The political economy triangle of government spending, interest-group influence, and income inequality: Evidence and implications from the US states

Abstract

This paper introduces the political economy triangle (PET) concept of government spending, special interest groups (SIGs) influence, and income inequality, empirically confirming its existence and unveiling its nature while directly addressing key shortcomings of most prior research on the determinants of such inequality. Using static and dynamic panel techniques and data from the US states, it reports several new results: (i) the findings of previous studies regarding the roles of government spending and interest groups, including labor unions, in income distribution are confirmed, however, their estimated inequality effects grossly underestimate those obtained when endogeneity issues are accounted for explicitly; (ii) a dynamic tripartite relationship between the variables of the PET exists; (iii) government spending and SIGs' influence, including union strength, beyond their direct effects on inequality, have a separate positive impact through their interactions; (iv) the effectiveness of government spending in reducing inequality diminishes as the level of SIGs' influence and union strength increase in the short and long run, (v) the aggregate inequality-increasing effect of SIGs is strengthened and the inequality-reducing effects of unions weakened as the spending rises, in the short run and long run. Finally, the broad implications of these findings are discussed.