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A Varying Coefficient Model for Assessing the Returns to Growth to Account for Poverty and Inequality

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Document pages: 22 pages

Abstract: Various papers demonstrate the importance of inequality, poverty and the sizeof the middle class for economic growth. When explaining why these measures ofthe income distribution are added to the growth regression, it is oftenmentioned that poor people behave different which may translate to the economyas a whole. However, simply adding explanatory variables does not reflect thisbehavior. By a varying coefficient model we show that the returns to growthdiffer a lot depending on poverty and inequality. Furthermore, we investigatehow these returns differ for the poorer and for the richer part of thesocieties. We argue that the differences in the coefficients impede, on the onehand, that the means coefficients are informative, and, on the other hand,challenge the credibility of the economic interpretation. In short, we showthat, when estimating mean coefficients without accounting for poverty andinequality, the estimation is likely to suffer from a serious endogeneity bias.

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