FACULTY FOCUS Will Mitchell
ARE STRONG MARKET-BASED ECONOMIES more socially equitable? My current research looks at whether the strength of market economies — based on factors such as the robustness of capital and labour markets — relates to income equality and life expectancy in those countries. According to my analysis of current patterns in more than 160 countries, the answer is Yes: On average, a stronger market orientation correlates with both more-even income distribution and greater longevity for people born in that country.
These results stand in the face of recent populist arguments in the U.S. and Europe that are seeking to overturn market-based institutions. At the same time, though, the patterns I have observed highlight limits in market-based institutions and point to a need for more thoughtful social policies as complements to market activity.
Before I discuss the patterns identified in my analysis, it is important to remind ourselves of what every student of statistics learns in their first class: Correlation does not imply causation. As a result, we need to be careful in explaining why market economies might help create more equity. Nonetheless, in this article I will attempt to provide some insights about opportunities for achieving both market-based activity and social equity—while highlighting limits that point to a need for effective social institutions as complements to market activity.
First, let’s consider two measures of social equity. One is the Gini index, which measures the income distribution of a country’s residents. In the Gini index, 0 represents ‘perfect equality of income distribution’ and 1 represents ‘perfect inequality’. Hence, a lower number indicates greater income equality. Countries with low Gini values (i.e. evenly spread incomes) include Ukraine, Slovenia, Norway, the Czech Republic, Sweden, Iceland and Denmark, all with scores below 0.30. Countries with high Gini ratings (i.e. uneven income distribution) include South Africa, Namibia and Haiti (all above 0.60).
A second indicator of societal equity is life expectancy: How long can a person expect to live if they are born in a particular place, and what is the country’s rate of infant mortality? Countries with longer average lifespans and lower infant-mortality rates have greater ‘life expectancy equity’. Currently, Hong Kong has the longest life expectancy in the
world (84 years), while Swaziland is lowest (48 years). Luxembourg has the lowest infant-mortality rate (1.5 deaths per 1,000 births), while Angola has the highest (96 per 1,000).
The question is, does the strength of a country’s market institutions relate to either income equity or life expectancy?
To measure the strength of a country’s market institutions, I developed what I call the index of Voids in MarketBased Institutions, VIMBI for short. The VIMBI index includes six aspects of market activity:
1. Strength of capital markets
2. Quality of labour markets
3. Simplicity of business rules
4. Ease of contract enforcement
5. Quality of physical infrastructure, and
6. Extent of corruption.
When combined, the six VIMBI items create an index with a scale of 0 to 1 that indicates how straightforward it is to establish and operate a business in that country, with a high value on the index indicating stronger market orientation. In 2017, Singapore and Hong Kong rate highest (0.94), while Libya ranks lowest (0.14). Other high-ranked countries include Denmark, New Zealand and Australia; while others with a low market orientation include Afghanistan and Eritrea.
As a first step in studying whether stronger marketbased economies are more equitable, I calculated correlations between the VIMBI and Gini indices. Figure One reports the correlations. As indicated, there are positive relationships with the degree of income equality (reverse scaling of the Gini index) and the strength of the aggregate VIMBI index (the green column in Figure One, with correlation equal to 0.38), as well as with each of the six components of the VIMBI index (the blue columns in Figure One). Therefore, countries with stronger market-based institutions tend to have more evenly- distributed incomes.
Before we discuss why strong market economies might be more equitable, it is useful to address a question that thoughtful readers may well raise: Does greater income equity simply mean that people equitably settle for lower average incomes?
The two columns on the right hand side of Figure One help to dispel this idea: These positive correlations (0.24 to 0.30) demonstrate that countries with greater income equity also tend to have higher average incomes (gross national income per capita, based on purchasing power parity) and higher growth in per capita income over the past quarter century. Thus, greater income equity tends to occur in countries with higher — rather than lower — average incomes.
As we discuss how market strength might contribute to income equality, it is important to recognize that any causality in these relationships is complex. It is possible that greater equity influences the formation of market institutions, for instance, as well as the other way round. And other factors, such as social norms, likely influence both equity and market institutions. Nonetheless, it is useful to consider how the
presence of strong market institutions might contribute to social equity.
