How macroeconomic factors affect income distribution : the cross-country evidence

The effects of macroeconomic factors on income distribution are of major concern to economists and have critical policy implications. Surprisingly, despite the fact that income distribution is one of the most investigated issues in economics, very few studies have looked at the direct link between macroeconomic factors and income inequality. This study examines, in a cross-section empirical framework, the relationship between the macroeconomic environment and trends in income distribution. It aims at identifying the macroeconomic variables that significantly affect trends of income distribution and at estimating the magnitude of these effects. The macroeconomic variables examined include both policy variables (such as public expenditure and inflation) and variables that are considered to be exogenous (such as changes in the terms of trade). In addition, a set of demographic indicators that are likely to affect income distribution is also included in the analysis. The macroeconomic variables that are found to have a significant negative effect on changes in income inequality (that is, are associated with an improvement in income distribution) are higher growth rate, higher income level, higher investment rate, real depreciation (found to be more important in the case of low-income countries), and improvement in terms of trade. Macroeconomic variables found to have no significant effect on changes in income distribution are inflation (including level, variability, and rate of change), public consumption, external position (both levels and changes), level of the real exchange rate, and the price ratio of investment/consumption goods. The estimated significant effects of growth, income, and investment provide evidence that policies designed to promote investment and growth are likely also to contribute to an improvement in income distribution. This result is particularly important given the wide-spread perception of a possible trade-off between growth and equity. Not only do we not find evidence of such a trade-off, but our results strongly suggest that the less fortunate segments of the population benefit relatively more from economic growth.