Decoupling of functional and household income distribution by economic growth: new findings from analysing the three‐way growth‐equity nexus

Abstract

This study analyses the three‐way relationship between economic growth and the two aspects of income distribution, namely, functional income distribution (labour income share) and household income distribution (Gini coefficient). One contribution of such three‐way analysis is to reveal the ‘decoupling’ pattern of the growth‐equity nexus, namely decoupling between functional income distribution and household income distribution, as it finds that economic growth tends to increase labour income share but worsen household income inequality, and also to confirm the reverse relationship that that higher labour income shares and household income inequality lead to a higher rate of economic growth. We show that these findings co‐exist with the traditional belief in the literature about the directly reinforcing relationship between functional and household income distribution. These findings are consistent with skilled labour compensated by performance‐based higher wages, which is often associated with a skill‐biassed technological change. The study confirms the same three‐way relationship in both developed and developing countries, but with several different determinants and different trends in the key variables. Given this nuanced trade‐off between economic growth and household income equality, coupled with no such trade‐off between growth and labour income share, a sensible policy prescription may be a combination of growth‐enhancing policy of increasing pre‐tax labour income share and a separate redistribution policy to decrease disposable household income inequality, which can mitigate income inequality without harming economic growth.