Income Inequality, Net Investment, and the U.S. Capital Stock: Is There an Equity-Efficiency Tradeoff?
28 Pages Posted: 31 Dec 2008 Last revised: 27 Feb 2011
Date Written: February 21, 2010
The equity versus efficiency approach emphasizes the importance of incentives and would predict a positive relationship between inequality and economic growth. This view was challenged in the 1990s by the incomplete markets and political outcomes theories, because of increasing empirical evidence of an inverse relationship between income inequality and economic growth. We offer a macroeconomic rationale which emphasizes the divergence between savings and investment in explaining the nature of the relationship amongst inequality, net investment spending, and a country’s capital stock. For the United States over the period 1970 to 2006, we have found no empirical evidence for the support of incentives being necessary for capital accumulation. In fact, it was discovered that in most cases, inequality has had little or no impact on movements in the U.S. capital stock, net investment, and consequently no effect on economic growth. Another interesting finding of this study was that inequality exhibits hysteresis--implying that any shock, such as the dot-com boom, can lead to persistent and enduring increases in inequality.
Keywords: cointegration, Vector Error Correction (VEC), income inequality, equity, efficiency, unit root, hysteresis, incomplete markets, political outcomes
JEL Classification: C32, D31, D63, E12
Suggested Citation: Suggested Citation