Good Institutions and Fair Trade

The paper examines how legal, economic, political and social institutions fare with different measures of inequality in a cross section framework. We differentiate between institutions based on four categories which are legal, economic, political and social. Among legal institutions, rule of law and control for corruption have a stronger impact on inequality than voice and accountability. We find that countries which practice democracy are less prone to unequal outcomes especially when it comes to wage inequality and income inequality whereas autocracy is associated with higher level of wage inequalities but its impact on income inequalities are insignificant. Though under good economic management, autocracies may redistribute incomes from the richest to the poorest, more generally an autocratic set up violates the median voter hypothesis. The results also show that political stability is more sensitive to inequalities than democracy and autocracy which is to say that the countries which are politically stable also form more equal societies. Though in a cross section analysis, our results indicate average sample characteristics of countries chosen which neutralise the single country case sensitivities and thus may have captured the simple observational analogy that most democracies in the world are also the ones which are politically stable and economically efficient whereas most autocracies, unless they are lead by enlightened leadership eventually suffer from unstable or repressed political systems. Economic institutions also play an important role in alleviating global inequalities. Whether the government is functioning effectively and whether it has a robust fiscal and monetary policy seems to have stronger impact on inequality than regulatory quality. Education for all, a proxy for social institutions, has a strong redistributive power. Overall, political stability, control for corruption and rule of law trumps any other institutional proxy in reducing inequalities in a country. On the other hand, middle income group is most likely to benefit from good functioning institutions than any other income group. Once controlling for institutions, openness is associated with increased wage inequalities across nations. However the results for trade policy are mixed. Decrease in import taxes increase wage inequality, whereas decrease in export taxes has an egalitarian effect. The results are applicable only to a larger sample of developed and developing countries and highlight the bottle neck faced by both developing and developed countries in WTO talks which have not been successful as yet in further decrease in trade taxes. In case the situation prevails, the paper calls for more South-South trade which would enable developing countries to decrease the relative wage gaps among labour force.