I will now discuss each of the six VIMBI elements relates to income equity.
STRONG LABOUR MARKETS. The labour market indicator includes three factors: The extent of post-secondary education in a country, the flexibility with which businesses can add or subtract employees, and the extent to which employees receive support if they lose employment. I found that, of the six VIMBI elements, strong labour markets have the strongest correlation with income equity (0.38). Stronger labour markets mean that it is easier for businesses to create high quality jobs and for people to shift between jobs. In turn, greater employment quality, flexibility and support mean that more people have access to well-paying jobs. Clearly, some executive positions will earn far above average wages—and those disparities sometimes create substantial social tension. Nonetheless, opportunities for desirable employment tend to extend throughout an economy, improving income equality.
CONTRACT EASE. This element also has a substantial correlation with income equity (0.38). The easier it is to create and protect contracts, the easier it is to create and change businesses, and in turn, this creates more employment opportunities. Moreover, the ability for businesses to adapt means that business activities tend to remain innovative, so that employment is more likely to offer well-paying opportunities for a larger number of people, again promoting income equality.
GREATER TRANSPARENCY/LOWER CORRUPTION. A high degree of transparency encourages new investment, including investment that can create market-leading opportunities. The new investments then create new jobs, including those in higher margin new businesses. This again promotes both higher income and wide-ranging employment opportunities. As a result, lower corruption has significant correlates with income equity (0.30).
ROBUST PHYSICAL INFRASTRUCTURE. Roads, airports, energy availability and other key support for business activity also correlate with income equality (0.26). Such infrastructure also promotes business activity, and that activity again creates desirable employment opportunities.
SIMPLICITY OF RULES. The simplicity of a country’s business rules also correlates with income equity (0.26). Countries with straightforward rules — such as streamlined construction permits and clear tax systems — facilitate business creation and adaptation. This business dynamism, again, offers broad-based employment opportunities.
ROBUST CAPITAL MARKETS. Finally, the presence of robust capital markets correlates with income equity (0.24). Ease of access to capital and the ability to protect investors facilitate business creation and growth. Once again, the dynamism helps create broad-based employment.
Overall, then, we can say that the presence of a strong set of market-supporting institutions promotes business activity, and that activity not only generates employment opportunities but also helps businesses in a country stay on the leading edge of their markets, so that many of the jobs are wellpaying. The most visible part of that activity is often high executive compensation, yet even if it is less visible, there also tends to be a broad base of employment opportunities. Hence, robust market-based institutions can help to facilitate income equity.
At the other end of the VIMBI scale, countries with limited market-based institutions often have both lower per capita income and highly unequal incomes. The high dispersion in income distribution arises because a small proportion of the population, often politically connected, controls many of the resources and opportunities in the country.
Figure Two shows that the VIMBI Index also correlates with both longer life expectancy at birth (0.72) and lower infant mortality (0.71). Let us briefly consider why robust market institutions might contribute to these health outcomes.
The greater dispersion of income in the U.S. partly reflects lesser integration of immigrants into its core economy.
The simplest explanation is that more active business activity generates wealth that can be invested in healthcare, ideally widely available to a population.
Again, we need to be cautious in interpreting life-expectancy patterns, because reverse causality can also apply: Healthier countries, as reflected in longer life expectancy, can facilitate business activity by providing healthy employees. In turn, growth in business activity will often encourage the development of strong market-based institutions. With this explanation, the causality would run from health to business activity to market-supporting institutions, rather than the other way around.
In practice, it is likely that both directions of causality arise: Market institutions facilitate business activity and health; and, in turn, health facilitates business activity and market institutions. This combination creates a virtuous cycle, with mutual reinforcement of market-supporting institutions, business activity, income and health — leading to the development of robust, equitable economies.
Exceptions to the Rules
The patterns I have discussed so far are general tendencies; they are not set in stone. Indeed, some countries are notable exceptions to the trends.
