Does inequality harm income mobility and growth? : an assessment of the growth impact of income and education inequality in Paraguay 1992 - 2002

Poverty reduction is entirely determined by the growth rate of population’s mean per capita income1 and by the change in the distribution of income. This places the empirical relation between growth and inequality at the heart of poverty reducing strategies. This study, which estimates the relation for Paraguay, aims to identify the growth effects of income and education inequality while controlling other factors such as initial levels of wealth and human capital, family characteristics and unobserved spatial heterogeneity. The paper uses two sets of small area welfare estimates often referred to as poverty maps to estimate five different models of per capita income growth between 1992 and 2002, by comparing pseudo panel samples of these poverty maps. Since the analysis is based on groups of people, grouped in a pseudo panel, the results can be understood as well as an income mobility indicator. In the models used, standard errors were corrected to reflect the uncertainty as a result of income estimates, rather than income observations, being used. These corrections are sizable: standard errors using estimates are between 1 and 20 times larger than using income observations. The more homogeneous the sample is, the lower the error increase. Conditional convergence (initially low income groups grew faster) is confirmed by the results. They indicate that it is income inequality rather than human capital inequality, that affects growth and that this effect is negative. Nevertheless, there are also positive growth effects of human capital inequality, however some not as strong as income inequality results.