Wage-led or profit-led: is it the right question to examine the relationship between income inequality and economic growth? Insights from an empirical stock-flow consistent model for Denmark

Abstract

For the last two decades an increasing number of empirical studies have analysed the relationship between income inequality and economic growth by classifying economies as either wage-led or profit-led. However, some critiques have claimed that rather than being unequivocally wage-led or profit-led, the growth regime of an economy might depend on the circumstances and the nature of the processes that determine income distribution. Using an empirical stock-flow consistent (SFC) model estimated for Denmark for 2005–2020 we run eight scenarios simulating changes in policy, structural and institutional variables to see how each affects income distribution and, through it, the business cycle and economic growth. We find that the relationship between demand, growth and income distribution is highly dependent on the source of the shock affecting income shares, its impact on the other areas of the economy and the intensity of feedback effects.