Inequality of opportunity, inequality of income and economic growth

Abstract

Despite the firm consensus that income inequality is intrinsically undesirable, its impact on economic growth is much disputed. We posit that the relationship between income inequality and economic growth is conditioned by the level of equality of opportunity. Our testable hypothesis is simple: in societies where opportunities are unequally distributed – where the material circumstances of parents act as binding constraints on the opportunities available to their children – income inequality exerts a greater drag on future growth. In contrast, in societies with a more equal distribution of opportunities, an increase in income inequality can be more easily reversed and need not constrain investment opportunities and growth. We identify equality of opportunity with intergenerational mobility, that is, the degree of the correlation between parents’ attainments (income and education) and childrens’ attainments. We use several recently developed internationally comparable measures of intergenerational mobility—including the World Bank’s comprehensive GDIM database—to confirm that the negative impact of income inequality on growth is higher the lower is intergenerational mobility. Our results suggest that omitting intergenerational mobility leads to misspecification, shedding light on why the empirical literature on income inequality and growth has been so inconclusive.