Economic Freedom and the Trade-off between Inequality and Growth

Policy Reports | Economy

No. 309
Monday, March 31, 2008
by Gerald W. Scully

The Link between Economic Freedom and Income Inequality

"Government transfers to reduce inequality reduce economic growth."

The most popular single measure of income inequality is the Gini coefficient.  The Gini coefficient measures the difference between the actual distribution of income among the population and an equal distribution of income.  The Gini coefficient is bound between zero (a perfectly equal distribution of income) and 1 (a perfectly unequal distribution of income).  If the Gini is equal to zero, everybody has exactly the same income.  If the Gini is equal to 1, one person has all of the income and the rest of the population has none.  Thus, the higher the value of the Gini coefficient, the more income inequality in a society. 10 Figure II shows the relationship between economic freedom and income inequality:

  • The effect of a one-unit increase in economic freedom, holding the economic growth variable constant, is to lower the Gini coefficient by 0.012 points (say, from 0.35 to 0.338).
  • This means that nations that have more economic freedom have a more equal income distribution.

Multiplying the difference in the range of economic freedom among these advanced and newly industrializing nations (6.2) by the decrease in the Gini coefficient (0.012) results in a predicted spread in the Gini coefficient of 0.074 points.  This is not terribly large, since the Gini coefficients among these countries range from 0.23 to 0.58, a difference of 0.35.

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