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

## TL;DR

This paper introduces a varying coefficient model to analyze how poverty and inequality influence the returns to economic growth, revealing significant differences across income groups and highlighting potential biases in traditional estimations.

## Contribution

It develops a novel varying coefficient model that captures the heterogeneous effects of growth on different income groups, addressing limitations of mean coefficient estimates.

## Key findings

- Returns to growth vary significantly with poverty and inequality levels.
- Traditional mean coefficient estimates may be biased due to unaccounted heterogeneity.
- Differences in coefficients challenge the interpretability of average effects.

## Abstract

Various papers demonstrate the importance of inequality, poverty and the size of the middle class for economic growth. When explaining why these measures of the income distribution are added to the growth regression, it is often mentioned that poor people behave different which may translate to the economy as a whole. However, simply adding explanatory variables does not reflect this behavior. By a varying coefficient model we show that the returns to growth differ a lot depending on poverty and inequality. Furthermore, we investigate how these returns differ for the poorer and for the richer part of the societies. We argue that the differences in the coefficients impede, on the one hand, that the means coefficients are informative, and, on the other hand, challenge the credibility of the economic interpretation. In short, we show that, when estimating mean coefficients without accounting for poverty and inequality, the estimation is likely to suffer from a serious endogeneity bias.