Inequality and Growth in Portugal: A Time Series Analysis

Abstract

Following the recent resurgence of interest on the relationship between inequality and growth and the considerable debate that remains on its sign, we examine this nexus for Portugal during the period 1985-2007 using different time series approaches. The results suggest that earnings inequality has a negative impact on output thus confirming the view that inequality is detrimental to growth. Moreover, according to the results from the impulse response functions based on the preferred trivariate structural VAR (SVAR) model, these effects last in some cases for three years after the inequality shock. As far as education is concerned, the third variable considered in our SVAR models, the evidence does not support the theoretical prediction that more inequality reduces human capital accumulation, pointing in fact in the opposite direction: an increase in earnings inequality leads to more educated workers. Thus, the evidence of a negative influence of inequality on output seems to be explained by the fact that it implies more redistribution, with the associated distortionary effects from taxes on investment.