Barriers to Entry and Income Inequality

There’s new research showing across the cross-section of countries, that higher barriers to starting new businesses is associated with higher levels of income inequality.

A problem with this sort of research is that it’s not clear if barriers cause inequality, or if inequality causes barriers. Causality is hard to establish in non-experimental settings.

However, economists are better than most social sciences at purging their results of the feedback between two possible causes, and this research does a good job of that.

The data on barriers comes from the World Bank, which publishes a cross-sectional data set on the number of consecutive steps an entrepreneur must complete prior to opening for business. These range from as few as one out into the twenties, and might include things like educational and training requirements, land or equipment ownership, licensing, testing, or health and environmental conditions.

The results show that between otherwise identical and typical countries, that the one with one more step involved in starting a business has a higher income share for the rich (roughly 31% vs. 29%), and a larger Gini coefficient (a limited and basic but very common measure of overall income inequality).

Income inequality is, of course, a macroeconomic concern. However, the microeconomic mechanism at work here is well known: more barriers means less entry in response to positive profit signals, and less competitors leads to bigger markups and profits.

The real world is no doubt a mix of these, but these results are consistent with these polar stories: 1) well-meaning governments erect barriers to protect consumers and those make the rich richer (presumably because they have the resources to overcome the barriers), or 2) the rich influence government to erect barriers to keep competitors out and this helps them get richer.

The research by Chambers, McLaughlin and Stanley appeared in Public Choice, and is entitled “Barriers to Prosperity: The Harmful Impact of Entry Regulations on Income Inequality”. The article is not available for download, but it can be viewed online for free.

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Part of the problem of understanding the interactions of macroeconomics and policy is … the policy choices that get linked together under the banner of parties are often nonsensical.

Consider the U.S.: Democrats tend to be more interested in erecting barriers to business formation, but are also more worried about income inequality, even though this research indicates the two go together. Republicans grandstand with an opposing pair that’s just as conflicted.

Macroeconomists are too dull to come with crazy stuff like this on their own ;-D