Socialism, Capitalism, And Income

Tuesday, May 12, 2020
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Proponents of free-market capitalism extol its high economic growth and freedom of choice. Advocates of socialism protest that capitalism is harsh and leaves too many behind. They argue that socialism is more benevolent. Most important is that if socialism is better for the poor, then low-income groups should fare better under socialism than under capitalism.

This study analyzes income data from 162 countries over multiple decades, coupled with measures of economic freedom, size of government, and transfers to determine how various parts of society fare under capitalism and socialism. The main conclusion is that the poor, defined as having income in the lowest 10 percent of a country’s income distribution, do significantly better in economies with free markets, competition, and low state ownership. More impressive is that moving from a heavy emphasis on government to a free market enhances the income of the poor substantially. For example, when countries were ranked on the basis of an economic freedom index in 2015, Mexico was the median country and Singapore was the most free. Changing freedom from the Mexico level to the Singapore level is predicted to raise the income of the poor by about 40 percent. All income groups benefit from the change, but the change typically helps the poor more than other income groups.

Additionally, a rising tide lifts all boats. When the median income in a country rises by 1 percent, the income of the lowest 10 percent also rises by about 1 percent. Furthermore, the richest 10 percent do not increase their income at the expense of the lowest 10 percent. In fact, the reverse is true. Incomes of the poor move with the incomes of the rich, not in opposite directions. Even when the income of the richest 10 percent grows more rapidly than the income of the poorest 10 percent, causing an increase in income inequality, the poor tend to be better off in absolute terms. China is an extreme example. There, the ratio of income of the top 1 percent to the bottom 10 percent rose from eight during the 1980s to forty by 2010. But during the same time interval, income of the poor increased five-fold.

The Nordic countries are important cases because they couple free markets with large government sectors and high levels of government transfers. The evidence supports the argument that large government and high transfers benefit the poor at least at a point in time. There is little doubt that an explicit program of transfers to the poor raises the income of the poor. There is a key additional fact, however. Only rich countries engage in significant redistribution to their poor. The median income in countries that rank in the top half for transfers is about 2.5 times as high as the median income in countries that rank in the bottom half for transfers. Generosity does not appear to be system-specific. There is no tendency for countries with more state ownership to engage in higher transfers.

Transitions from socialism to free-market capitalism take different forms and have different consequences. In China, growth was rapid and the income of all groups rose rapidly, but at substantially higher rates for the top 10 percent of earners than for the bottom 10 percent. In Chile, growth was substantial and parallel. Incomes of the richest and poorest grew at similar rates. The former Soviet bloc experienced a large drop in GDP during the early transition, which hurt the poor more than the rich. Venezuela, which went in the opposite direction, namely from freer markets and private ownership to socialism, saw income stagnation and decline for all.

In sum, all income groups benefit from having free markets and private ownership, but this does not preclude some income transfers. The disadvantage of having a large government sector is slower growth for all, which affects incomes of subsequent generations, rich and poor alike.