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The case of US
Economic growth and income
inequality: the case of the US
Yu Hsing
College of Business & Technology, Southeastern Louisiana University, 639
Hammond, Louisiana, USA

Abstract
Purpose – The purpose of this study is to examine the impact of income inequality on economic
growth in the US.
Design/methodology/approach – This paper applies the endogenous growth model including
human capital and technological progress. The generalized autoregressive conditional
heteroskedasticity (GARCH) technique is applied to estimate regression parameters. The number of
patents granted is chosen to measure technological progress. Percentage of people 25 years old and
over who have completed 4 years of college or more is selected to measure human capital.
Findings – The findings show that a higher Gini index hurts economic growth. Economic growth
has a positive relationship with the growth in civilian employment, investment spending,
technological progress, and human capital. When three other indicators of income inequality are
considered, similar conclusions can be reached.
Research limitations/implications – A major implication is that a deterioration of inequality
would be harmful to economic growth.
Originality/value – Major contributions of the paper are to consider human capital in the model and
different measures of inequality in empirical work.
Keywords Income, Economic growth, United States of America, Human capital
Paper type Research paper

1. Introduction
In the latter half of the 1990s, the US experienced an annual economic growth rate of
4.10 percent, which is better than the 3.58 percent in the 1970s and 3.35 percent in the
1980s. The high growth rate can be attributed to several major factors. The
advancement of the internet and information technology has created many new
business and job opportunities. The Federal Government pursued balanced budget
and reduced Federal Government debt, thus lowering the cost of capital in the long run.
The Federal Reserve Bank monitored the economy closely to pursue price stability and
full employment and was ready to step in and took an active role in case of financial
crises. Low inflation rates helped the economy to grow because of potential
misallocation of resources and adjustment costs associated with high inflation rates.
One of the factors that may affect economic growth is income inequality. In recent
years, we have seen rising income inequality. During 1990-2001, the Gini index rose 8.9
percent from 0.428 to 0.466; the ratio of top fifth income to the bottom fifth income
increased 5.2 percent from 4.42 to 4.65; the ratio of top 5 percent income to the bottom International Journal of Social
20 percent income went up 10.55 percent from 7.58 to 8.38; and share of aggregate Economics
Vol. 32 No. 7, 2005
income by the top 5 percent of households grew from 18.6 to 22.4 percent. A question to pp. 639-647
be answered is whether rising income inequality would facilitate or hinder economic q Emerald Group Publishing Limited
0306-8293
growth. DOI 10.1108/03068290510601153
IJSE This study attempts to reexamine the impact of rising income inequality on
32,7 economic growth in the US and differs from previous studies in several aspects. The
model is based on the endogenous growth model incorporating human capital and
technological progress. Capital growth is replaced by the investment-output ratio to
avoid a high degree of multicollinearity among input factors. Several measures for
income inequality are considered in empirical work in order to determine whether the
640 results are robust. The paper applies the generalized autoregressive conditional
heteroskedasticity (GARCH) model developed by Engle and Robert (2001) to determine
whether the error variance depends on past squared errors and past error variances.
The study is organized in the following manner. Literature survey is described in
Section 2. A theoretical model is presented in Section 3. Empirical results are presented
in Section 4. A summary and conclusions are made in Section 5.

