Economic Inequality and International Trade

In recent decades, the world has seen dramatic changes in economic inequalities, both within and between countries. Several population-rich countries have experienced unprecedented economic growth and hitherto unknown prosperity for sizeable parts of their populations. In China, India, Brazil, and other countries large middle classes have been emerging, creating huge new consumer markets with a high export potential for the rest of the world. Dramatic increases in inequality have also taken place within industrialized countries, with more polarized income distributions and eroding middle classes, particularly in the U.S. but also in other rich economies. These trends have generated dramatic changes in the distribution of purchasing power both within and across countries around the globe. This project will study the implications of these large and changing economic inequalities for the pattern and volume of international trade. The basic approach of our project aims to extend the existing literature in two ways. First, our focus is on the distribution of economic resources among world citizens. This is different from the majority of the existing literature that emphasizes the distribution of economic resources across nations and abstracts from within-country inequality. How do the new and growing middle classes in emerging markets affect the pattern of international trade? How will rising inequalities within rich countries affect trade structures and trade volumes? How will trade liberalizations affect the poor and the middle classes in the developing and the developed world? Our approach allows investigating such potentially important issues that cannot be (easily) addressed within the standard frameworks in international economics and macroeconomics. Second, on a more general basis, we explore economic inequality as a potentially important determinant of trade outcomes. This focus is quite different from a long tradition in international economics that has been exploring the opposite chain of causality: the impact of international trade on factor prices and the distribution of income across factors of production within countries or across representative factor owners across countries. Our project is both theoretically and empirically oriented. On the theoretical side, we aim to contribute to and extend the recent theories of international trade in two ways. First, the main focus of our theoretical projects will be to explore the implications of economic inequalities through the channel of non-homothetic preferences. Our basic framework emphasizes the extensive margin of consumption choices and builds upon empirically relevant consumption patterns: rich households consume more types of goods than poor households. This framework is rich enough to address the interesting questions mentioned above. Yet it is simple and tractable enough to cover a broad range of related issues such as trade and growth, the quality and variety of trade, and international product cycles. A second contribution of our project explores how income and wealth inequalities affect trade flows through the channel ofimperfect capital markets. Here our goal is to contribute to the growing literature that explores to which extent a country's financial development explains its economic integration. While this literature explores the importance of access to credit, only very few papers have looked at how this interacts with income and wealth inequalities. On the empirical side, we will extend the existing literature by a strong focus on structural modeling. For decades, the empirical analysis of the determinants of bilateral or multilateral trade has focused on reduced-form empirical models, mostly along the lines of the so-called gravity equation. In our analysis we intend to go beyond this empirical tradition and take more seriously the opportunities arising from structural empirical analysis of general equilibrium models of income inequality and bilateral trade.