world which would lower inequality across countries without experiencing appreciable increases in inequality within its boundaries.

# **VII.** **<u>Conclusions</u>**

There are sharp differences across developing countries in returns to years of schooling and work experience that are large enough to explain why between-nation income differences are the dominant source of the world income inequality documented by T.P. Schultz (1988). T.W. Schultz (1975) argued that countries that limit the magnitude of economic shocks or that limit the degree to which individuals can react to those shocks will eliminate much of the source of the return to human capital. This paper suggests that if T.W. Schultz was correct, then differences in economic institutions across countries that limit or enhance economic freedom should be a source of the persistent differences in income levels documented by T.P. Schultz.

Using the Heritage Foundation’s Economic Freedom Index as a gauge of the extent to which a country is open to market forces and allows market responses, we find broad support for the Schultz hypothesis. Private returns to schooling are significantly higher in more economically free countries. The higher returns to schooling persist even when we add measures other political institutions that might affect returns and when we add controls for the level and pace of economic development, life expectancy, skill intensity and population in the country. There is no one element of economic freedom that seems to be the key factor; economic freedom in one arena appears to complement economic freedom in other markets. We find similarly higher returns to work experience in more economically free countries which persist when other political institutions are added, but the evidence weakens when controls for the level of economic development are added.

There is no evidence that more market-oriented economic institutions exacerbate withincountry wage inequality. While policies that enhance economic freedom raise returns to schooling most for workers at the upper-tail of the ability distribution, they raise returns to experience most for those at the bottom-tail of the ability distribution. More to the point, they do not lower wages at any point along the ability distribution, and so they improve the lot of all workers. Furthermore, they raise wages for men and women and for urban and rural dwellers. Concerns that these policies raise inequality within countries appear overblown. On the other hand, because they raise wages in developing countries compared to the world average, more market-oriented policies in developing countries will tend to lower the between-country component of world income inequality.

An interesting implication of these findings for international migration is that individuals will experience the largest gains in private returns to human capital when they migrate from economically repressed to economically free countries. Should appropriate data exist for international migrants, we should find the largest gap in estimated returns to schooling or experience between expatriates and non-movers from countries that are the least economically free. Similarly, looking at the expatriates from a given country, we should find the highest returns to human capital for the expatriates in the most economically free countries. The least market-oriented countries will experience the greatest brain-drain, or else they will have to use other means to suppress the desires of their citizens to leave.

18