Political Determinants of Income Inequality: Panel Analysis

Most previous studies on the determinants of income inequality across countries included emerging and advanced democracies in one sample, which raises concerns that the independent variables’ effect might be largely attributed to the differences between the emerging and advanced democracies. This study mainly addresses variations among emerging democracies while also outlining the differences between emerging and advanced democracies. Thus, it investigates the effects of political market failure and weak state capacity upon income inequality using an unbalanced panel dataset for the 1985–2012 period for emerging democracies across continents (N = 57), advanced democracies (N = 18), and all democracies (N = 75). The fixed effects (FE) model with a lagged dependent variable (LDV) was adopted because it controls for the country-specific effects, captures the gradual nature of changes in income distribution, and errs on the conservative (underestimate) side in coefficient estimation. The dependent variable is the estimated after-tax Gini coefficient. The challenge of finding measurements of incremental and cumulative change in institutional quality was addressed by choosing (1) the age of the largest opposition party for political market and (2) higher-order lags of the Quality of Government indicator and the control of corruption for state capacity. The analysis demonstrated that both political market quality and state capacity reduce inequality; however, the latter takes more time to show its effect. The results were supported by robustness checks for influential observations and an alternative dependent variable.