Does Income Inequality Hamper or Foster Economic Growth in Sub-Saharan Africa?

Abstract

POLICY QUESTION

“What is the relationship between inequality and economic growth? Specifically, does income inequality hamper or foster economic growth in developing countries?”

BACKGROUND

As the global economy experienced rapid economic growth after World War II, an intense debate arose as to whether such growth benefited poor people and reduced income inequality or vice versa. In the 1950s, Kuznets explained that there is a trade-off between income inequality and economic growth. He proposed that income inequality initially rises but then declines as per capita income increases. If this hypothesis is true, the income inequality that developing nations are experiencing is not something that they should be concerned about, as it would eventually decline over the course of their economic growth. Many scholars have attempted to confirm as well as rebut this relationship; however, it remains ambiguous.

In contrast, studies of this relationship for sub-Saharan African countries have not been conducted thoroughly. African regions were struggling with extreme poverty and, as a result, dealing with poverty issues was the main concern of the governments and researchers. And sub-Saharan Africa countries had desperate health issues to deal with, such as high HIV prevalence rates. Finally, and most importantly, sufficient data for sub-Saharan African countries were lacking.

Recently, academic research on income inequality in sub-Saharan African countries became available as several countries started household surveys, which allowed the collection of more empirical data in this region. The increasing attention of international organizations further accelerated the research. Thus, the purpose of this master’s project is to examine the relationship between income inequality and economic growth in sub-Saharan African countries using these newly-available data. METHODS AND MEASUREMENTS The measure of income inequality used in the current study is the Gini coefficient. The main data source for income inequality is PovcalNet, an online poverty analysis tool provided by World Bank. The constructed data set is an unbalanced panel with data from 40 sub-Saharan African countries from 1980 to 2009. This paper examines the relationship between income inequality and economic growth with country-fixed effects to exclude time-invariant omitted variable bias.

RESULTS AND INTERPRETATION This paper finds that income inequality is positively correlated to annual changes in economic growth, controlling for changes in other explanatory variables. As a non-linear relationship was tested, this paper expects that the positive correlation will not continue for long for sub-Saharan African countries and that income inequality will eventually slow and decrease economic growth. This does not support other previous research in which only linear relationships were tested.

DISCUSSION AND CONCLUSION The results of this paper cannot guarantee that income inequality will eventually be detrimental to economic growth in the longer term. The measurement error and the possibility of reverse-causality remain as limitations. This paper, however, does address the fact that income equality is related to economic growth, suggesting that policy-makers in both the sub-Saharan African countries and international organizations should be more concerned about income inequality. Finally, this paper suggests that future researches consider the importance of instrumental variables to delineate the causal relationship between income inequality and economic growth.