Unequal societies, Unequal Terms of Trade and Trade Policy

We consider a demand based theory along the lines of Murphy et al. (1989) to study the interaction between income inequalities and trade patterns. We analyze the effect of redistributive policies on the production patterns and welfare. We distinguish an intensive and an extensive channels through which an increase of demand - driven by redistribution or trade opening - leads to output growth inside a country and in its partner country. Trade between dierent countries (in terms of income or inequality) generates a modication of the demand distribution between sectors which impacts the industrialization process, the terms of trade and the welfare distribution within countries. Our framework hopefully provides a basic tool for studying the interactions between changes in taris on welfare and inequalities inside and between countries. We obtain non monotone relationships between the degree of inequality in the home country and the level of income of its trade partner. We can observe a U-shape or an inverted U-shape depending on, among other things, the relative size of the two countries. As a result the welfare eect of trading with unequal countries is ambiguous.