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Does Wealth Inequality Matter for Growth? The Effect of Billionaire Wealth, Income Distribution, and Poverty SUTIRTHA BAGCHI† & JAN SVEJNAR‡ † Villanova University ‡ Columbia University NOVEMBER 2015 Motivation for the paper “. . . the absence of data on the distribution of wealth for a sufficient number of countries forces researchers to use proxies in empirical studies. The most common approach is to use data on income inequality as a proxy for wealth inequality.” Aghion, Caroli, and GarciaPenalosa (1999) Bénabou (1996) echoes this point and notes that the lack of almost any data on the distribution of wealth is a general problem, given that in most theories it is this distribution rather than that of income which is the determinant of outcomes. Ravallion (2012) emphasizes that “wealth inequality is arguably more relevant though this has been rarely used due to data limitations.” Research questions 1. How does wealth inequality affect economic growth? 2. Does the relationship between growth and inequality depend on the nature (source) of this inequality? e.g. Does inequality based on political connections differ from one that is based on success as an entrepreneur? 3. What is the relative growth effect of wealth inequality, income inequality, and poverty? Theoretical literature provides arguments for why inequality is good for growth Marginal propensity to save of the rich is higher than that of the poor 2) Investment indivisibilities: 1) Low inequality Low levels of innovation Low productivity growth Low growth in real GDP per capita 3) Trade-off between equity and efficiency … but it also provides arguments for why inequality is bad for growth Credit market imperfections: You cannot borrow against your human capital 2) Greater demand for redistribution leading to a choice of economically inefficient policies; and 3) Greater social unrest, possibly also leading to a higher degree of macroeconomic volatility 1) Existing empirical evidence: Mixed Cross - country & cross-sectional regressions suggest that income inequality is bad for growth: Alesina & Rodrik (QJE, 1994) Persson & Tabellini (AER, 1994) Results do not always hold up under robustness checks; do not answer the question of what happens when inequality in a given country changes Distinctly different results when examined in a panel set-up Forbes (AER, 2000) Data source for the paper Forbes magazine’s list of billionaires: Published list of billionaires from around the world since 1987 Estimate wealth based on the holdings of individuals in public companies or estimated holdings in private companies using standard price multiples We use the Forbes ’ billionaire data set to create two variables: Proxy measure of wealth inequality = Sum of wealth of all billionaires in a country/ Country GDP E.g. Country 1 has 3 billionaires with wealths equal to $5 billion, $2 billion and $1 billion, and country’s GDP = $500 billion. Measure of wealth inequality = (5 + 2 + 1)/ 500 = 1.6% Correlations between wealth distribution data from UNU–WIDER & Forbes’ list of billionaires Raw correlation coefficient and Spearman rank correlation coefficient for the share of wealth going to the top decile and our measure of wealth inequality for a sample of 18 countries are 0.54 (p-value = 0.0199) and 0.58 (p-value = 0.0122). Cross-country correlation between the Gini coefficients of wealth available for 22 countries for the year 2000 from the Davies et al. (2008) data set and our measure of wealth inequality for 2002: 0.50 (p = 0.0188). These are relatively high positive correlations We split wealth inequality into two components Wealth Inequality (or Billionaire wealth/GDP) “Politically connected” “Politically