RELATIONSHIP BETWEEN INCOME INEQUALITY AND ECONOMIC GROWTH IN ETHIOPIA

Abstract

The main objective of this study is to investigate the relationship between income inequality and economic growth in Ethiopia. The study hypothesized the existence of long run and short run relationship between income inequality and economic growth. This research used secondary data for the years 2002-2017 and it employs Auto Regressive Distributed Lag Model (ARDL) in time series econometric framework. The study finds that in the long-run cointegration analysis income inequality is significantly and positively related to economic growth. The coefficient of Gini is 13.8 which is the income inequality elasticity of real GDP. It means that if we increase income inequality by one percent, real GDP will grow by 13.8 percent. In the short run the error correction model is statistically significant at the 5% significance level with negative sign which implies that the error correction process converges monotonically to the equilibrium path relatively quickly and such high significance of ECM (-1) is further a proof of the existence of established stable long run relationship between the variables. The positively relationship between income inequality and economic growth indicates that high income inequality increase growth which follow Kuznets hypothesis since Ethiopia is a low income country and this would make economic growth and income inequality to rise at the same time. To enhance the economic growth of the country, the government should address the dependence on rain-fed agriculture, enhancing the productivity of factors of production and the productivity of land, encourage foreign investment in manufacturing industry to achieve targets to become a low middle-income by transforming the country into a manufacturing hub as stipulated in the Growth and Transformation Plan II, and revenue generated from different sources should be used to improve the welfare of people in low income group.