Inequality and Trade: A Behavioral-Economics Perspective

In this paper we present a version of the Mitra and Trindade (CJE, 38: 1253-1271, 2005) model to examine how differences in preexisiting levels of inequality between countries may determine the pattern of international trade when individual preferences are non-homothetic. In particular, using a standard 2x2x2 Heckscher-Ohlin framework, we propose a behavioral linkage between asset inequality and trade pattern by endogenizing non-homotheticity in terms of status dependent preferences. We show that for sufficiently high ratios of capital to labor earnings, there exists a critical level of inequality such that specificities of the pattern of trade that emerge between the two countries are contingent upon whether the inequality levels prevailing in the countries are above or below this level. For sufficiently low ratios of capital to labor earnings, however, the trade pattern is independent of the exisiting levels of inequality relative to the critical level. Based on our model, we examine the impact of the resultant trade pattern on the levels of income inequality. Finally, we discuss some interesting international spillover effects of redistributive policies.