unconnected” billionaire wealth /GDP billionaire wealth /GDP Classify billionaires as politically connected or not (A billionaire can be in only one of the two categories) Previous example: Suppose billionaire 2 gets classified as politically connected Politically connected billionaire wealth / GDP = $2/$500 = 0.4% Politically unconnected billionaire wealth / GDP = $6/$500 = 1.2% How do we classify someone as “politically connected”? Extensive search on Factiva & Lexis-Nexis “Criteria”: Have political connections played a material role in the success of the billionaire? Would they have been billionaires absent political connections? Careful to distinguish between explicit government support from a generally pro-business regulatory environment Classic examples: Oligarchs from Russia or the cronies of Suharto (Indonesia) Ranking of countries in terms of politically connected matches priors Countries that rank highest in terms of politically connected wealth inequality 1. 2. 3. 4. 5. Malaysia Colombia Indonesia Thailand Mexico Median rank on TI’s Corruption Perceptions Index: 32 /41 (1995) & 94/174 (2012) Countries that rank lowest in terms of politically connected wealth inequality 1. 2. 3. 4. 5. 6. Hong Kong Netherlands Singapore Sweden Switzerland and United Kingdom Median rank on TI’s Corruption Perceptions Index: 9 /41 (1995) & 8/174 (2012) Other countries which just follow these include – Chile, South Korea, Philippines, Argentina, and, India. Italy has the 11th highest level of politically connected wealth inequality in our sample – the highest of any European country. What we include in our data set 20-year period from 1988 – 2007 divided into 4 periods of 5 years duration each All countries in the world subject to availability of data on covariates. When a country does not have billionaires, we set billionaire wealth = 0 (more on this later) ~ 60 countries (and 160 country-period combinations) appear in the final estimation Growthi,t = β0 + β1Wealth inequalityi,(t−1) + β2Income inequalityi,(t−1) + β3Headcount povertyi,(t−1) + β4Incomei,(t−1)+ β5Schoolingi,(t−1) + β6PPPIi,(t−1) + β7Dummyi,(t−1) + αi + ηt + νi,t One may be concerned about reverse causality Relationship runs not from inequality to growth but from growth to inequality (Kuznets’ hypothesis, 1955) The early stages of development exacerbate inequality while later stages of development improve equality. Empirically this lacks support. (See e.g. Fields, 2001) Empirical strategy - use lags of the explanatory variables, which are pre-determined as regressors Also we use IV & GMM estimation approaches Number of countries & billionaires on the list Year Countries Number of billionaires/ billionaire families 1987 23 201 1992 31 340 1996 38 543 2002 42 568 Impact of wealth inequality, income inequality, and poverty on economic growth (Benchmark) (1) (2) (3) (4) (5) (6) Dependent variable: Growth rate in real GDP per capita Wealth -0.132* -0.547 -50.07*** Inequality (0.0771) (0.351) (13.27) Politically unconnected -0.0464 -0.154 -48.98 wealth inequality (0.0714) (0.301) (36.52) Politically connected -0.331*** -1.625*** -51.01** wealth inequality (0.0965) (0.536) (22.79) 0.000530 0.000753 0.000498 Income Inequality Headcount Poverty 0.000564 0.000763* 0.000498 (0.000422) (0.000455) (0.000417) (0.000426) (0.000456) (0.000418) 0.000301 0.000252 (0.000296) 0.000353 0.000298 0.000243 0.000352 (0.000307) (0.000286) (0.000298) (0.000310) (0.000297) N 160 149 160 160 149 160 R2 0.59 0.59 0.61 0.60 0.60 0.61 Including the controls: GDP/ capita; Schooling & Price level of investment S.e. in parentheses * p < 0.10, ** p < 0.05, *** p<0.01 Comparing our results with Forbes (2000) (1/2) (1) (2) (3) (4) Panel A: Assuming income and wealth inequality to have the same effect