general relationship between inequality and growth, from these, and almost certainly other data sets. The final section draws together our conclusions.

# 2.0 Why Might Village Inequality Affect Growth?

There are three conventional classes of explanation: imperfect credit markets, imperfect factor markets, and political economy.<sup>3</sup> In the first class of explanations, credit market constraints tie the ability of households to exploit opportunities for growth to their own resources. As the poorest of households have the fewest resources, holding average village incomes fixed, unequal villages have more resourceconstrained households. If credit markets are fully developed, the relationship breaks down, as the distribution of own resources no longer determines the distribution of household growth rates. A second possible channel is through factor markets. Higher income inequality (or inequality of land, human, or physical capital) may be associated with imperfect competition or other impediments to factor market development that limit opportunities for trade, especially for the poor.<sup>4</sup> The most common channel in the cross-country literature, however, implies the mechanism is through local political economy: unequal communities make different collective choices that affect the growth potential of households. For example, high-inequality communities may adopt more progressive tax structures, as low-income households pressure for redistribution in ways that inhibit growth. This is the conventional taxation-based story offered by Alesina and Rodrik (1994), Benabou (1996), and Persson and Tabellini (1994). Alternatively, the greater homogeneity (equality) of households may facilitate consensus for more efficient tax systems, and higher investment in public goods and services.<sup>5</sup> Localities also play an important role in targeting assistance to the poor, and international evidence suggests that there may be greater leakage, and thus poorer targeting in more unequal communities.<sup>6</sup>

> 3 See Aghion, Caroli, and Garcia-Penalosaand (1999), Lloyd-Elllis (2003), and Perotti (1996) for excellent summaries of the cross-country inequality and growth literature, with detailed discussions of the theoretical linkages between inequality and growth.

> 4 Notable examples include: Galor and Zeira (1993), Besley and Burgess (2000), Banerjee, _et al_ (2001), Banerjee, Gertler, and Ghatak (2002), Galor and Moav (2004), Banerjee and Iyer (2005), and Besley _et al_ (2010).

> 5 Several papers suggest that collective action and provision of public goods may be complicated by high levels of inequality within communities. See for example, Alesina and La Ferrara (2000), Bardhan, Ghatak and Karaivanov (2007), Dayton-Johnson (2000), Araujo, _et al_ (2008), and Khwaja (2009). With respect to public finance, Sokoloff and Zolt (2005) find that high inequality is correlated with more regressive taxes, and less funding of local public investments and services. Glaeser (2006) reviews evidence suggesting that unequal societies are less likely to have governments that respect property rights. Acemoglu, _et al_ (2008) show that in the case of Columbia, it was political, _not_ economic (land) inequality that adversely affected long run outcomes, further reinforcing the importance of this class of explanations.

> 6 See, for example, Baird _et al_ (2009), Bardhan _et al_ (2008), Galasso and Ravallion (2005), Shankar _et al_ (2010).

_Inequality and Growth in Rural China_ , Page 4