standard
deviation)
andHeston)
Log(GDPpercapita)in 1980dollars(Summers
1965 8.03(0.86)
1975 8.37(0.85)
1985 8.58(0.82)
1995 8.82(0.79)
Ginicoefficient
1965 0.38
1970 0.4
1975 0.4
1980 0.38
1985 0.37
1990 0.38
of thesampleand variable,see
and Squire"highqualitysample.*'Fortheconstruction
Source:Deininger
text.

6. Conclusion
Themaingoalofthispaperis toinvestigate thepertinence ofthelinearrelationships that

havebeenusedin theliterature to investigatetheeffect ofinequality on growth. We find
thattherearestrong a priorireasonsto doubttheirvalidity, andthatthedatadoes seem
inconsistent witha linearstructure.
Thispaperis primarily an attempt toforestall a potentiallyinfluential
misinterpretation
ofthedataoninequality andgrowth. Ifitservesanypurpose beyondthat, itis toserveas a
broaderwarning againsttheautomatic use of linearmodelsin settings wherethetheory
doesnotnecessarily predicta linearorevena monotonic relationship.
Onthemorefundamental question ofwhether inequalityis badforgrowth, ourdatahas
littleto say.It is clearthatthemostcompelling evidenceon thispointhastocomefrom
microdata.Whilesomeinteresting evidenceis beginning totricklein,34weareonlyatthe
beginning ofan enormous enterprise.
Notes
1. Theauthors notethatthisis notnecessarily inconsistent withthecross-sectional relationship.

2. Thisis thedatasetusedbyForbes(2000).Wedescribe thedataconstruction inmoredetailinthetext.Table
Al intheappendixshowsthelistofcountries in thesampleandsomedescriptive statistics.
3. Inthissampleofcountries, andusingeither PerottiorBarrocontrol variables, thecoefficientofinequality in
1960on growth between1960and 1995is - 0.46,witha standard errorof0.028.
4. We werenotabletoexactlyreplicate Forbes(2000) resultfortheArellanoandBondestimator (sheobtains
withthePerotti specification a coefficient
of0.13).Thecoefficients oftheotherregressors aresimilar.
5. Forversions ofthisargument seeAlesinaandRodrik ( 1994),PerssonandTabellini( 1991) and,Benhabib and
Rustichini( 1998).Fora contrarian pointofview,arguing thatneither
ofthetwopremises ofthisargument are
truein thedata,see Benabou(2000).
6. As in,forexample,AcemogluandRobinson (2000).
7. Itmustbe keptinmindthatthetransfer couldinvolveabolishing a distortionarytax.Forthisreason,therest
oftheexamplessuggested abovefitourpurpose better - inthoseexamples, thefactthatthereis anefficiency
lossis independent ofthedirection ofthetransfer.
8. Thisinterpretation clearlyonlymakessenseifg is nottoosmall.
9. Notethatwe arenotworried aboutthedirecteffect of growthon distribution (theKuznetscurveeffect)
becausethatispresumably subsequent orcontemporaneous tothegrowth episode.Whatworries usis thefact
thattheremayalso be an effect on thedistributionpriortothegrowth episode.
10. See AlesinaandRodrik (1994),Persson andTabellini (1991)andAlesinaandFterotti (1996).Theargument in
AlesinaandPerotti (1996) is mostcloselyrelated toours:Incomeinequality leadstopoliticalinstabilityand
henceto lowergrowth: indeed,instabilitymavbe a svmDtom ofwhatwe call grabbing.
11. See AlesinaandRodrik ( 1994),Persson andTabellini( 1991) andBenhabib andRustichini ( 1998) formodels
ofthisclass.
12. Itshouldbe statedattheoutsetthattheeffects ofinequality ongrowth through thesechannels is unlikelyto
be realizedoverthetime-scale of 5 or even 10 years.Therefore it is unlikely to providea convincing
forestimating
justification a relationbetween short-run changesininequality andchangesinthegrowth rate.
On theotherhand,ittellus a lotaboutthemorelone-run effects
ofinenuaiirv on growth
13. Forsucha modelofthecapitalmarket, see Aghion,BanerieeandPiketty (1999).
14. Thismodelis a closerelative ofthemodelin BanerieeandNewman(1994).
15. It maybe objectedthatthisconclusion restson theclearlyunreasonable prediction ofconvergence at the
individuallevel,butthisis notthecase. Therecouldbe idiosyncratic shocksto thewealthof individuals

whichwouldprevent long-run convergence attheindividual level,butwithout affecting thefactoflong-run

