The evolution of inequality after trade liberalization

Abstract

The paper presents a general framework for the analysis of the evolution of personal income distribution following trade liberalization. The model allows many factors of production and the possibility of capital gains. In this framework, the short run evolution of inequality depends on the wage to wealth ratio, while changes in the interest rate determine the changes in long run inequality. The general framework is applied to the dynamic specific factors model of Eaton (Rev. Econ. Stud., VLIV (1987)). In this model, the land–labor ratio determines whether a country exports the land-using or the capital-using good in the long run. The type of the export good determines the effects of liberalization on inequality. In land (labor)-abundant countries, inequalities increase (decrease) along the dynamic path. The model provides an explanation for the differences between Latin American and Asian countries in their response to trade liberalization. Econometric analysis provides mixed results for these predictions, with the correct signs but non-significant coefficients for the coefficient on the interaction between openness and the land–labor ratio.