Inequality, Financial Deepening and Current Account Impact

In this paper we analyze if changes in levels of inequality are associated, ceteris paribus, with changes in the balance of the current account, taking in consideration the role of the development stage of the economy in the interaction between these variables. In this sense, the financial system emerges as a key intermediary, which may affect the sign and intensity of these relationships. Using panel data from 29 countries for the 1970-2011 periods, our results confirm the need to distinguish between functional and personal income distribution. Greater participation of wages in total income is related with a deterioration of the current account. This result is robust to different specifications and estimation methodologies. On the other hand, while we find evidence that deterioration in personal income distribution is associated with a lower current account balance, our results shows that the relationship is stronger in emerging economies than in advanced, unlike what is suggested by the recent literature, which has focused mainly on the case of the US. The existence of differences between groups of countries confirms that the relationship between income concentration and external sector is mediated by various structural and idiosyncratic factors and, as a result, the net effect will vary depending on the sample used. Given the complexity of these relationships, we warn about the risks of generalizing to emerging countries results based only in the study of advanced economies.