The paper’s empirical strategy relies on the estimation of a reduced-form growth equation with poverty added to an otherwise standard set of growth determinants. We estimate the resulting specification on a large country panel data set, using a generalized method of moments approach to control for the potential endogeneity of the regressors.

On the whole we find that poverty has a significant negative impact on growth. This result holds irrespective of whether inequality is also added in the regressions, and hence we interpret it as representing a pure poverty effect rather than an indirect inequality effect on growth. Moreover, the result is robust to a variety of departures from the basic specification, namely: (i) the use of alternative poverty lines, (ii) the use of alternative poverty measures, (iii) the use of alternative sets of control variables in the regression, (iv) the use of alternative sets of instruments in the estimation, (v) the use of alternative estimation techniques, and (vi) allowing for nonlinear effects of inequality on growth. When we go one step further and try to identify the specific mechanisms behind this poverty effect on growth, we find that it appears to operate through investment: poverty deters investment and thereby growth, and the effect is bigger the lower the degree of financial development.

The rest of the paper is structured as follows. In section II we illustrate how poverty can be a growth deterrent, using a simple model that is just a modified version of Aghion _et al_ . (1999), extended to include a minimum consumption subsistence level. In Section III we describe our empirical strategy to test for the effect of poverty on growth in a panel context. Section IV reports estimation results for the basic model and performs a variety of robustness checks. Section V explores the mechanism responsible for the effects of poverty on growth identified in section IV. Finally, Section V concludes.

# **II. An illustrative model**

To illustrate the effects of poverty on growth, we sketch a model in the spirit of Aghion _et al_ . (1999), who introduce learning-by-doing and knowledge spillovers in a simple overlapping generations framework. We modify their basic setup by adding a minimum consumption requirement in the model. With a subsistence consumption requirement, poor consumers (defined as those whose initial endowment is below the minimum consumption level) cannot save and, in the absence of capital markets, cannot invest either.<sup>7</sup> Thus they do not contribute to the economy’s aggregate growth.

# _II.1 Individuals_

There is a continuum of non-altruistic overlapping generations individuals, indexed _i_ ∈ [0,1] that live for at most two periods. Individuals born at time _t_ have a random endowment _wti_ . Survival into the second period entails a minimum consumption requirement _~~c~~_ (possibly reflecting nutritional needs), which can exceed the original endowment. We

> 7 More precisely, for this result to obtain we do not need to rule out capital markets altogether. It would suffice to assume that lenders impose on borrowers a collateral requirement, which individuals below the minimum consumption level would be unable to meet.

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