7 (2014) investigate a recent data set – which, they claim, allows them to “calculate redistributive transfers for a large number of country-year observations” (p.4) – and find that after-tax inequality is robustly associated with lower rates of economic growth.<sup>10</sup> Taken together, this latest, third phase of the empirical literature tends to replace the positive results of the second phase (“inequality is, if anything, good for growth”) with the negative results that used to prevail in Phase 1: “inequality is bad for growth, after all”. The pendulum would seem to have come full cycle.

Another possibility raised in this latest phase of research into the link between distribution and economic performance is that scalar measures of income or expenditure inequality may be composite indicators, the constituent elements of which affect economic performance in different ways. In particular, it has been suggested that inequality of opportunity might have more adverse consequences than the inequality which arises from differential rewards to effort (e.g. Bourguignon et al. 2007b). This claim resonates with some of the theoretical mechanisms reviewed above, for example that low wealth leads to forgone productive investment opportunities for part of the population. Such mechanisms operate through differences in the opportunity sets faced by different agents, and are potentially still consistent with differences in earnings that provide incentives for effort being good for growth.

If overall income inequality comprises both inequality of opportunity and inequality due to effort, and these two components have different effects on economic growth, then the relationship that has typically been estimated is mis-specified, and one ought to distinguish between the two kinds of inequality. Marrero and Rodriguez (2013) do this for 26 states of the United States: they decompose a Theil (L) index into a component associated with inequality of opportunity and another, which they attribute to differences in efforts. When economic growth is regressed on income inequality and the usual control variables in their sample of states, the coefficient on inequality is statistically insignificant. But when the two components of inequality are entered separately, the coefficient on “effort inequality” is generally positive, and that on inequality of opportunity is negative and strongly significant.

To our knowledge, Marrero and Rodriguez (2013) is the only published paper that investigates whether inequality of opportunity is the “active ingredient” in the relationship between inequality and growth.<sup>11</sup> Their findings suggest that this component of inequality was negatively associated with economic growth in the United States in the 1970-2000 period. Is this a more general result? Can the same be said of other places and contexts? In particular, can a decomposition of inequality into an opportunity and a residual component help resolve the inconclusiveness of the cross-country literature on this subject? In order to address this question, the next section briefly reviews the recent empirical literature on the measurement of inequality of opportunity, and defines the indices we use in this paper.

> unequal communities in Ecuador are less likely to receive Social Fund investment projects that provide private goods to the poor – with the effect being strongest for expenditure shares at the top of the distribution. 10 The data set used by Ostry et al. (2014) is the Standardized World Income Inequality Database (SWIID) – see Solt (2009). Unfortunately, this database relies on a very large number of imputed inequality entries for country-year cells for which no household surveys were conducted. Reliance on such “made-up data” makes the results in this paper suspect, at least until considerable additional validation can be carried out.

> 11 But see Teyssier (2013) for an attempt to replicate Marrero and Rodriguez’s approach to the case of Brazil, finding opposite results: no effects of inequality of opportunity (or effort) on state-level growth rates.