2. Literature survey
In his opening remarks on the income inequality symposium sponsored by the Federal
Reserve Bank of Kansas City, Chairman Greenspan (1998) attributed income inequality
to technological progress, changing organizational structure, and increase in
international trade. Technological progress raised wages for highly skilled workers
relative to unskilled workers. Globalization or trade tends to depress the return of
low-skill workers and raise the return for high-skill ones. He indicated that the
distribution of consumption and wealth should also be considered in evaluating
inequality. A Gini index constructed from the US consumption spending shows that
US households were better off in the later 1990s, whereas the Gini index based on
income exhibits rising income inequality.
Feldstein (1998) argued that rising income inequality is not a problem that needs
remedy. He reasoned that the society is better off if some people receive more income
while other people’s income does not decline. These high-income people were
successful because they were more productive, exhibited entrepreneurship, worked
longer hours, and could borrow money with lower costs. He stressed that poverty is a
serious concern due to long-term unemployment, lack of earning ability, and individual
choice. Reform of the unemployment insurance (UI) program in the 1980s helped
reduce unemployment rates. Poverty can be addressed through better on-the-job
training programs in the private sector and improved education with emphases on
decentralization and competition. Monetary policy cannot solve the poverty problem in
the long run.
Tyson (1998) indicated that inflation eroded real minimum wages and may have
reduced the earnings of the bottom fifth households by 20 percent and that the
declining unionization may account for 20 percent of the rise in income inequality
among men. The increase in single-parent households also contributed to the rising
income inequality. She suggested that human capital investment and college education
should be targeted at the children who come from low-income families. To deal with
the income inequality issue, the earned income tax credit (EITC) rose by as much as
210 percent and real minimum wages increased by 19 percent. She estimated that
during 1989-1997, the increases in the EITC and minimum wages combined to raise
earnings of a single mother by as much as 27 percent.
According to Romer and Romer (1998), in their study on monetary policy and the
well-being of the poor, a higher unexpected inflation rate reduces income inequality;
more output and inflation variability contributes to more income inequality; a lower The case of US
unemployment rate reduces poverty; and monetary policy can provide the poor with
more jobs and more wages in the short run. They maintained that the long-term costs
of rising inflation of expansionary monetary policy would outweigh the short-run
benefits.
In investigating the relationship between income inequality and business cycles for
the UK, the US, Italy, and Greece, Dimelis and Livada (1999) found that higher output 641
reduces inequality in the US and the UK, but it increases inequality in Greece. Besides,
the poor suffer from high unemployment, but they gain from high inflation.
Based on the US regional data since 1960, Rodriguez (2000) provided empirical
support of the institutionalist view that income inequality would cause socio-political
instability, which would reduce economic growth. Based on the cross-state data and
using the generalized moment method and fixed effects, Panizza (2002) found that
inequality and growth in the US have a negative relationship. However, he also
indicated that the negative relationship is weak and would vary with the
methodologies used.
Acemoglu and Robinson (2002) found that growth may result in an “East Asian
Miracle” with high output and low inequality or an “autocratic disaster” with low
output and high inequality. Burtless (2003) compared economic growth and inequality
between the US and other G7 countries and found that the US has more economic
growth and more inequality than these countries. He attributed the US situation to less
regulation in the market place and less assistance to the needy.

3. The model
Extending the works of Feldstein (1998), Tyson (1998), Romer and Romer (1998),
Furman and Stiglitz (1998), Dimelis and Livada (1999), Acemoglu and Robinson (2002),
and others, real GDP (Y) can be expressed as a function of major input factors such as
labor (L), capital stock (K), technology (T), human capital (HC), and income inequality
(IN).
Y ¼ FðL; K; T; HC; INÞ ð1Þ
Let the production be a simple function of L, K, and T. Because of a high degree of
multicollinearity among time series variables, estimated regression parameters may
change signs and may not be precise. To avoid potential problems of multicollinearity,
we differentiate the production function and divide it by output to obtain the output
growth rate equation.
+ + + +
Y ›Y L ›Y K ›Y =Y T
¼ · þ · þ · ð2Þ
Y ›L Y ›K Y ›T=T T
Entering human capital and income inequality into the above equation, we obtain
equation (3) for estimation.
GY ¼ b1 CLY þ b2 IY þ b3 GT þ b4 HC þ b5 IN ð3Þ
+ +
where Y =Y ; GY; the growth rate
+
of real GDP; L=Y ; CLY; the ratio of change in
labor employment
+
to real GDP; K=Y ; IY; the ratio of investment spending to real
GDP; T=T ; GT; the growth rate of technological progress; ›Y =›L ; b1 ; the
IJSE marginal product of labor; ›Y =›K ; b2 ; the marginal product of capital; and
ð›Y =Y Þ=ð›T=TÞ ; b3 is the output elasticity with respect to technological progress.
32,7 Furman and Stiglitz (1998) cited four possible factors in determining the sign of b5,
namely, savings, imperfect information and agency costs, fiscal policy, and social or
political stability. Though the rich tend to save more, the empirical result on rising
income inequality and aggregate saving is inconclusive. Segmented markets and
642 imperfect information often characterize a society with low equality. Asymmetric
information leads to the principal-agent problem and high agency cost and results in a
widespread economic inefficiency and slow growth. Under the pressure of rising
income inequality, the government may consider a progressive income tax policy to
redistribute income. However, such a policy may hinder capital accumulation and
economic growth. Or the rich and the powerful may lobby for lowering the tax rate
and government spending. If income inequality continues to worsen, social unrest and
political instability would occur, which strains the growth.
In analyzing time series data, researchers may find that error variance is not a
constant. Thus, the GARCH model is employed and can be expressed as:
X
p X
q
V t ¼ b0 þ bi 12t2i þ uj V t2j ð4Þ
i¼1 j¼1

