An extensive data on poverty traps suggests that high levels of poverty deter growth. However, a seemingly basic implication of the underlying theoretical models, namely that countries suffering from higher levels of poverty should grow less rapidly, has remained untested.
A parallel data has suggested a variety of mechanisms through which inequality may affect growth in opposing directions. Because inequality and poverty are different aspects of the income distribution, inequality can also affect growth through poverty, an indirect channel that has not been explicitly analyzed.
The research paper by World Bank contributes to filling both gaps. Using a large cross-country panel data set, it estimates a reduced-form growth equation adding both inequality and poverty to an otherwise standard set of growth determinants.
Given inequality, the correlation of growth with poverty is consistently negative. In contrast, given poverty, the correlation of growth with inequality can be positive or negative, depending on the empirical specification and econometric approach used. Yet, the indirect effect of inequality on growth through its correlation with poverty is robustly negative.
Closer inspection shows that these results are driven by the sample observations featuring high (but not extremely high) poverty rates.
These empirical findings are consistent with the predictions from an analytical framework with learning-by-doing and knowledge spillovers, in which consumers cannot save and invest if their initial endowment is below a minimum consumption level.
The full research paper is available on World Bank’s website.