The Impact of Income Inequality on Economic Growth Through Channels in the European Union

Abstract

There is contradictory evidence about the impact of rising income inequality on economic growth through different transmission channels. Inequality can positively influence growth by raising savings and investments, providing incentives for innovation, investment in research and development, as rich people save a higher part of their income, especially in less developed countries. However, inequality may be harmful to growth because it leads to higher levels of social and economic instability, which reduces investment. Investment may also be discouraged by less demand from lower income households in countries where the level of inequality is high. The aim of this research is to assess the impact of income inequality on economic growth through the savings channel and sociopolitical unrest channel in the European Union’s 28 countries grouped according to the level of income inequality and country’s level of development. We use the ordinary least square regression method for panel data of 28 EU countries, divided into groups, over the period 1995–2014. Econometric results show that rising inequality has a negative impact on growth through savings channels in all groups of countries. However, it was also found that rising inequality had a negative impact on growth through the sociopolitical unrest transmission channel in the groups of the countries defined by the lower income inequality level at different stages of country development and a positive impact in the groups of the countries defined by the higher income inequality level.