Essays on institutions, economic development, and inequality

Abstract

It is commonly asserted that free market capitalism promotes economic efficiency at the expense of equality. This view is reflected in the common claim that the rich are getting richer and the poor getting poorer. The current research examines how economic institutions consistent with economic freedom, which approximates the degree to which a nation is committed to free market capitalism, impact economic inequality. Two common concepts of economic inequality are between-nation and within-nation inequality. Chapter two can be thought of how economic freedom impacts between-nation inequality. Institutions were largely spread throughout the world during the European colonization era, providing a natural experiment in history. The analysis simultaneously accounts for the two prevailing institutional theories of post-colonial development, settlement conditions and identity of the colonizer, to empirically examine the causal impact of economic institutions on comparative economic development. The results suggest that favorable settlements conditions and colonization by Britain resulted in the development of more market-oriented economic institutions, resulting in sustained long-run economic development. The positive impact of favorable settlement conditions on institutional and economic development was partially offset when France, Portugal, or Spain was the colonizer. Poor settlement conditions led to poor institutions and economic stagnation, regardless of the colonizer. The results are robust to a number of alternative theories of economic development, suggesting that economic freedom is a positive causal determinant of modern levels of per capita income and that institutional differences between countries are largely responsible for the large disparity in average living standards that exists in the world today. As such, a significant portion of between-nation inequality is attributable to heterogeneous levels of economic freedom. How economic freedom impacts within nation inequality has been much less studied, partially because of the lack of inequality measures that are comparable across countries. Chapter three examines the concept and measurement of economic inequality. It describes the construction of a custom inequality dataset as well as several other inequality measures that are used for the analyses in chapters four and five. Chapter four examines the ambiguous economic freedom-inequality relationship. A simple theoretical framework demonstrates this ambiguity. A review of the existing literature suggests that the empirical relationship follows the theoretical, as several studies have looked at the issue empirically but often reached contradictory results. Each of the main studies has employed a different econometric model, possibly providing an explanation for the inconsistent results. Using eight alternative measures of inequality, additional empirical analysis of the four main econometric models from the literature suggests that the same model specifications are often sensitive to the measure of inequality and/or economic freedom, country sample, and/or time period examined. The analysis from chapter four suggests that additional research on the channels through which economic institutions impact inequality is needed. Chapter five is a first step in this direction, as it empirically examines the historical influence of factor endowments and legal tradition on the development of legal institutions and the rule of law, and their importance for determining modern levels of within-nation inequality. Consistent with the Engerman-Sokoloff and Friedman Hypotheses, elites in society have historically sought to protect their status and perpetuate inequality by influencing the development of legal institutions and the rule of law in their favor at the expense of the population. Factor endowments suitable for plantation relative to family farming and the receipt of the French civil law tradition aided the elites in their quest to perpetuate economic inequality through the creation of poor legal institutions, while endowments suitable for family farming and/or the receipt of one of the other legal traditions hindered these efforts. The results from this chapter suggest that legal and property rights institutions that promote equality before the law, which are characteristic of a market economy, result in more equitable distributions of income. Chapter six offers conclusions, summarizing the key findings and practical implications of the current research, as well as identifying several areas for future research.