The Fundamental Determinants of Economic Inequality in Average Income Across Countries: The Declining Role of Political Institutions

Abstract

Within the fundamental determinants of cross‐country income inequality, political institutions represent a hallmark factor that societies can influence. Focusing on the portion of inequality explainable by differences in political institutions, we decompose annual cross‐country Gini coefficients from 1960–2012. Although inequality has marginally decreased since 1988, the portion that cannot be explained by political institutions has increased markedly, with the explanatory power of institutions falling rapidly from the late 1980s to the early 1990s. This result prevails when using alternative variables, weightings, samples, and controls, and appears to be unlikely to be driven by contemporary regional events alone. However, we find that the link between institutions and income levels has become increasingly nonlinear as countries with the most inclusive political institutions enjoy even higher incomes than before. Our results imply that, if we hold societies responsible for their political institutions, cross‐country inequality has become notably less fair since the late 1980s.