The two countries with the highest VIMBI ratings in 2017, Singapore and Hong Kong, have relatively high recent Gini scores (0.46 and 0.54), well above the average score of 0.40 for the 164 countries with recent Gini ratings from the World Bank. For these two countries, the exceptions partially reflect the recency of the development of market institutions, as both have undertaken strong market orientations during the past half century. Both countries also have extensive ‘guest worker’ populations, many of whom have incomes far below that of citizens of the countries.
Nonetheless, people in both Singapore and Hong Kong enjoy high life expectancy (83 and 84 years) — well above the global average of 72 years, partly as a result of social investment in healthcare services. Hence, although the strong market institutions in a country may not have generated income equity, they are consistent with life expectancy, par- ticularly when reinforced with social policies.
Comparing the United States and Canada is also intriguing: The U.S. has a relatively high VIMBI rating (0.83) and a Gini score (0.41) slightly above the average of the World Bank estimates. By comparison, Canada has a similar VIMBI rating (0.82) and a substantially lower Gini score (0.34). The greater dispersion of income in the U.S. partly reflects lesser integration of immigrants into its core economy. In addition, the somewhat weaker social safety net in the U.S. — and in particular, more limited availability of health insurance — has made it more difficult for some people to remain employed. The lower availability of health insurance also likely contributes to the somewhat lower life expectancy at birth in the U.S. (79 years vs. 82 in Canada) and higher infant mortality rate (5.6 per thousand births vs. 4.3 in Canada). In this comparison, once again, greater equity reflects a combination of market and social institutions.
Exceptions also arise at the other end of the VIMBI scale. São Tomé and Principe, Niger, Guinea, Cambodia and Burundi all have low VIMBI scores (0.25 to 0.30) and
Gini ratings well below average (0.31 to 0.34). These countries also have low per capita income (from less than $700 to about $3,300). In these cases, a lack of market-based institutions has translated into few opportunities for almost all people in the country.
Unquestionably, there is a substantial statistical relationship between market orientation (the VIMBI Index) and social equity, as measured by the Gini index of income disparity and life expectancy measures. As noted, the causality underlying these relationships is multifaceted. Nonetheless, part of the explanation stems from the ability to create dynamic businesses that, in turn, create widespread employment opportunities and support for good health. In turn, healthy employed people help to foster business opportunities, creating a virtuous cycle of commerce and equity.
These patterns both defend market-based capitalism and illustrate its limits. Market institutions help to create equitable societies, with widespread benefits; yet, these same institutions are now under attack by populist revolts in multiple countries — including countries in which market institutions first took root, such as the U.S. and Western Europe.
The patterns discussed herein should serve as a warning about the risks of destroying the benefits of the market. Nonetheless, these equity patterns do not support the idea of an unfettered market, dominating social activity in a country. Indeed, over-reliance of market domination within countries and via global strategy has contributed to the rise of populism in the U.S. and Europe. While, on average, market activity may help to facilitate equity, market economies also create losers, as some people suffer real declines in welfare. Others, perhaps more commonly, do not face lower living standards in absolute terms but face relative declines, as others catch up and sometimes move ahead. Hence, the reshuffling of position — including the very process of creating greater equity — can generate anger and opposition.
In order to defend market-based capitalism, we need to recognize and address its limits. Social equity within a country does not stem solely from business activity: Social engagement in support mechanisms is also critically important. In this regard, policies that facilitate broad-based healthcare are critical.
Similarly, it is essential to invest in institutions that help people stay abreast of changing employment needs and opportunities, and to catch up when their industries and jobs are displaced. As a result, ongoing support for education in grade schools, community colleges, and other post-secondary institutions is critically important, as is income support that helps people retain dignity and provide time to go back to school when needed. Programs that help immigrants quickly engage in the economic and social fabric of a country are equally important.
Indeed, many of the market-based institutions that make up the VIMBI Index depend on social investments. Support for education and policies that support employees when they lose jobs (labour), legal policies that promote transparency (corruption), public investments in roads, airports, and other infrastructure (physical infrastructure), and regulations that seek a balance of risk and reward in financial services (capital) are central to the Index. Hence, at the core, strong equitable economies reflect a thoughtful mix of both business and social institutions.
The reshuffling of position—including the very process of creating greater equity—can generate anger and opposition.