Summary of JOIE article (First View 30 November 2020) by Vadim Kufenko, Institute of Economics, University of Hohenheim, Schloss, Germany and Vincent Geloso, Department of Economics and Finance, King’s University College, Ontario, Canada. The full article is available on the JOIE website.
Does inequality affect economic outcomes? The recent surge in interest in the proper measurement of inequality has been accompanied by an equivalent in tying inequality to socio-economic outcomes. However, the direction of the connection between inequality and growth has, however, been an object of debate as the range of effects goes from positive to null to negative. Some scholars have argued that these conflicting results can be explained through the role that institutional setting within which inequality emerges (see notably Ashby and Sobel 2008; Hall and Lawson 2014; Bennett and Nikolaev 2017).
In this paper, we take up the role that institution may play in determining the nature of the relationship between inequality and socio-economic outcomes by using the microcosm of Olympic games. Microcosms have frequently been used in the literature on inequality to tie it to long-term outcomes (DiPrete and Eirich 2006; Redelmeir and Singh 2001a,b; Marmot et al. 1984, 1991). By concentrating on a narrow setting, they were able to more easily identify a mechanism to tie inequality to outcomes. The Olympics can serve the same purpose.
Innate talents required to compete in the Olympics are unrelated to wealth; rich and poor can be high-performing athletes. The costs of talent development are subjectively greater for the poorest. Thus, all else being equal, higher inequality limits the ability of the poorest to develop their talents. However, and simultaneously, the effects of inequality can be mitigated or even overturned thanks to institutions if they allow for appropriability of gains (Alchian 1965). The substantial rewards in the form of income, prestige and status are key motivators for developing athletic talents. These rewards are disproportionately large for the poorest (relative to their incomes) so that there is a strong incentive to invest in training. If institutions make it easier to appropriate such rewards and/or increase the returns on efforts, they mitigate the effects of inequality.
To test this possibility, we use the Fraser Institute’s economic freedom of the world (EFW) data (in conjunction with the 2016 Olympics medal counts relative to a country’s population. The reason for using the EFW is that it has the protection of property rights as one of its key components – something that speaks directly to the issue of appropriability of gains from Olympic participation. Simply put, we run a horse race between economic freedom (as our proxy of institutions) and inequality to see which runs fastest. To do so, we employ a threshold regression model to break our sample of countries into “low” and “high” economic freedom.
What we find confirms the idea that inequality hurts Olympic performance. That is especially true at low levels of economic freedom. However, at higher levels of economic freedom, inequality (regardless of the type of measure used) yields either small and marginally significant effects or effects that are not statistically significant. In other words, the effects of economic freedom appear to be able — at higher levels –to overpower those of inequality.
For the sake of robustness, we also employed a hurdle model in order to assess the continuous impact of economic freedom for the odds of winning at least one medals and on the number of medals. These non-linear regressions show that it is less clear whether economic freedom fully offsets the effect of inequality even though it shows up as a powerful mitigating force.
This is, we argue, a powerful microcosm. It forces us to consider how institutions modulate the effect of inequality. This is something which ties in very well with the literature suggesting that people can tolerate highly unequal distributions of income conditional on whether they perceive these distributions as fair and merit-related (Shariff et al. 2016; Starmans et al. 2017). Indeed, we are essentially showing a mechanism by which inequality’s potentially perverse effects can be mitigated. It confirms the intuition of Finis Welch (1999, 2) who stated that “inequality is destructive whenever the low-wage citizenry views society as unfair, when it views efforts as not worthwhile, when upward mobility is viewed as impossible or as so unlikely that its pursuit is not worthwhile.
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