Measuring Income Inequality and Implications for Economic Transmission Channels

WP/20/164 Measuring Income Inequality and Implications for Economic Transmission Channels by Robert Blotevogel, Eslem Imamoglu, Kenji Moriyama, and Babacar Sarr © 2020 International Monetary Fund WP/20/164 IMF Working Paper Fiscal Affairs Department Measuring Income Inequality and Implications for Economic Transmission Channels Prepared by Robert Blotevogel, Eslem Imamoglu, Kenji Moriyama, and Babacar Sarr Authorized for distribution by Nikolay Gueorguiev August 2020 Abstract We study the channels that theoretically transmit the effects of inequality to economic growth, unlike much of the existing literature that focuses on the direct linkage. The role of inequality in these transmission channels is difficult to pin down and varies with the particular inequality indicator chosen. We run our analyses with six methodologically distinct inequality measures (Gini coefficients and Top10 income shares). Methodological differences within the set of Gini coefficients and the Top10 income shares exert a first-order impact on the estimated relationships, which is generally larger than the effect of switching between Gini and Top10 income shares. For a given inequality indicator, we find that the transmission channels can react in opposite directions, with the net effect on growth difficult to determine. Finally, we emphasize two additional but so far underappreciated empirical complications: (i) estimated relationships change over time; and (ii) fragile countries create significant but counterintuitive empirical associations that may obscure structural relationships. JEL Classification Numbers: D31, P36, P16, O15, O47. Keywords: economic growth, fragile countries, growth transmission channels, income inequality, inequality measurement, and political stability. Author’s E-Mail Address: RBlotevogel@imf.org; EImamoglu@imf.org; KMoriyama@imf.org; BSarr@imf.org IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management. 3 Content Page ABSTRACT _______________________________________________________________________________________ 2 I. INTRODUCTION _______________________________________________________________________________ 4 II. DATA __________________________________________________________________________________________ 6 III. EMPIRICAL STRATEGY _____________________________________________________________________ 13 IV. RESULTS ____________________________________________________________________________________ 20 V. CONCLUSION _______________________________________________________________________________ 34 REFERENCES ___________________________________________________________________________________ 36 FIGURES 1. Means of Inequality Indicators ________________________________________________________________ 10 2.1 Event Study and Transmission—Top10 Income Share ________________________________________ 21 2.2 Event Study and Transmission Channels—Gini _______________________________________________ 22 3. Rolling-Window Regressions: Long-Run Impact on Transmission Channels ___________________ 32 4. Rolling-Window Regressions: Long-Run Impact on Political Stability __________________________ 33 TABLES 1. Methodological Characteristics of Inequality Indicators ________________________________________ 8 2. Overview of Inequality Indicators _______________________________________________________________ 9 3. Pairwise Correlations between the Inequality Indicators ________________________________________ 9 4. Correlations between the Means of Inequality Indicators for Advanced Economies Only______ 11 5. Overview of Transmission Channel Variables __________________________________________________ 12 6. Overview of ‘Large Changes’ by Inequality Indicator __________________________________________ 15 7. Three Alternative Sets of Control Variables ____________________________________________________ 17 8. Cross-Sectional Dependence Test _____________________________________________________________ 20 9.1 Weighted-Average Least Squares Results—Top10 Income Share ____________________________ 25 9.2 Weighted-Average Least Squares Results—Gini _____________________________________________ 27 10. Pooled Mean-Group Regressions Results ____________________________________________________ 31 4 I. INTRODUCTION 1. This paper makes the case that measurement of income inequality has a first-order impact on its estimated empirical effects. We specifically explore the empirical association between inequality and the transmission channels identified in the literature through which inequality can affect economic growth—human capital, fertility, capital services