Do Free Markets Produce Inequality?
To understand Latin America’s inequality, look no further than the satellite picture below. In Ciudad Juárez, Chihuahua, low-income multifamily housing buildings, with difficult access (don't even have a paved street) are separated only by a wall from houses that are sometimes larger than these entire buildings. These homes often feature swimming pools, spacious yards, and vast green areas, despite being located in the middle of the desert. Similarly, in San Isidro, an upscale suburb of Buenos Aires, the razor-sharp contrast between manicured lawns and corrugated rooftops tells a story replicated across the region, from the golf clubs of Mexico City’s Santa Fe to the precarious favelas that tumble into Rio’s swimming pools. Inequality in Latin America isn’t just visible, it’s visceral.
A common assumption dominates public debate in Latin America and beyond: that more capitalism means more inequality. The free market is often portrayed as an efficient but immoral machine, great at producing wealth, terrible at distributing it. Yet the data tell a different story. According to the Economic Freedom of the World (EFW) report, there is no meaningful correlation between income inequality and economic freedom. In fact, in freer economies, even the poorest are generally better off.
The following graph shows the income share of the bottom 10% of the population across countries, grouped by their level of economic freedom. The differences are minimal. In other words, economic freedom does not significantly change how much of the national income the poorest receive, but it does determine how big the overall income pie is.
What truly differs between free and unfree economies is who gets rich and why. In economically free societies, wealth is typically earned by those who create value, entrepreneurs, innovators, and businesses that serve consumers well. In less free economies, by contrast, wealth often stems from rent extraction: connections to political power, control over scarce licenses, or legal monopolies. The former reflects consumer choice; the latter reflects institutional failure.
This misconception has important consequences. If freedom doesn't cause inequality, then efforts to reduce it by limiting markets, through heavy regulation, redistribution, or populist intervention, may do more harm than good. Latin America is a region that illustrates this problem well.
Latin America is the most unequal region in the world outside sub-Saharan Africa. Unlike Africa, however, it has a much higher average income. That paradox, of wealth amid inequality, has led to a common but misguided solution: more redistribution. Yet, the actual record shows that Latin America’s governments are among the least effective in using taxes and transfers to reduce inequality. According to The Economist, fiscal policies in rich countries reduce the Gini coefficient by nearly 40%; in Latin America, barely 5%.
The problem isn’t that Latin American societies are allergic to redistribution; it’s that they’ve built inefficient, politicized, and mistrusted states that cannot deliver it properly. Meanwhile, their tax systems rely on regressive consumption taxes rather than productivity-boosting income taxes. But there's a bigger issue: the obsession with redistribution has distracted from the real engine of opportunity, economic growth.
A young, enterprising couple runs a small but thriving food business, and I do business regularly with them, shared their story with me. They've been operating for over ten years, have a steady demand, and have even employed up to ten full-time workers. However, they remain completely informal, and not for lack of ambition.
“If we tried to formalize,” they explained, speaking on condition of anonymity due to concerns about potential tax repercussions, “we would have to register with the municipal commerce office, pay state payroll tax, get approval from the public registry, and start paying federal income tax. Then there’s the IMSS (Social Security, which in Mexico is mostly paid by the employer) for our employees. We’d go from making a modest living to not making anything at all.”
Their case is far from unique. For many small businesses in Latin America, the cost of formality exceeds its benefits. The state doesn’t offer services in proportion to what it demands. The informal economy, far from being a cultural leftover, is often a rational response to institutional failure.
Even with these institutional issues, between 2000 and 2014, inequality in the region declined. What caused it? According to the Inter-American Development Bank, only about 20% of the reduction came from cash transfer programs like Brazil’s Bolsa Família. Over half came from rising wages among the poor, driven by a period of robust economic growth fueled by global demand for Latin American commodities. In short, markets, when allowed to grow, delivered results where governments could not. Growth empowered low-income workers by expanding demand for their labor. It pushed many into more formal, better-paying jobs. It began to break the cycle of inherited disadvantage.
If Latin America wants to reduce inequality in a sustainable way, it should stop trying to redistribute a small, stagnant pie, and instead focus on growing the pie through market-friendly reforms. That means simplifying tax systems, making labor markets more flexible, investing in competitive education (not state-run monopolies), and ensuring the rule of law so that businesses can thrive. Countries that have succeeded in reducing inequality, from South Korea to Estonia, didn’t do it by handing out subsidies forever. They did it by unleashing growth, competition, and innovation.
Latin America’s inequality is real, unjust, and unsustainable. But it is also solvable, not through bigger government, but through smarter markets. What the region needs is not a war on wealth, but a commitment to opportunity. Growth is not a trickle-down myth; it’s a ladder. And free markets, when backed by good institutions, are still the best way to climb it.
Juan José Casillas Quezada | Research Assistant | jcasillasquez@miners.utep.edu
The views represented here are those of the author and do not represent the position of The University of Texas at El Paso or the Center for Free Enterprise.