It indicates that current error variance Vt is a function of past squared errors 12t2i and
past error variances V t2j : Note that if uj ¼ 0; equation (4) reduces to an ARCH model.

4. Empirical results
The sample consists of annual data ranging from 1967 to 2001. The number of patents
granted was taken from the US Patent and Trademark Office. Real GDP and
investment spending were taken from the Bureau of Economic Analysis, US
Department of Commerce. Real GDP and investment spending are expressed in
billions. Civilian employment is expressed in thousands. Civilian employment came
from the US Bureau of Labor Statistics. The data for the Gini index and percentage of
people 25 years old and over who have completed 4 years of college or more came from
the US Bureau of Census. The value of the Gini index ranges from 0 (complete income
equality) to 1 (complete inequality). The following three widely used measures of
income inequality are also considered:
(1) P95/20 is the ratio of income for the household at the 95th percentile to the
household at the 20th percentile;
(2) P90/10 is the ratio of income for the household at the 90th percentile to the
household at the 10th percentile; and
(3) P80/20 is the ratio of income for the household at the 80th percentile to the
household at the 20th percentile.
Let us first consider the regression including the Gini index. The results for the
GARCH (1,1) regression are presented in Table I. As shown in the variance equation,
the coefficient of the lagged squared residual is insignificant, and the coefficient of
lagged residual variance is significant at the 1 percent level. Because the
Durbin-Watson statistic of 2.151 is less than the critical value of 3.439 ð4 2 dL ¼
4 2 0:561Þ at the 1 percent level, the null hypothesis of no negative autocorrelation
 Coefficient Std error z-statistic Prob.
The case of US
CLY 7.614840 0.544667 13.98073 0.0000
IY 0.171146 0.088499 1.933881 0.0531
GT 0.023773 0.010393 2.287491 0.0222
HC 0.156894 0.063603 2.466777 0.0136
GINI 2 9.747337 2.571663 23.790285 0.0002 643
Variance equation
C 0.023659 0.042838 0.552297 0.5807
ARCH(1) 2 0.146973 0.250176 20.587480 0.5569
GARCH(1) 1.100611 0.311927 3.528425 0.0004
R2 0.683871 Mean dependent var 3.080387
Adjusted R 2 0.598760 S.D. dependent var 2.140651
S.E. of regression 1.355964 Akaike info criterion 3.166202
Sum squared resid 47.80459 Schwarz criterion 3.525346
Log likelihood 2 45.82544 Durbin-Watson stat 2.150993
Dependent variable: GY
Method: ML-ARCH (Marquardt)
Sample (adjusted): 1968-2001
Included observations: 34 after adjusting endpoints
Convergence achieved after 27 iterations Table I.
Bollerslev-Wooldrige robust standard errors and covariance GARCH regression with
Variance backcast: ON the Gini coefficient

