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