Inequality Affects Long-Run Growth: Cross-Industry, Cross-Country Evidence

Abstract

The theoretical literature has predicted that inequality affects long-run growth by reducing human and physical capital, particularly in the presence of imperfect credit markets and other contractual frictions. We test these four mechanisms using measures of inequality at the country-level, dating as far back as the 1700s, and the 1800s, and data for 27 manufacturing industries across 88 countries during 1981–2015. Our findings show industries that are more dependent on financial markets experience lower long-run growth in real output, number of firms and real salaries in more unequal countries compared to more egalitarian. Similarly, industries intensive in physical capital experience lower growth in salaries in highly unequal countries. However, there is no evidence that industries intensive in human capital experience any differential growth in output, the number of firms, average number of employees or salaries in unequal countries compared to more egalitarian, suggesting that the progress made in public schooling provision could have lessened the effect of inequality. Moreover, industries with complex contractual arrangements experience lower growth in the number of firms and paradoxically higher growth in the number of employees hired in more unequal countries, in line with the predictions of the theoretical literature. These findings are robust to using contemporaneous indicators of inequality and instrumental variable specifications.