The Role of Institutions in Inequality

This study attempts to empirically examine the relationship between the quality of the institutional environment and income inequality. In order to determine the causality and direction of this relationship, a Vector Autoregressive Model (VAR) has been used, and to overcome the limitations pertaining to the data, a panel composed of data from 121 countries has been used and tested; hence, a Panel VAR model (Panel VAR) has been implemented. Civil liberties, political rights, economic freedoms, the risk of countries, six indicators of good governance as institutional indicators, Gini coefficient, and the income ratio of top decile to bottom decile of the population have been considered as the indicators of inequality. According to the results, the inverse relationship between the quality indicators of civil liberties, political rights, economic freedoms, the risk of countries and political stability indices (indices of good governance) with inequality is verified. In other words, the results show that the quality of the institutional environment has positive effects on inequality and poverty, thus better quality institutional environment will lead to less inequality and poverty; in other words, the results indicate that a higher quality of institutional environment will reduce inequality, but there is weak evidence as for the opposite direction for this relationship.