The non-linear effect of inequality on investment

Abstract

We fill a gap in the literature on the investment determinants that do not take into account distributive issues, estimating the effect of income inequality on investment based on a heterogeneous panel of 95 countries from 1990 to 2015. Additionally, we (i) control for a wide set of control variables, contrasting different theoretical approaches, including trade and financial globalization; (ii) analyze advanced and developing countries; and (iii) test for a possible non-linear relationship between inequality and investment. Unlike the Kuznets curve, which fades in data panels, we find a significant and non-linear (‘U-shaped’) relationship between inequality and investment even when controlling for the panel dimension. At low levels of initial inequality, the relationship is negative; at high levels of initial inequality, the relationship is positive. A possible explanation for our results lies in the interaction between inequality, the productive matrix and international integration.