Long-term determinants of income inequality: evidence from panel data over 1870–2016

Abstract

We investigate the major factors which drive income inequality in the OECD countries, using long panel data which span the period from 1870 to 2016. We consider two measures of inequality: the Gini coefficient and the income share of the top 10% of the population. Employing the panel vector auto-regression method, we show that a positive shock to the real interest rate and government spending is negatively and significantly associated with income inequality in the middle, as well as at the top end of the income distribution. An increase in real GDP per capita leads to an increase in income inequality, measured by the Gini coefficient, whereas an advance in financial development reduces it. We find that income inequality responds negatively to positive innovation shocks initially, but this effect becomes positive with some time lag for top-income inequality. Educational attainment significantly reduces top-income inequality. Our results are robust to alternative specifications, including the local projection method and estimations based on different samples. We also capture the time dynamics in our series using a time-varying nonparametric panel data model and show that the real interest rate and financial development are negatively associated with income inequality for most of the period in the post-World War II era, while the effect of real GDP per capita is positive and significant over the same period.