When Aiyagari meets Piketty: Growth, Inequality and Capital Shares

Abstract

We incorporate the division of income between capital and labor into analysis on the relationship between inequality and growth. Using historical data, we document that changes in the top 1 % income shares are positively associated with subsequent growth of per capita GDP when the capital share of income is low, whereas under high capital share, the association is negative. We show that these findings are compatible with a theoretical analysis that emphasises how changes in the distribution of income translate into the accumulation of capital and overall economic activity through the interplay between precautionary saving motives and consumption smoothing. We also investigate how accounting for financial frictions affects our main findings.

Keywords: Economic growth, Inequality, Top income shares, Capital shares

JEL Classification: D31, E21, E25, O15