How Capitalism Can Reduce Poverty

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Posted: Sep 15, 2020 1:15 PM
How Capitalism Can Reduce Poverty

Source: AP Photo/Richard Vogel

Back in 2017, I shared this video explaining why capitalism is unquestionably the best way to help poor people.


I’m recycling the video today because it’s a great introduction for a discussion about how best to help poor people.

As part of my Eighth Theorem of Government, I made the point that it’s wrong to fixate on inequality. Instead, the goal should be poverty reduction.

And the best way to help the poor, as I noted when criticizing Pope Francis’ support for statism in a BBC interview, is free markets and limited government.

Now we have additional evidence for this approach thanks to a new study from the Hoover Institution.

Authored by Ed Lazear, former Chairman of the Council of Economic Advisors, it uses hard data from Economic Freedom of the World and the Index of Economic Freedom to see how poor people do in capitalist nations compared to socialist nations.

If you’re pressed for time, here are the key passages from the introduction.

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. …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.

For those interested, let’s now dig into the details.

The study specifically looks at the degree to which state ownership (i.e., textbook socialism) has an impact on income.

As one might suspect, more state ownership means lower income.

A number of measures of free-market capitalism and socialism have been suggested. The analysis starts by examining the metric that most closely matches the dictionary definition of socialism, namely, the amount of state ownership of capital… The basic approach in this section is to examine the relation of income of three groups to state ownership. …All coefficients on the state ownership index are positive, strong, and statistically significant. For example, using the coefficient in column 4, a one standard deviation increase in private ownership increases median income by about 19 percent of the mean value of the log of median income. Also interesting is that the lowest income groups benefit as much or more from private ownership as the highest income groups. …The cross-country correlation between private ownership and income ten years in the future is positive and strong. It is also true that median income seems to rise over time within a country as the country moves toward more private ownership and less state ownership.

The study highlights several interesting examples.

For instance, it shows that poor people immensely benefited from China’s partial shift to capitalism, even though inequality increased (something I pointed out a few years ago).

To see income inequality in China, click here.

Here’s the data on Chile, which shows both rich and poor benefited from that nation’s shift to capitalism.

By the way, I have several columns (hereherehere, and here) documenting how poor people have been the big winners from Chile’s pro-market reforms.

Next we have the example of South Korea.

That data is especially powerful, by the way, when you compare South Korea and North Korea.

Last (and, in this case, least), we have the data from the unfortunate nation of Venezuela.

Chavez’s family personally gained from socialism, but this chart shows how the rest of the nation has stagnated.

So what’s the bottom line?

Lazear summarizes his results.

…there is no evidence that, as a general matter, high-income groups benefit more from a move toward capitalism than low-income groups. The effect of changing state ownership and economic freedom on income is not larger for the rich than for the poor. Second, income growth is positively correlated across deciles. The situation is closer to a rising tide lifting all boats than to the fat man becoming fat by making the thin man thin. Finally, there is no consistent evidence across the large number of countries and time periods examined of any strong and widespread link between income growth and inequality. There are examples, like China, where income growth was coupled with large increases in inequality, but others like Chile, where strong income growth came about without much change in inequality, and South Korea, where inequality declined slightly as economic freedom and income grew over time.

Amen. This analysis underscores my oft-made argument that inequality is irrelevant and that policy makers instead should have a laser-like focus on economic growth.

Assuming, of course, that they want poor people to climb the economic ladder to prosperity.

P.S. The Lazear study points out that Scandinavian nations are definitely not socialist based on measures of state ownership.

Some might define socialist economies as merely being those that have high levels of redistribution, meaning high taxes and transfers. …It is certainly true that the Scandinavian countries have higher taxes and transfers than non-Scandinavian countries… Scandinavian countries all have low state ownership index values…and high values of the economic freedom index. The values for Scandinavia look much more like those for the United States than they do for pre-1985 China or post-2000 Venezuela. …Perhaps a more accurate description of Scandinavia is that the countries rely primarily on private ownership and markets but have chosen to have a large government transfer program, which implies not only high transfers but also high taxes.

I’ll simply add that the high transfers and high taxes have negative consequences for Scandinavian nations, but those countries at least have very pro-market policies in other areas to compensate for the damage caused by bad fiscal policy.

P.P.S. For my friends on the left who may suspect that Lazear cherry-picked his examples. I’ll simply challenge them to show a contrary example.