Globalization, economic freedom, and inequality: What can we learn from composite indices?

This paper examines the relationship between income and wage inequality and globalization using composite indices designed to quantify social, political and economic dimensions of globalization. The KOF globalization index and the Economic Freedom of Index (EFI) of the Fraser Institute and their subindices are used to measure the process of globalization and economic liberalization. Household Income inequality data comes from the All the Ginis data set compiled by B. Milanovic and wage inequality data is obtained from the University of Texas Inequality Project (UTIP). Panel data set covers the period 1970-2005 with around 80-99 countries. We use both static and dynamic formulations for the relationship between inequality and the composite indices of KOF and EFI and their subcomponents and control for several factors such as real income per capita and its square, education, democracy, age dependency ratio and share of industry in the economy. Results from static and dynamic models for income inequality indicate strong support for the Kuznets hypothesis whereas results for wage inequality, in both static and dynamic formulations, do not support it. Static models imply that income and wage inequality increase with political globalization and with smaller government. Static results also support the hypothesis that economic globalization increases income inequality in emerging markets and non-OECD countries. Smaller government leads to more unequal income and industrial earnings distribution in OECD and EU countries. Dynamic system GMM estimation results indicate strong persistency in both income and wage inequality measures. Dynamic results also imply that income inequality rises with smaller government role in the economy and wage inequality declines with more stable price system.  However, the KOF globalization index and its subcomponents are all insignificant in dynamic formulations for both income and wage inequality.