The impact of institutions on economic growth and Income inequality in the Western Balkan countries

Abstract

The relationship between income inequality and economic growth has attracted a lot of attention among scholars and policy makers. This dissertation revisits inequality - growth nexus by investigating the complex relationship in the specific context of Western Balkan (WB) Countries. Specifically, we add to the recent literature by incorporating financial market development and quality of institutions to the empirical model, using up-to-date data covering WB countries and employing comprehensive methodological approaches. This study contributes to previous studies by employing various methods of investigation while paying attention to endogeneity issues addressed in previous literature and analyzing the interplay between these variables in an integrated empirical framework. We use four methodological approaches (panel regression analysis, instrumental variable, two-stage least squares and simultaneous-equation models) and compare the results obtained relying on different econometric techniques. Through rigorous analyses and empirical investigation, our findings shed some light on the impact of financial market development and quality of institutions on economic growth and income inequality relationship in selected WB countries. Our estimates generated three key results. First, there is evidence of a positive relationship between GDP per capita growth and income inequality. Thus, we found no evidence of trickle-down effect over the course of transition, as economic growth goes hand with hand with growing income inequality. Second, we find strong evidence that income inequality spurs economic growth, indicating highly unbalanced economic growth pattern, and persistent dual-economy over the course of transition. These findings suggest that income inequality has played important role in stimulating economic growth in the WBC, plausibly due to persistent structural weaknesses of WB economies. Third, our results support the proposition that financial market development proxied by credit and bank branches have positive impact on income per capita while simultaneously improving distribution of income. Additionally, institutions are found to have a dual effect, they enhance GDP per capita while simultaneously reducing inequality. Specifically, the results obtained from different methods of investigation including FE, IV, 2SLS, FE2SLS and FE3SLS regressions indicate that the rule of law and credit growth positively impact economic growth while simultaneously reducing income inequality