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Income Inequality, Social Mobility, and Economic Freedom

 

 

By Ryan Bourne, Cato Institute

 

Should we much care about income inequality? I don’t think so. Yet one pushback I get, even from some classical liberals, is that high income inequality diminishes social mobility. This, they say, should really worry me – for it makes our society less dynamic and prosperous.

Their theory is that high income inequality today means greater opportunities for the children of the rich. Perhaps they might benefit from relatively more investment in their education or can better afford to take the best low‐​paid internships. Either way, more unequal societies might deliver lower levels of intergenerational income mobility. People will find it harder to buck the socioeconomic class of their parents, creating an ossified society.

Indeed, much evidence has found associations between high income inequality and lower intergenerational mobility. Trying to produce total “equality of opportunity,” eliminating this, would clearly be antithetical to liberty. But, for argument’s sake, let’s presume that more intergenerational mobility is desirable. Does the observed correlation with high inequality suggest we should rush to use the power of government to equalize incomes through punitive taxes and generous transfers?

No. For we are clearly ignoring other factors. A research article by economists Justin Callais and Vincent Geloso, for example, highlights how different economic institutions can also affect intergenerational mobility. Failing to consider them can lead to very misguided policy interventions.

The pair focus on economic freedom, especially the security of property rights in a country and freedom from trade without regulation. An absence of economic freedom could strangle opportunity for the poor, by constraining their market‐​based opportunities for betterment. A lack of economic freedom has also been found to slow growth and lower household incomes, which could reduce the relative life chances of the poor indirectly too. If we simply assume some causal relationship between high inequality and low intergenerational mobility, ignoring other factors like this, we could be wrongly ascribing to high inequality the impact of a lack of economic freedom and the opportunities it brings.

Geloso’s previous work highlights the Olympic games as an example. Innate sporting talent is probably distributed quite independently of income. But it’s costly to develop that talent, particularly in sports requiring expensive equipment. It might be much easier for the rich to make those investments. We might therefore expect to find that high‐​inequality countries send relatively fewer really high‐​performance athletes to the Olympics, winning fewer medals as a result.

And, yes, high inequality is indeed found to be a drag on the number of Olympic medals a country wins. But this relationship evaporates when looking at high‐​economic freedom polities alone. Perhaps stronger property rights give families more confidence to invest in their sporting skills. Or maybe lightly regulated credit markets reduce the cost of financing those investments. Whatever the mechanism, Geloso concludes that “Economic freedom enhanced the capabilities of the poor more than income inequality reduced them.”

Callais and Geloso’s more recent work uses cross‐​country World Bank data on intergenerational income mobility, data on economic freedom from the Fraser Institute, measures of income inequality, and several controls to assess whether this story generalizes. It does so by running several regression specifications to test the direct and indirect effects of economic freedom on intergenerational income mobility.

The results differ somewhat depending on the precise specifications used or the measures for economic freedom harnessed, but overall “suggest that economic freedom is a powerful determinant of intergenerational mobility and that its potency rivals, or exceeds, that of inequality,” especially once you control for the pure mechanical nature of much of the statistical relationship between inequality and immobility.

Higher levels of economic freedom for countries, then, are associated with more intergenerational income mobility, as are the higher incomes generated by those higher levels of economic freedom. If more social mobility is to be a goal of politicians across the world, they should first prioritize securing property rights and limiting regulation, before reaching for the tools of crude redistribution.

 


Ryan Bourne occupies the R. Evan Scharf Chair for the Public Understanding of Economics at Cato and is the author of the recent book Economics In One Virus.