Income inequality and trade of ‘Made in China’

Abstract

This paper presents a theory and empirical evidence on how destination countries’ income inequality affects the export price and volume of Chinese products. We provide a simple model to illustrate exporters’ market dynamics and product-quality specialization induced by the change in the destination country's income distribution. Under the nonhomothetic preference assumption, the model predicts that higher income inequality makes Chinese exporters who produce low-quality products concentrate on serving low-income consumers, which accounts for a large proportion of the population. Exploiting highly disaggregated customs transaction records of Chinese exporters, we provide empirical evidence consistent with the model predictions: (i) A rise in income inequality leads to a lower export price, (ii) induces entry of new exporters, and (iii) leads to higher export value and export price dispersion.