Liberalization and income inequality: A comparative analysis (1974-2014)

Liberalization, broadly understood as the removal of market barriers, has been a prominent trend in both coordinated and liberal market economies in the last fifty years. The literature has argued that countries implement different types of liberalization with varying distributive outcomes. The extent to which liberalization is associated with inequality is relevant because the distribution of winners and losers affect the political dynamics that explain the trajectories of change of these market economies. However, empirical evidence on the distributional implications between (different types of) liberalization and inequality is still scarce. In this paper, we study the relationship between liberalization and income inequality using a new database on liberalizing reforms in 13 policy fields, covering 37 advanced capitalist democracies between 1974 and 2014. We combine this data with inequality estimates from the Luxembourg Income Study, and use error correction models to estimate the short- and long-run distributional impact of liberalization. Our preliminary findings indicate that liberalizing reforms increase market inequality (measured with the Gini indicator) and bottom-end inequality (measured as the income ratio between the median and bottom decile). However, we also find no statistically significant effects on disposable inequality (Gini) and the 90-10 income ratio, and we even find a negative association between liberalization and top-end inequality (measured as the income ratio between the top decile and the median). Exploring potential mechanisms behind these associations, we find that liberalization significantly reduces social expenditures, weakens union membership, and the coverage of collective bargaining agreements, but it does not significantly affect redistribution. Overall, these findings suggest that liberalization substantially widens market inequalities but does not necessarily hamper governments’ ability to compensate voters whose relative position is endangered by liberalizing reforms.