INEQUALITY, TRADE AND ECONOMIC DEVELOPMENT:Evidence from Developing Countries

This study analyses the impact of trade on within-country inequality using a panel data set from 65 developing countries [see, Appendix (Table A-2)]. This study differs from the existing literature on distributional impact of trade by explicitly noting the importance of development stage in shaping the link. The analysis shows that the effect of trade on inequality depends upon the level of GDP-per-person (to some extent a proxy for economic development) of the trade-integrating economy. Among the developing economies, those with a high level of GDP-per-person enjoy a favourable effect of trade openness on income distribution, while the impact is unfavourable for those with low GDP-per-person. In sum, trade does not accentuate ameliorates inequality in developing countries with the low level of economic development – the opposite of the prediction of standard economics [Heckscher-Ohlin (HO) Model]. The HO model implies that free trade between labour-intensive (developing) and capital-intensive (developed) countries should lead to more specialization in labour-intensive products in developing and capital-intensive products in developed countries. This should bid up the price of labour, relative to capital in developing countries, and vice versa in developed countries, increasing inequality in developed countries and decreasing it in developing countries. The Stolper-Samuelson theorem has similar consequences. Findings of the study are robust to the sensitivity analysis, different estimators, inclusion of regional and time effects.