Causal Relationship between Income Inequality and Economic Growth

This paper investigates the causal relationship between economic growth and income inequality using the time-series data of Korea. Prior to conducting the causality test, properties of the time-series variables are carefully examined using the unit root test and the cointegration test, and an error correction model is constructed to test the direction of causality. The quarterly data covers the period from 1990 to 2017. Income quintile ratio is used as a measure of income inequality. The unit root test result indicates that the variables are first-order integrated. The cointegration test result, however, shows that there is a cointegrating relationship between the two variables. Based on these results, an error correction model is constructed to test the causal relationship. The result of the Granger causality test based on the error correction model indicates a uni-directional causality running from economic growth to income inequality in the short-run. In the long-run, however, there is a uni-directional causality running from income inequality to economic growth. Estimation result of the cointegration equation shows that income inequality positively affects economic growth in the long-run.