The IMF Working Papers series is designed to make IMF staff research available to a wide audience. Almost 300 Working Papers are released each year, covering a wide range of theoretical and analytical topics, including balance of payments, monetary and fiscal issues, global liquidity, and national and international economic developments.
The linearity of the relationship between income inequality and economic development has
been long questioned. While theory provides arguments for which the shape of relationship
may be positive for low levels of inequality and negative for high ones, most of the empirical
literature assumes a linear specification finding conflicting results. Employing an innovative
empirical approach robust to endogeneity, we find pervasive evidence of nonlinearities. In
particular, similar to the debt overhang literature, we identify an inequality overhang level
in that the slope of the relationship between income inequality and economic development
switches from positive to negative at a net Gini of about 27 percent. We also find that in an
environment characterized by widespread financial inclusion and high income concentration,
rising income inequality has a larger negative impact on economic development because banks
may curtail credit to customers at the lower end of the income distribution. On the positive
side, a sufficiently high female labor participation can act as a shock absorber reducing such
negative impact, possibly through a more efficient allocation of resources.