Purpose--This paper investigates the effects of income distribution on economic growth in Islamic Republic of Iran.
Design/methodology/approach--An endogenous growth model is specified, that includes human capital and technological progress. The generalized autoregressive conditional heteroskedasticity (GARCH) technique is used to estimate regression parameters.
Findings--The results show that rising income inequality, which is measured by the Gini index and the ratio of income of the household at the 90th percentile to the household at the 10th percentile, would hinder economic growth in Iran. However, there is a positive relation between economic growth and the growth in employment, investment spending, technological progress, and human capital.
Practical implications--The main practical implication of the paper is that the effect of a rise in inequality on economic growth is negative in Iran.
Originality/value--The current study is believed to be the first of its kind that enters human capital in the model, uses two different measures of inequality, and focuses on the case of Iran.
In the last decades, the world has witnessed the global expansion of neo-liberal economic ideas and policies, most notably drastic cutbacks in government regulations of economic activities. The belief that economic performance is best enhanced by freeing markets of government interference has become widely accepted among policy planners and politicians on both the left and the right. (1) The most visible examples of purportedly harmful government interference in market processes are social welfare and other redistributive programs. These are widely regarded as both wasteful and harmful, diverting societal resources from more productive use and discouraging initiative and effort. In this view, program outcomes may include a more equitable distribution of income, but at the cost of decreased economic performance.
Neo-liberals justify the economic inequalities associated with markets in terms of efficiency. In their views, by providing a greater incentive for individual hard work and initiative, freer markets are supposed to lead to more competitive national economies and a bigger economic pie for everybody. (2) This neo-liberal argument has impressive academic credentials, a persuasive voice in public policy debates, and decades of worldwide political successes. However, it lacks enough empirical supports. Simply put, there is not persuasive evidence that increasing inequality is associated with improved economic performance. Considering this, there is a need to empirically answer the question that whether the rising income inequality would facilitate or hinder economic growth in different countries.
This study attempts to answer this question in the case of Islamic Republic of Iran. It empirically examines the impact of income inequality on economic growth. An econometric model is used which is based on the endogenous growth model incorporating human capital and technological progress. In this model, Capital growth is replaced by the investment-output ratio to avoid a high degree of multicollinearity among input factors. Two different measures for income inequality are considered in order to determine whether the results are robust. The paper applies the generalized autoregressive conditional heteroskedasticity (GARCH) model developed by Engle and Robert (2001) to determine whether the error variance depends on past squared errors and past error variances.
The study is organized in the following manner. The literature review is described in Section 2. A theoretical model is presented in Section 3 and data sources and methodology are discussed in section 4. Empirical results are given in Section 5. Summary and conclusions are provided in Section 6.
The relation between inequality and growth has been under discussion for a long time. In classical economic theory, inequality of incomes was thought to influence economic growth rates through savings and consumption. According to Adam Smith, (3) an increased division of labor raises productivity, but savings govern capital accumulation, which enables production growth. It was a common belief in the 18th century that only rich people saved. Therefore, economic growth was possible only when there were enough rich people in society. Adam Smith also argued that production growth would not be possible without sufficient demand. He stated that every man should be able to provide for himself and his family. This would constitute the threshold of sustainable inequality and would assure a sufficient level of demand.
According to John Maynard Keynes, (4) inequality of incomes leads to lower economic growth. Keynes argued that marginal consumption rates are equal among all income brackets. As a result, aggregate consumption depends on changes in aggregate income. According to Keynes, demand is the basis of investments, and because inequality lowers aggregate consumption, inequality of incomes will diminish economic growth.
If one seeks to evaluate the literature more specifically, he or she might find that no study has explicitly focused on the impact of inequality on economic growth in Iran. However, this relation or other related ones, has been considered for other countries or group of countries. Greenspan (5) attributed income inequality in US to technological progress, changing organizational structure, and increase in...