Economic Freedom for the Free: How Neoliberalism is Leading to Greater Income Inequality Within Countries

Abstract

Many observers have noticed a sharp divergence of household incomes in the last few decades that seems unrelated to the traditional explanations of inequality like economic development. My dissertation examines the question of how the rise of neoliberalism—or the market über alles—impacts this inequality in countries around the world. High inequality is known to hinder economic growth, social mobility, democratic functioning, social capital, and to adversely affect health and education outcomes, as well as to exacerbate racial and residential inequality. Equality, meanwhile, is seen as desirable in its own right as a matter of social justice. Neoliberalism is a likely suspect because it emerged at the same time and in the same places that inequality began to rise after three postwar decades of decline. It is also a particularly competitive form of capitalism, and thus produces more winners and losers at both ends of the income distribution. With its focus on profits, it is much more beneficial to income derived from capital gains at the expense of wages, deepening the typical class divide under capitalism. Finally, neoliberalism is an elite consensus formed without any public participation, and these special interests shape the economy and society to the benefit of this privileged minority. I find four major shortcomings of existing research related to my research question. First, all but the most recent research has had to rely on sub-standard data for cross-national comparisons, which I address using Frederick Solt’s (2009) Standardized World Income Inequality Database (SWIID). Second, past analyses of cross-national data have improperly handled between-country variation, which I address using a dual fixed-effects modelling approach. Third, there are operationalization problems with neoliberalism, in which past research has failed to capture the phenomenon in its entirety. I address this by developing a new multi-dimensional measurement approach. Moreover, there is a determined failure by many to fully consider neoliberalism as a likely explanation because it contradicts the myth of liberal democracy and capitalist benevolence. Along these lines, the fourth shortcoming is that most popular explanations of rising inequality blame otherwise benign trends such as globalization and technological advancement. This obscures the political nature of neoliberalism, especially how the rich are able to dominate political economy at the expense of the masses. In doing so, it makes it appear that inequality is just a byproduct of progress, that we must accept it as inevitable, and that only palliatives are available. The reality, however, is that neoliberalism is neither inevitable nor progressive and requires systemic change to rectify. I address the research question with three research components. First, I develop a definition of neoliberalism in contrast to existing theoretical narratives, namely globalization, neo-Keynesianism, dependency theory, and economic freedom. I argue neoliberalism is a social and political project that emerged in the economic stagnation of the 1970s—a way for corporate elites to revitalize profits by whatever means necessary, regardless of the consequences. These means have included tax cuts, social spending cuts, deregulation, neoliberal monetary policy, corporate and industrial restructuring, free trade agreements and increased foreign investment, export-led growth, and the growing power of global economic institutions. I operationalize this definition using the Economic Freedom for the World Index (42 variables) and other World Bank data. Empirically, I show that many neoliberal variables correlate and thus may embody a wider phenomenon, but they also show moderate independence which supports the multi-dimensional approach rather than a single neoliberal metric. In the second part of the dissertation, I use the measurement developed in part one to analyze neoliberalism’s relationship with inequality. I find a relatively robust relationship in the expected direction, with some exceptions, and the dual-model approach underscores the importance of analyzing both between- and within-country variation. The latter is useful because it inherently controls for cross-country heterogeneity, but it comes at a substantial loss of variability. The former has regrettably been derogated, but it provides much explanatory power and complements within-country analysis well. In other words, between-country variation captures deep institutional and cultural differences across countries, while the other captures more superficial but flexible policy shifts and trends within countries at various points in time. I also explore the nonlinear effects of neoliberalism on inequality. Generally, the analysis showed that more developed countries had a stronger association between various neoliberal dimensions and greater inequality. I speculated this was because more developed countries historically have more institutional protection from the adverse effects of markets, and by weakening these, neoliberalism generates more inequality than in countries whose public intervention is already less robust, especially in unmeasurable ways. The analysis also generally showed that at low levels of neoliberalism the relationship sometimes reversed, creating a U-shaped curve that was typically centered left of the mean. I speculated this was due to the fact that very low scores of neoliberalism occur in underdeveloped countries usually suffering from serious state corruption, which translates into greater inequality. In such cases, moving away from a corrupt state and toward market institutions generates relatively less inequality. In the third part, I expand on the above model to establish competitive testing of alternative explanations of rising inequality using contingency effects. The alternatives include globalization, technological advancement, industrial restructuring, human capital/skills, and female employment. The test asks whether the effects of these alternatives are actually contingent on above average levels of neoliberalism, and thus not responsible for inequality per se. Instead neoliberalism makes globalization, technology, and the other trends more inegalitarian than they would have otherwise been. In general, the analysis showed that the alternatives are robustly contingent in the expected direction. Greater levels of neoliberalism drive many ordinarily benign trends and processes toward greater inequality. Remarkably, even basic education, long thought to be the great equalizer, can actually exacerbate inequality at high levels of neoliberalism. In fact, at average levels of neoliberalism, the alternatives mostly had weak relationships to inequality. And below the average, many alternatives actually appeared to generate less inequality—that is, inequality was lower where and when neoliberalism was less embedded. Overall, the findings demonstrate that neoliberalism is an important if not predominant explanation for rising income inequality that many countries have experienced in the last several decades. It suggests that superficial solutions like more education spending or job creation may be insufficient without addressing, at least to some extent, the deeper issue of neoliberal capitalism. I provide suggestions for this, but ultimately it means shifting our major institutions away from market logic toward public interests, control, and orientation. A future economic crisis more severe than the Great Recession could advance such systemic change, but popular protest will likely also be needed to ensure that addressing today’s challenges becomes more egalitarian.