This chapter examines distorted views of capitalism, challenging the popular view that capitalism is a villainous perpetuator and government a saintly corrector of cronyism and inequality. These misperceptions result not only in a distorted understanding of the institutional structure that underlies capitalism and the mechanisms in which income is distributed, but also lead to perilous reform prescriptions that undermine the ability of capitalism to improve individual and societal well-being. A theory is outlined that links an economy’s institutions to the type of capitalism, entrepreneurship, and inequality to emerge in society. Institutions that constrain the discretionary authority of government incentivize productive entrepreneurship and facilitate free market capitalism, giving rise to a market-determined income distribution and opportunity for economic mobility. An examination of available evidence suggests that countries whose institutions are more consistent with economic freedom exhibit less inequality than those in where government is more prominent.
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