Threshold effects of inequality on economic growth in the US states: the role of human capital to physical capital ratio

Theory suggests that the effect of inequality on growth varies with the level of economic development, as captured by the ratio of human capital to physical capital. In particular, the effect is shown to be positive at lower levels of this ratio, and turns negative beyond a threshold in such models. Using a comprehensive panel of annual data for the 48 contiguous US states over the period 1948 to 2014, we find overwhelming evidence in support of this theory, unlike prior work on this topic. Hence, our paper highlights the importance of accurately measuring the process of economic development using data on human capital and physical capital, instead of using proxies that are not theoretically consistent. Understandably, if not done so, policymakers would end up undertaking incorrect decisions.