A spectre has haunted the west: did socialism discipline income inequality?

The aim of this paper is to discuss the role of the existence of a powerful socialist bloc as a disciplining device to inequality in western countries. The recent literature on top income inequality has emphasized explanations that go beyond the marginal productivity framework to explain top incomes. Usually the literature points to domestic factors such as top income tax rates and bargaining power. Some authors also assign a role for external factors such as the two World Wars that played in destroying capital, whether physical or financial, through inflation. Nevertheless, this literature does not embody the contributions of the state capacity literature that recognizes external conflicts as a source for the development of institutions that increase state capacity. In this paper, we analyze the role of a latent conflict that has occurred from WWII to the eighties: the Cold War. We believe this lasting conflict helped to shape the creation of common-interest states, as Besley and Persson (2013) defined. Under these commoninterest states, a social cohesion emerged because of the presence of a powerful external enemy, leading to reduced top income shares. In order to test our hypothesis, we run a panel of 18 OECD countries between 1960-2010. We find a robust and negative significant relation between Soviet Union’s relative military power and top income shares.