during the entire sample period Income Inequality 0.000751 0.000991 0.00102 0.000947 (0.000886) (0.000830) (0.000858) (0.000840) Wealth Inequality -0.154*** (GDP used for normalization) (0.0484) Wealth Inequality -0.578*** (Physical capital used for normalization) (0.179) Wealth Inequality -6.255*** (Population used for normalization) (2.061) Number of observations 162 162 152 162 R2 0.39 0.45 0.44 0.42 F 5.343 8.717 8.740 7.138 S.e.in parentheses * p < .10, ** p <.05, *** p <.01 Comparing our results with Forbes (2000) (2/2) (1) (2) (3) (4) Panel B: Introducing dummy variable for first half of the sample period & corresponding interactions Income Inequality Wealth Inequality (GDP used for normalization) Wealth Inequality (Physical capital used for normalization) Wealth Inequality (Population used for normalization) Income Inequality X First half of sample period Wealth Inequality X First half of sample period (GDP used for normalization) Wealth Inequality X First half of sample period (Physical capital used for normalization) Wealth Inequality X First half of sample period (Population used for normalization) Number of observations R2 F S.e.in parentheses * p < .10, ** p <.05, *** p <.01 0.000419 (0.000894) 0.000757 (0.000858) -0.131** (0.0493) 0.000698 (0.000896) 0.000630 (0.000847) -0.525** (0.201) 0.000750** (0.000327) 0.000492 (0.000333) 0.000614* (0.000327) -7.771*** (2.690) 0.000742** (0.000317) 0.0691 (0.0797) -0.0110 (0.324) 162 0.41 4.720 162 0.46 9.321 152 0.46 9.280 -6.665 (5.169) 162 0.46 6.751 Robustness checks RC1: Robustness to Forbes magazine’s choice of countries for the billionaires in the data set RC2: Use of alternative econometric approaches: i. ii. iii. Random effects instead of a fixed effects specification Instrumental variables Dynamic panel methods of estimation (Arellano & Bond difference-GMM and Blundell & Bond system-GMM) RC3: Robustness to inclusion of additional control variables: i. ii. Adding a measure of institutional quality Controlling for the exchange rate RC4: Using $1.25 per day per person as the poverty line Impact of wealth inequality, income inequality, and poverty on economic growth (Using RE) (1) (2) (3) (4) (5) (6) Dependent variable: Growth rate in real GDP per capita Wealth Inequality -0.162* -0.652 -59.05*** (0.0962) (0.431) (14.67) Politically unconnected -0.0145 0.0261 -17.52 wealth inequality (0.0688) (0.284) (48.52) Politically connected -0.458*** -2.332*** -90.14*** wealth inequality (0.0600) (0.409) (20.85) Income Inequality Headcount Poverty N -0.000143 -0.0000126 -0.000145 -0.000171 (0.000513) -0.000151 0.0000258 (0.000435) (0.000438) (0.000509) (0.000437) (0.000441) 0.000386* 0.000364 0.000417** 0.000434** (0.000214) (0.000223) 160 149 0.000406* 0.000425** (0.000205) (0.000209) (0.000218) (0.000205) 160 160 149 160 Including the controls: GDP/ capita; Schooling & Price level of investment S.e. in parentheses * p < 0.10, ** p < 0.05, *** p<0.01 Impact of wealth inequality, income inequality, and poverty on GDP per capita (Using Arellano-Bond difference-GMM estimator) (1) (2) (3) (4) (5) (6) Dependent variable: Log of GDP per capita Wealth -0.498* -2.059 -167.3** Inequality (0.292) (1.263) (66.25) Politically unconnected -0.112 -0.437 -126.2 wealth inequality (0.220) (0.969) (174.7) Politically connected -1.514** -6.960* -202.2 wealth inequality (0.720) (3.854) (149.4) Income Inequality 0.00144 0.00171 0.00146 0.00160 0.00184 0.00154 (0.00173) (0.00182) (0.00180) (0.00186) (0.00194) (0.00176) 0.00330* 0.00300* 0.00340* 0.00348** 0.00323* 0.00329* (0.00174) (0.00167) (0.00174) (0.00176) (0.00173) (0.00173) Lagged log GDP per 0.660** 0.659** 0.682** 0.715*** 0.716*** 0.663** capita (0.275) (0.277) (0.276) (0.265) (0.271) (0.280) 89 88 89 89 88 89 Headcount