# **1. Introduction**

The most commonly used measure of a country’s economic activity and the overall well-being is gross domestic product (GDP). It gauges the magnitude of economic production, which in turn affects the payments to factors of production such as capital and labor. GDP _growth_ is therefore an estimate of how the aggregate income of a country increases over time. A country’s aggregate income, in turn, provides resources that can increase the incomes of families and individuals.<sup>1</sup> Given these relationships, economists have long been concerned about explaining the determinants of economic growth and formulating policies to elevate it.

But whether economic growth is sufficient to improve the welfare of every individual depends on _how_ the benefits of growth are spread across the society. If all individuals benefit proportionately, then studying growth through the device of a “representative agent” would be sufficient to determine the economic forces at work and the policy options needed to improve the welfare of each individual. However, if growth does not raise everyone’s incomes proportionately, then an analysis of the economic welfare of an individual requires studying aggregate economic growth in conjunction with the distribution of income within the economy.<sup>2</sup> So, what is the relationship between growth and measures of the inclusion of individuals in the economy and society, such as inequality and poverty? Does growth help pull people out of poverty? And how does growth affect inequality, if at all? What about the reverse relationship: that is, how do poverty and inequality affect growth?

This paper studies the nexus of growth, poverty, and inequality, seeking answers to these questions. The relationship between inequality and economic activity has been a subject of interest throughout the history of economic thought. In the _Wealth of Nations_ , Adam Smith (1776) noted that wealth inequality could lead to social unrest and that the government had a role in protecting property rights and preventing the poor from seizing the property of the rich. From

> 1 GDP omits some components of economic production, such as housework and home production, because it measures goods and services traded in market transactions. It also fails to deduct economic “bads” such as environmental degradation or to fully account for other aspects of well-being and happiness. For a full discussion, see the 2020 IMF report, Measuring Economic Welfare: What and How?

> 2 While there are multiple ways of measuring inclusiveness, this paper focuses the analysis on two metrics:  the poverty rate and the Gini coefficient of income distribution. The first measure captures the percentage of the population that is unable to meets its needs, based on an estimated threshold defining the cost of consumption basket for satisfying basic needs. To expand the coverage of data, this paper uses the World Bank’s threshold of $3.20 per day in purchasing power parity (PPP) terms, rather than the $1.90 PPP indicator of extreme poverty. The second measure of inclusiveness, the Gini coefficient, captures the degree of dispersion or inequality in the distribution of income, where a value of 1 indicates maximum inequality (whereby one person accrues all income) and 0 indicates perfect equality (whereby everyone in the entire population receives the same income). Additional indicators that might capture different dimensions of inequality, living standards, and inclusiveness are discussed in more detail in Cerra et al. (2021, Chapter 1), along with their limitations.

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