Equality in an Inegalitarian Region - The Equality Multiplier Effect in Uruguay

Abstract

Under a context of a developing country, I try to disentangle the two mechanisms that drive the negative correlation between wage inequality and welfare generosity. The main mechanism, goes from pre-tax wage inequality to welfare generosity, relying on the role of welfare spending as social insurance and the political competition under democratic conditions. The feedback mechanism, captures the empowering effect from a higher welfare generosity on the weaker groups in the society. By raising the fallback position, vulnerable groups are able to command a higher pay and improve their relative wage. The combination of the two mechanisms results in a political economic equilibrium, incorporating the mutual dependence between wage setting and welfare spending. I find a robust negative correlation between inequality, prior to taxes and transfers, and welfare generosity for Uruguay, contradicting the classical view. It was difficult to fully disentangle both mechanisms due to a lack of sufficient independent variation from the instruments. But I find compelling evidence that equality may generate more equality.