Quality of Institutional Indicators and Income Inequality: A Global Panel Data Analysis of 114 Economies

Abstract

This paper corroborates the importance of institutional quality for the eradication of income inequality and also evaluates the efficacy of institutions for ameliorating inequality in different political regimes. To establish an empirical relationship, we have exploited the panel data of 114 countries from 1984 to 2018 and employed 2SLS, pooled OLS and System of Generalized Method of Moments to cope with the problem of endogeneity among regressors and to obtain consistent parameter estimates. The analysis is based on a diverse and broad array of institutional measures that are government stability, corruption, bureaucratic quality, law and order and democratic accountability. In addition, this study uses the indicators of civil liberties and political rights to measure the strength of institutions. Finally, we use ‘governance index’ and its different dimensions to proxy the quality of institutions. Our empirical results indicate that an improvement in indicators of institutional quality lowers income inequality; however, the strength of negative effect varies depending upon the measures of institutions. Moreover, the impact of ‘governance index’ and its different forms on income inequality is also negative and significant except voice and accountability. Finally, we allowed institutional quality to depend on the political regime and found that whereas income inequality moves negatively with strong institutions in democracies, it moves positively in autocracies. To the best of our knowledge, it is the first study of its kind that provides comprehensive and deeper understanding of institutional-inequality nexus using diverse institutional measures, allowing heterogeneity of political regimes and conducting Principal Component Analysis.