Political economy and income inequality: how did trade liberalization and changes in political and economic freedom affect the middle classes across the world?

AbstractPolitical economy reforms have generated significant economic development in many countries in the last few decades. We explore the impact of changing political and economic freedoms on income inequality, and how different income groups were affected by this economic growth. Particular attention is paid to the income levels of middle class in response to expanding trade freedoms. Data from 248 countries over a period of 25 years is analyzed using OLS estimation after identifying middle and other classes using absolute and relative approaches. Models include interactions of different classes with levels of political and economic freedoms as well as the level of economic development. Results suggest a positive impact of trade freedom across all income groups. The impact was higher in percentages for lower incomes groups, but insufficient to reduce income inequality. The effects of other freedoms varied with level of development of a country and with its different income groups: For middle-income countries, free trade created large middle classes. Rule of law and regulatory efficiency resulted in positive and limited government in negative impacts across quintiles. Political freedom positively impacted the income of upper quintiles in middle-income and lower classes in high-income countries, and negatively for upper classes in high-income countries. Policy makers can consider the results in prioritization of the reforms to gauge political support from various income groups, and in devising approaches to remedy the negative implications on income levels for certain groups.