Subnational Economic Freedom, Economic Performance, and Income Inequality: Some Evidence of an Efficiency-Equality Trade-Off

Abstract

This paper uses panel data for the U.S. states and Canadian provinces over the period 1980-2010 to examine how subnational economic freedom effects income inequality through the former’s impact on economic performance. Using a 2SLS fixed effects framework, the results point towards an efficiency-equality trade-off, suggesting that economic freedom may exert a positive direct effect on economic performance and a positive indirect effect on inequality. Limited government and labor market freedom are associated with higher levels of GDP per capita and employment rates, respectively, which in turn are positively associated with income inequality. The estimates suggest that labor market freedom exerts a stronger and more robust impact on inequality than limited government.