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Poverty, Income Inequality and Economic Growth in U.S. Counties: - page 6 / 33

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hands of a few people (perhaps rich) would facilitate economic growth if larger

investments yield increasing returns than smaller investments (Barro 1999).

The credit-market imperfection theory can fail to hold in a rich, yet unequal

society (Goudie and Ladd 1999). In such an economy, where most of the people are

relatively well-off, only a few will be credit constrained and therefore the theory’s

prediction could fail. Because higher inequality does not necessarily imply a larger

fraction of poor people, the credit-market imperfection argument can be better suited to

explain the link between poverty and economic growth.

The political economy argument focuses on the distortionary interventions in an

unequal society that leads to slower economic growth. Alesina and Rodrik (1994),

Persson and Tabellini (1994) and a few others contend that majority of the voters may

vote in favor of redistributive policies if their income is below the mean income. Such

policies, primarily in the form of higher capital taxes, serve to reduce investment

incentives and thus lower economic growth. However, this effect will be minimal in

economies where there is a strong lobbying of rich-special interest groups. As Bhatta

(2001) argues, egalitarian societies are more likely to implement redistributive policies

and thus experience lower economic growth.

Alesina and Perotti 1996, Barro 1999, and a few others present a different version

of the political economy argument that focuses on social unrest in unequal economies.

Social discontent creates an uncertain political-economic environment that reduces

investment and consequently lowers economic growth. As per this version, social unrest

can hamper economic growth through two channels. First, in a highly unequal society,

the poor may engage in disruptive activities such as crimes and riots that can destroy or

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