The Quality of Institutions and the Relationship Between International Trade and Inequality

Abstract

This paper investigates the relationship between international trade and inequality in Brazilian municipalities, distinguishing them by the quality of local institutions. It departs from the theoretical hypothesis of a reinforcing relationship between inequality and quality of institutions. The related literature shows that initial conditions of inequality shape the gradual evolution of institutions over time, while institutions also determine current inequality. I apply micro data from the 2000 and 2010 Brazilian censuses combined with data on international trade at the municipal level. Focusing on a unique political regime facilitates analysis of the direct influence of institutional quality on the international trade-inequality nexus. The empirical analysis regresses municipal Gini index on municipal exports and imports for two subsamples of the available data, representing municipalities with weak institutions and municipalities with strong institutions, according to two specific institutional variables. The first variable measures the distance to a labor court of a given municipality, and the second variable measures the municipal concentration of resources, represented by land Gini. I find that only municipal exports robustly reduce inequality and the magnitude of reduction is higher in municipalities with strong institutions than in those with weak institutions, which is in line with a redistributive aptitude associated with the quality of institutions. If exports increase 10%, Gini reduces by 0.00756 points in municipalities with low distance to justice, while the effect of exports on Gini is not significantly different from zero in municipalities with high distance to justice. An increase of 10% in exports reduces the Gini index in 0.00548 point in municipalities with high concentration of land, and reduces the Gini index in 0.00905 point in municipalities with low concentration of land. The empirical results show that exports reduce inequality to a greater extent in places with relatively strong institutions, predominantly located in the south, that already present a lower level of inequality than northern municipalities. Thus, exports exacerbate inequality between regions. For this reason, policy implications of exports-inequality nexus are quite limited regarding the reduction of inequality between regions. For this proposal, it would be desirable a factor that could reduce inequality in regions with higher levels of inequality.