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Poverty, Income Inequality and Economic Growth in U.S. Counties: - page 5 / 33





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2. Relationship among Economic Growth, Poverty and Inequality

Inequality and Poverty on Economic Growth

The three main theories that relate income distribution, poverty and economic

growth are a) savings rate argument b) credit market imperfection argument and c)

political economy argument. The Harrod Domar model, which is based on the savings

rate theory, predicts that a higher income inequality leads to higher economic growth.

According to this strand of literature, the savings rate in an economy is directly

proportional to income level. Thus, a richer person saves on average a larger fraction of

his or her income than a poorer person does. Consequently, concentrating income in the

hands of a few rich people can maximize the aggregate savings rate in an economy

compared to an equitable income distribution among the population. Fields (1989)

maintains that inequality leads to higher growth as one of his null hypothesis.1 The

implicit assumption in these models is that a higher savings rate translates to higher

investment (leading to higher economic growth), which is not necessarily true for all

economies, particularly for small open economies.

According to credit-market imperfection theory, inequality curtails the ability of

people to accumulate human and physical capital. In general, people’s income level and

possession of assets largely determine their access to credit markets. Therefore, people in

unequal societies typically face borrowing constraints that preclude them from investing

in human and physical capital. Stocks of physical and human capital in an unequal

society are much lower compared to a more egalitarian society, which leads to lower per

capita income and income growth rate. However, concentrating assets and income in the


The hypothesis was not supported by his data set.


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