Poverty N Including the controls: GDP/ capita; Schooling & Price level of investment S.e. in parentheses * p < 0.10, ** p < 0.05, *** p<0.01 Impact of wealth inequality, income inequality, and poverty on GDP per capita (Using Blundell-Bond system-GMM estimator) (1) (2) (3) (4) (5) (6) Dependent variable: Log of GDP per capita Wealth -0.593* -2.135 -210.9*** Inequality (0.355) (1.439) (57.86) Politically unconnected -0.277 -0.564 -183.6 wealth inequality (0.475) (1.589) (332.7) Politically connected -1.405* -6.699* -236.7 wealth inequality (0.782) (3.589) (266.0) Income Inequality -0.00207 -0.000981 -0.00199 -0.00215 -0.00110 -0.00200 (0.00404) (0.00334) (0.00399) (0.00395) (0.00327) (0.00387) 0.00726*** 0.00633*** 0.00720*** 0.00733*** 0.00647*** 0.00726*** (0.00271) (0.00240) (0.00267) (0.00277) (0.00238) (0.00272) Lagged log GDP per 0.865*** 0.903*** 0.868*** 0.867*** 0.907*** 0.868*** capita (0.105) (0.109) (0.103) (0.107) (0.111) (0.109) 161 149 161 161 149 161 Headcount Poverty N Including the controls: GDP/ capita; Schooling & Price level of investment S.e. in parentheses * p < 0.10, ** p < 0.05, *** p<0.01 Impact of wealth inequality, income inequality, and poverty on GDP per capita (Using Blundell-Bond system-GMM estimator) (Taking wealth inequality as pre-determined) (1) (2) (3) (4) (5) (6) Dependent variable: Log of GDP per capita Wealth -0.833* -3.154* -258.2*** Inequality (0.470) (1.898) (90.84) Politically unconnected -0.389 -0.731 -94.39 wealth inequality (0.370) (1.210) (311.0) -2.092*** -10.04*** -403.3** (0.629) (2.866) (162.0) Politically connected wealth inequality Income Inequality -0.000634 -0.000545 -0.000931 -0.000348 0.000497 -0.00107 (0.00255) (0.00267) (0.00256) (0.00302) (0.00296) (0.00306) 0.00310* 0.00333* 0.00334** 0.00320* 0.00297 0.00343* (0.00174) (0.00189) (0.00166) (0.00187) (0.00192) (0.00184) Lagged log GDP per 0.991*** 1.031*** 1.000*** 0.987*** 1.003*** 1.000*** capita (0.0345) (0.0429) (0.0323) (0.0232) (0.0310) (0.0291) 161 149 161 161 149 161 Headcount Poverty N Including the controls: GDP/ capita; Schooling & Price level of investment S.e. in parentheses * p < 0.10, ** p < 0.05, *** p<0.01 Why is politically connected wealth inequality detrimental? Example 1: Birla family of India: “The nationalists who later became free India’s power elite rewarded the Birla family with lucrative contracts. After independence, the Birlas continued their lavish contributions to the ruling Congress Party. So accomplished are they in manipulating the bureaucracy, and so vast their network of intelligence, that they frequently obtain preemptive licenses, enabling them to lock up exclusive rights for businesses as yet unborn.” (Forbes, 1987) Why is politically connected wealth inequality detrimental? Example 2: Tobacco billionaires in Indonesia: Indonesia is the only country in Asia to have not signed the WHO Framework Convention on Tobacco Control, a treaty that as of September 2013 had been signed by 177 parties. This is in spite of the fact that in Indonesia, Muslims constitute 86 percent of the population and “smoking is either completely prohibited in Islam or abhorrent to such a degree as to be prohibited.” (WHO Regional Office for the Eastern Mediterranean). Indonesia’s average tobacco tax of 37 percent is the lowest in Southeast Asia and well below the global average of 70 per cent of the sales price (South China Morning Post, 2008). Conclusions 1. 2. 3. High levels of wealth inequality appear to have negative consequences for economic growth; income inequality and headcount poverty do not Wealth inequality arising on account of political connections reduces economic growth v. wealth inequality arising otherwise Growth-related policy debate should focus on distribution of wealth