convergence fortheeconomyas a whole.
16. Ithasalso beenarguedthattheproduction function forhumancapitalderivedfromhealthis S-shaped(see
DasguptaandRay(1986)andtheresponse bySrinivasan, 1994).Thereis somedebateabouttheactualshape
of theproduction function forhumancapitalderivedfromeducation, withthecurrent weightof opinion
leaningtowards theviewthatitis fairly atleastindeveloped
linear, economies (Angrist andKrueger, 1999).
17. Thereareotherwaystogenerate thisshape:Forexample, theassumption thatbequests area luxury good,and
thereforesubjectto strong incomeeffects willalso giveus thisshape.
18. Theexactexperiment is movinghalfthepopulation to w*- Awlandtherestto w*+ Awj.
19. Thepossibility ofdivergence in thistypeofeconomywas first formalized inGalorandZeira(1993).
20. Inprinciple, thisis also trueinourbasicmodel,buttheretheeffect is likelytobe monotonic andthereis no
obvioussourceofnon-linearity (though thereis also no reasontobelieveitis linear).
21. See Piketty (1997). Fora moregeneraldiscussion oftheissueofconvergence in thisclassofmodels,see
BanerjeeandNewman(1993).
22. Thereis,however, a counteracting effect:Poorer economies withhighlevelsofinequality mayactuallyhave
lowinterest ratesbecausea fewpeoplemayownmorewealth thantheycaninvest intheir ownfirms, andtherest
maybe toopoorto borrow. Fora modelwherethiseffect playsan important role,see AghionandBolton
(1997).
23. Allowing Xtovaryalsoimplies thatthecausaleffects ofinequality willvarywithfinancial development (which
is howBarro(2000) explainshisresults). TheOLS coefficient is therefore a weighted averageofdifferent
parameters, wheretheweightsare thecountry-specific contributions to theoverallvariancein inequality
(Krueger andLindahl,2001).Itis notatall clearthatwe areparticularly interested inthissetofweights.
24. See Acemogluand Zilibotti(1997) and Greenwood and Jovanovic (1999) fortheoriesof growthwith
endogenous financial development.
25. Forexample,inBulgaria, theginicoefficient wentdownby3.7 percentage pointsbetween1975and 1980,
andupby7.2 between1980and1985.In Brazil,itwentupby4.3 percentage pointbetween1970and1975,
downby4.2 percentage pointbetween1975and1980,andupagainby4 percentage pointbetween1980and
1985.Columbia, Hong-Kong, SriLanka,Sweden,andVenezuelaaretheothercountries withconsecutive
increasesanddecreasesin theginicoefficient ofmorethan3 percentage points.
26. Inaddition, Barroincludes theaveragegrowth ofterms oftradeovertheperiod, indicesofdemocracy andthe
ruleoflaw,thesquareofthelogarithm ofGDP,thesquareofthedemocracy index,andtheaverageinflation
intheperiod.He implements a threestageleastsquaresmethod, whereheuseslaggedvaluesoftheregressor
as aninstrument forcurrent values.As inequality is an instrument foritselfinhisspecification, we willfocus
on thereducedformanduse theinstruments as control variables.In particular, we followBarroandcontrol
fory,,.,,,noty,,,in theregression (although thisdoesnotaffect ourresults to control fory.,instead).
27. Thehighqualitydatasetincludesonlythoseobservations whichsatisfy thefollowing The survey
criteria:
comesfroma national coverage, theinformation is basedon directsurveys ofincomes, thesurveyssample
thecomplete population (notonlythoseearning an income),thedatadoesnotcomefromtaxrecords, and,
thedatagivesa clearreference
finally, totheprimary source.Thelistofcountries inthesample,as wellas the
summary statisticsforthelog(GDP)andtheginicoefficients, areshowninTableAl.
28. Thisis thesampleusedinForbes(2000)andLi andZou (1998).TheDeininger andSquiredatasetprovides
theyearinwhichtheobservation was taken.To construct a measureofinequality every5 years,we follow
Forbes(2000)andwechosetheclosestmeasure inthe5 yearspreceding therelevant dateifthemeasure was
notavailableforthisparticular year.Wealso followprevious studiesin adding6.6 to theginiwhenitwas
constructed fromexpenditure insteadof income.However,stillfollowing theotherstudies,we did not
attempt to correcttheginicoefficient forwhether it was grossor netof taxes,and whether theunitof
measurement was thehousehold ortheindividual.
29. In an attempt to expandthesamplesize,Barroproposedaddingsomeobservations thatwererejectedby
Deininger andSquireon thegrounds thattheywerenotidentified bya clearprimary source.Thecoverage
increases substantially, at theexpenseofan additional reduction in theaccuracyofmeasurement.
30. All oftheseequationsareestimated usinga random effectspecification, to allowforcorrelation ofgrowth
ratesbetween countries overtime.
31. Wepresent theresults withonlya lineartermintheginicoefficient becausewe didnotfindanystrong non-

298 abhuit v. banerjee and Esther duflo
linearitywhen we looked at the h( • ) functionseparately,but the exact same resultsare obtained if we

introducehigher-ordered polynomialsas well.
32. This is implementedby firstregressingall the controlvariables (yingitand Xit) and thedependentvariable
tyit+a =yu+a-yn non-parametricallyon Agit= git- git_a and formingthe residuals of this non-
parametricregression.Estimatesof theparametersa and /?are thenobtainedfromtheOLS regressionof the
residual of the dependentvariables on the residualsof the controlvariables. Finally,the functionah{ • ) is
estimatedby estimatingnon-paramctrically thefunction:E(Av +a |Ag), E(Ay\Ag),E(X\Ag)P and formingthe
differenceE(Av + a\Ag) - (aa + l)E(Ay\Ag) - aE(X\Ag)j}.
33. For example, we did not deal withthe inconsistencyintroducedby the lagged endogenousregressor.
34. Forexample,Banerjee et al (2001) show,usinga panel of data fromsugarcooperativesin India,thatthemost
unequal cooperatives(in termsof land ownershipamongcooperativemembers)are theleastproductive,with
a differenceof more than50 percent(measuredby capacity,whichis a proxyforoutput)betweenthemost
and least egalitariancooperatives.
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Inequality and Growth: What Can the Data Say?

Author(s): Abhijit V. Banerjee and Esther Duflo

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