Equality and growth benefits of social market economies: Political-economic institution, aggregate demand, and economic growth

Abstract

This paper examines whether political-economic institutions have effects on poverty and economic growth and analyzes the mechanism of the association of poverty with economic growth, using the case of social market economies (SMEs). The paper analyzes the direct and indirect association among SMEs, poverty and inequality, and economic growth by using three empirical methods: (1) regression-based sequential mediation models modified to estimate within-country and between-country effects in a Mundlak way; (2) structural equation modeling (SEM) also modified in a hybrid correlated random (Mundlak) way to distinguish within-country and between-country effects and decompose direct, indirect, and total effects; and (3) bootstrapping of the estimates of both regression-based models and SEM to test indirect and direct effects. The results provide consistent data patterns that show that SMEs promote economic growth indirectly through a mediated institutional mechanism. They show that SMEs are associated with lower poverty, and lower poverty is associated with higher household consumption and investment growth, which in turn is associated with higher economic growth. These findings support a sequential causal chain linking institutions, distribution, and growth. The results thus show that equality and economic growth can be compatible with each other, and countries can achieve both at the same time.