Income Inequality and Political Stability

Partly prompted by the recent financial crisis, a debate has resurfaced about the implications of inequality and political instability for prosperity.  One strand of this literature, associated with Lewis (1955) and Kaldor (1956), argues that higher inequality is beneficial for growth because wealthier groups hold the resources necessary for investment.  Another strand, which is the focus of this post, shows that the channel through which inequality affects growth is political.  In an unstable political environment, which can be created by high income inequality, investment is discouraged by a higher risk of expropriation and voters’ preferences towards redistributional policies, both of which affect growth adversely.

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