The Relationship between Income Inequality and Economic Growth: A Review of Theoretical Approaches and Empirical Findings

Abstract

The relationship between income inequality and economic growth has been debated in economics for over half a century without a settled consensus. This paper reviews the major theoretical approaches to this relationship, from Kuznets's early hypothesis of an inverted-U relationship between development and inequality, through political-economy models predicting that inequality harms growth by constraining redistribution and human capital investment, to new growth theory perspectives emphasizing credit constraints and imperfect capital markets. The review then examines the empirical literature, which has produced conflicting findings depending on time period, country sample, and inequality measure, before considering more recent work, including the historically grounded analysis of Piketty and the cross-country panel studies conducted by the International Monetary Fund, that has moved toward a more contingent, context-dependent understanding of the relationship. The review concludes that the theoretical and empirical literature no longer supports either the older assumption that inequality is a necessary by-product of growth or its inverse, that redistribution can be pursued without any growth cost, and instead points toward a research agenda focused on identifying the specific institutional and policy conditions under which inequality and growth are complements or substitutes.