Inequality and Growth: A Joint Analysis of Demand and Supply

Empirical evidence on the relationship between a country?s wealth inequality and economic growth is ambiguous. This paper provides reasonable explanations of this ambiguity. We investigate the implications which the shape of wealth distribution has for economic growth in a framework combining the Schumpeterian quality improvement model and the neoclassic production function. Since two types of individuals are assumed, the poor and the rich, the Gini-coefficient is decomposed in two variables, namely the relative wealth of the poor and the population share of the poor, each having a different effect on economic performance. Particularly in the separating equilibrium, an improvement in the relative wealth of the poor impedes economic growth, but a decline in the population share of the poor enhances economic growth. This suggests that empirical research on the base of the Gini-coefficient cannot generate a general relationship between wealth inequality and economic growth. Moreover, the impact of wealth inequality on economic growth is through the supply of human capital as well as the demand for better quality goods. Hence, the relationship between wealth inequality and economic growth is non-linear.