Introduction:

Over the past decades, the relationship between income inequality and economic growth has become of major interest to economic analysis. In most studies, only one direction of this relationship is analyzed, either the influence of inequality on economic growth or the impact of economic growth on distribution dynamics. Only few studies consider the interdependence of this relationship. In endogenous growth theory, the long-term rate of growth is supposed to be influenced by a variety of factors. Income inequality is one of the major determinants under discussion. In theoretical analyses, more inequality as well as more equality can be able to promote economic growth, depending on the channel connecting these two areas of interest. Human capital is often the decisive link between income distribution and economic development and supposed to be another important growth factor. Empirically, the influence of human capital on economic growth is still controversial, mainly due to data problems. Income inequality, however, is ignored in many empirical growth analyses like e. g. Levine/Renelt (1992) and Sala-i-Martin (1997). Other empirical studies, though, often find a robust negative relationship between economic growth and inequality.

The relationship between inequality and economic growth is not a new subject: Kuznets (1955) pointed out that in the historical process of economic development of some industrialized countries income inequality first rose and then declined, leading to his famous U-curve hypothesis (UCH). Due to ambiguous empirical results, some economists favor the UCH, others doubt its existence.

Though the mutual relationship between inequality and economic growth is at least a theoretical subject, most empirical studies consider only one direction of the relationship or the other. Barro (2000) and Deininger/Squire (1998) analyzed both directions of the relationship between inequality and growth. While the former finds evidence for a negative influence of income inequality on growth and for the UCH, the latter reject these results. In both analyses, however, the results might be biased due to the employed methods of empirical growth and UCH analysis.

In this paper, we examine empirically the interdependence between income inequality and economic growth employing more appropriate methods of empirical growth and UCH analysis. We particularly consider whether income inequality has a significant impact on economic growth and vice versa. As human capital often plays a decisive role for this relationship, we also test for the influence of human capital and education policy on economic prosperity and distribution.

In various empirical growth studies, cross-country regressions, panel estimations and time-series analysis are carried out in order to test for different types of convergence and for significance of major determinants of economic growth. Up to now, the influence of inequality on economic growth and the Ucurve hypothesis have been mainly examined in cross-country regressions suffering from poor quality and quantity of data. Given a slightly updated version of the data set from Deininger/Squire (1996), panel techniques can be taken into account as well in this area of interest