Democracy, Capitalism, and Income Inequality: Seeking Causal Directions

Recent research shows that lower levels of income inequality cause higher levels of democracy, and vice versa in a simultaneous relationship. A critical factor missing from these studies is a direct exogenous measure of capitalism in models explaining variation in income inequality and democracy. This study examines 50 countries over the years 1978-1993 and finds in a pooled two stage least squares modeling exercise that the Fraser Institute measure of capitalism appears to have a positive linear impact on POLITYIV measures of democracy and a negative linear impact on income inequality (more capitalism, more inequality). There appears to be no higher-order relationship between capitalism and democracy or income inequality, though there is a parabolic relationship between democracy and income inequality.