Thursday, April 03, 2008

Economic Freedom Leads to Less Inequality

Those on the left politically believe that in order to produce a more equal society (in terms of income distribution) the rich must be taxed at ever increasing rates and this revenue redistributed to lower income people. They don't put it that way of course, but that is the practical result. According to this new paper by Gerald Scully of the National Center for Policy Analysis, policies that decrease economic freedom actually act to increase income inequality. So those on the left who advocate these policies will not get the reuslts they expect:

This study examines the effect of economic freedom on economic growth and income inequality. It also examines the trade-off between income inequality and economic growth. It includes data for 26 advanced countries, including some newly industrializing Asian nations.

It measures economic freedom by constructing an index based on 10 components of government policy, including the share of government-owned enterprises in the economy and the top marginal tax rates. Income inequality is measured as market-based income, as represented by a Gini coefficient, which ranges from 0 (meaning everybody has the exactly the same income) to 1 (meaning one person has all the income). Economic growth is defined as the real growth in per capita gross domestic product (GDP) in U.S. dollars.

All else equal, the central findings are:

1. Freer economies enjoy higher rates of economic growth than less free ones.

2. Freer economies are more equal economies; economic freedom reduces inequality by increasing the share of market income going to the poor and lowering the share going to the rich.

3. Economic growth increases income inequality, but the effect is small.

4. Overall, the increase in inequality from economic growth is outweighed by the reduction in inequality caused by greater economic freedom — creating a net benefit to lower income groups.

Conversely, nations in which the government more aggressively redistributes income have significantly lower rates of economic growth. In the long run, this income redistribution hurts the poor. For example, among the countries analyzed in this study:

1. Lowering a country’s Gini coefficient by 0.01 would require reducing the income share of the rich by 0.6 percent and redistributing it to others.

2. However, this would lower the economic growth rate by 1.6 percentage points (from 2.3 percent to 0.7 percent).

3. With the transfer, but a lower growth rate, average household income in the lowest group would reach only $8,050 after 25 years, instead of the $10,320 that would be achieved without the transfer.

This study confirms that a relatively free market with a limited role for government will, over time, produce the greatest economic benefits for the lowest income earners.

The higher income brought about by economic growth ultimately raises the incomes of low-income households more than an increase in the equality of incomes brought about by a redistribution of income

I have not read the entire paper yet, but as with many economic ideas, the results are counter-intuitive. I also haven't investigated the NCPA yet to see if they have a political agenda. I will complete my study of the paper when time permits and post my findings.

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