The Relationship Between Economic Growth and Income Inequality in Economies in Transition

Abstract

ABSTRACT In this study, we focus solely on economies in transition. The classification of the countries into the low-income and high-income economies in transition are based on the classification of the World Bank and on our own classification based on an income threshold that is endogenously estimated by our model. We use fixed-effects and dynamic panel technique such as system generalized method of moments (GMM) estimation in our analysis to mitigate endogeneity problem. Our empirical study uses dynamic econometric models to examine the relationship between income inequality and economic growth in the economies in transition. We find a positive relationship between income inequality and economic growth in high-income economies in transition, which is in stark contrast with the negative relationship for low-income economies in transition. We also find that inflation rate negatively and significantly affects economic growth in the low-income economies in transition, while it positively and significantly affects economic growth in the high-income economies in transition. We estimate an income threshold endogenously and reestimate both regressions according to our own threshold. Importantly, the contrasting qualitative difference (between low-income economies in transition and high-income economies in transition) in the relationship between income inequality and economic growth is robust whether we follow the World Bank’s classification of economies in transition or whether we classify them accordingly to what the data in our sample suggest.