cannot be rejected. All the coefficients are significant at the 1 or 5 percent level. The
sign for the Gini index is negative and significant, suggesting that an increase in
income inequality is harmful to economic growth. If the Gini index increases by 0.1,
real GDP will decline by 0.975 percentage points. The signs for the coefficients of other
input factors are as expected. Based on the estimate, if CLY rises by 1, real GDP will
grow by 7.615 percentage points, and if IY increases by 1 percentage point, real GDP
will grow by 0.171 percentage points. A 1 percent increase in patents granted would
lead to a 0.024 percent growth of real GDP. Moreover, if years of school completed rises
by 1, real GDP will grow by 0.157 percentage points.
In order to compare with the GARCH model, the results from the OLS regression are
described in Table II. As shown, except for the coefficient of CLY, all coefficients are
insignificant at the 10 percent level. The values of some of the coefficients change in the
GARCH model. It appears that the GARCH estimation is more appropriate than the
OLS. Because the OLS does not consider autoregressive conditional heteroskedasticity,
its residual variance is likely to be biased, and hypothesis tests are invalid.
The results of using the ratio of the 95th percentile to the 20th percentile (P95/20) as
an indicator of income inequality are presented in Table III. In the variance equation,
the coefficient for GARCH(1) or the lagged variance is significant at the 1 percent level.
As shown, the coefficient of P95/20 is negative and significant at the 2.5 percent level.
The sign of the coefficient of IY is insignificant. In the regression using the ratio of the
90th percentile to the 10th percentile (P90/10) in Table IV, income inequality has a
negative sign and is significant at the 1 percent level. The coefficient for IY is
insignificant, and the coefficient for GP has a weak significance. In the regression
including the ratio of the 80th percentile to the 20th percentile (P80/20) in Table V,
IJSE Variable Coefficient Std error t-statistic Prob.
32,7
CLY 7.099273 0.811474 8.748613 0.0000
IY 0.006749 0.193491 0.034881 0.9724
GT 0.019389 0.019989 0.969996 0.3401
HC 0.144589 0.108784 1.329136 0.1942
644 GINI 2 4.829797 4.259422 21.133909 0.2661
R2 0.700732 Mean dependent var 3.080387
Adjusted R 2 0.659453 S.D. dependent var 2.140651
S.E. of regression 1.249207 Akaike info criterion 3.417947
Sum squared resid 45.25500 Schwarz criterion 3.642412
Log likelihood 2 53.10510 Durbin-Watson stat 2.153943
Dependent variable: GY
Method: Least squares
Table II. Sample (adjusted): 1968-2001
OLS regression with the Included observations: 34 after adjusting endpoints
Gini coefficient White Heteroskedasticity-Consistent standard errors and covariance

the coefficient for the income inequality variable P80/20 is negative and significant at
the 1 percent level. Other outcomes are similar to those in Tables III and IV.

5. Summary and conclusions

This paper employs the endogenous growth model to examine the relationship
between economic growth and income inequality in the US. The GARCH model is
applied in empirical work. There is strong empirical evidence that rising inequality, as

Coefficient Std error z-statistic Prob.

CLY 7.426505 0.594115 12.50011 0.0000

IY 0.080502 0.119033 0.676298 0.4989
GT 0.025173 0.012428 2.025569 0.0428
HC 0.185358 0.085734 2.162009 0.0306
P95/20 2 0.496867 0.196741 22.525487 0.0116
Variance equation
C 0.008692 0.055941 0.155370 0.8765
ARCH(1) 2 0.128944 0.271375 20.475150 0.6347
GARCH(1) 1.098389 0.353401 3.108057 0.0019
R2 0.691782 Mean dependent var 3.080387
Adjusted R 2 0.608800 S.D. dependent var 2.140651
S.E. of regression 1.338890 Akaike info criterion 3.232002
Sum squared resid 46.60831 Schwarz criterion 3.591145
Log likelihood 2 46.94403 Durbin-Watson stat 2.187928
Dependent variable: GY
Method: ML-ARCH (Marquardt)
Sample (adjusted): 1968-2001
Included observations: 34 after adjusting endpoints
Table III. Convergence achieved after 23 iterations
GARCH regression with Bollerslev-Wooldrige robust standard errors and covariance
the 95/20 income ratio Variance backcast: ON
 Coefficient Std. error z-statistic Prob.
The case of US
CLY 7.554505 0.561759 13.44795 0.0000
IY 0.062354 0.111742 0.558022 0.5768
GT 0.020362 0.012016 1.694541 0.0902
HC 0.181434 0.073757 2.459895 0.0139
P90/10 2 0.351224 0.114286 23.073199 0.0021 645
Variance equation
C 0.016042 0.042065 0.381356 0.7029
ARCH(1) 2 0.130520 0.252726 20.516449 0.6055
GARCH(1) 1.093496 0.326324 3.350949 0.0008
R2 0.692380 Mean dependent var 3.080387
Adjusted R 2 0.609559 S.D. dependent var 2.140651
S.E. of regression 1.337591 Akaike info criterion 3.214832
Sum squared resid 46.51791 Schwarz criterion 3.573976
Log likelihood 2 46.65215 Durbin-Watson stat 2.153883
Dependent variable: GY
Method: ML-ARCH (Marquardt)
Sample (adjusted): 1968-2001
Included observations: 34 after adjusting endpoints
Failure to improve Likelihood after 14 iterations Table IV.
Bollerslev-Wooldrige robust standard errors and covariance GARCH regression with
Variance backcast: ON the 90/10 income ratio

Coefficient Std error z-statistic Prob.

