On the Ambiguous Economic Freedom-Inequality Relationship

Previous research on the relationship between capitalistic institutions and income inequality has produced mixed results. We provide a short survey of this literature, identifying potential causes for this empirical heterogeneity. Next, we replicate the results from two of the relevant studies using six alternative measures of income inequality for an updated dataset of up to 112 countries over the period 1970-2010. Most notably, we use the latest release of the Standardized World Income Inequality Dataset, which allows us to account for the uncertainty of the estimated Gini coefficients. We find that the results of previous studies are sensitive to the choice of country sample, time period and/or inequality measure used. Finally, we use a novel econometric approach, fractional polynomial regression analysis, to investigate if a non-linear relationship between economic freedom and income inequality exists. The results are sensitive to the measure of inequality used. We conclude with suggestions for future research in the area