CLY 7.515182 0.612176 12.27618 0.0000

IY 0.061068 0.123176 0.495777 0.6201
GT 0.021499 0.012685 1.694856 0.0901
HC 0.163561 0.075172 2.175813 0.0296
P80/20 2 0.707913 0.272088 22.601782 0.0093
Variance equation
C 0.009037 0.063662 0.141951 0.8871
ARCH(1) 2 0.109468 0.271651 20.402973 0.6870
GARCH(1) 1.070953 0.377810 2.834634 0.0046
R2 0.695851 Mean dependent var 3.080387
Adjusted R 2 0.613965 S.D. dependent var 2.140651
S.E. of regression 1.330024 Akaike info criterion 3.246700
Sum squared resid 45.99305 Schwarz criterion 3.605843
Log likelihood 2 47.19390 Durbin-Watson stat 2.206116
Dependent variable: GY
Method: ML-ARCH (Marquardt)
Sample (adjusted): 1968-2001
Included observations: 34 after adjusting endpoints
Convergence achieved after 18 iterations Table V.
Bollerslev-Wooldrige robust standard errors and covariance GARCH regression with
Variance backcast: ON the 80/20 income ratio
IJSE measured by the Gini index and the other three indicators, hinders economic growth.
32,7 Other findings indicate that growth in employment, investment spending, patents
granted, and human capital all contribute to economic growth.
To help the poor or the unemployed and to reduce income inequality, the US
government provides welfare benefits, financial assistance, UI benefits, food stamps,
Madicaid, child tax credit, etc. The social security system is an income maintenance
646 program for the retired people. To enhance human capital, the government also
supports training programs and provides college financial aids or loans to eligible
students whose income is below a certain level. The National Science Foundation and
other government agencies provide grants to support research. In evaluating or
improving income inequality, the government may need to maintain a balance between
efficiency, which refers to the production of maximum output with minimum cost, and
equity, which means fair share of output or income among the members of the society.
A society with relatively high income inequality may face relatively more
undereducated citizens, high crime, social unrest, political instability, less
consumption spending, and other socioeconomic problems. A country with a less
efficient economic system could result in less investment, high production costs, high
prices, low productivity, and disadvantage in global competition.
For future research, one may consider different measures for human capital and
technological progress. The insignificant sign for IA for some of the regressions may
suggest that the measurement of the capital stock may need to be examined. Because
economic growth and income inequality may affect each other, a vector autoregression
(VAR) model may be considered to investigate the simultaneous relationship among
income inequality, economic growth, human capital, and technological progress.

References
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Inequality: Issues and Policy Options, Federal Reserve Bank of Kansas City, Kansas, MO,
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Reserve Bank of Kansas City, Kansas, MO, pp. 1-9.
Panizza, U. (2002), “Income inequality and economic growth: evidence from American data”,
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Rodriguez, C.B. (2000), “An empirical test of the institutionalist view on income inequality:
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647
Further reading
Levy, A. (2002), “A note on income inequality and macro-economic volatility”, Australian
Economic Papers, Vol. 41 No. 2, pp. 233-8.
Lindback, A. (1998), “How can economic policy strike a balance between economic efficiency and
income equality?”, Income Inequality: Issues and Policy Options, Federal Reserve Bank of
Kansas City, Kansas, MO, pp. 295-336.
Snower, D.J. (1998), “Causes of changing earnings inequality”, Income Inequality: Issues and
Policy Options, Federal Reserve Bank of Kansas City, Kansas, MO, pp. 69-133.
Yui Leung, C.K. (2001), “Productivity growth, increasing income inequality and social insurance:
the case of China”, Journal of Economic Behavior and Organization, Vol. 46 No. 4,
pp. 395-408.