Skip to main content

Income inequality, productivity, and international trade

Abstract

This paper studies the effect of income inequality on selection and aggregate productivity in a general equilibrium model with non-homothetic preferences and product quality. The model matches the empirical fact that an increase in income shifts one’s consumption towards goods that have higher quality both at the intensive and extensive margins. It also implies a negative relationship between the number and quantity of goods consumed by an income group and the earnings of other income groups. The central result is that a mean-preserving spread of the income distribution negatively affects aggregate productivity through the softening of firms’ selection. In the presence of international trade, this effect is amplified with lower trade barriers or a larger number of trade partners. Furthermore, the model implies that the domestic expenditure shares and welfare gains from trade are constant across income groups. A simple quantitative exercise suggests that an income redistribution like the one induced by the US Federal taxes and transfers raises average productivity by about 3%.

This is a preview of subscription content, access via your institution.

References

  • Acemoglu, D.: Technical change, inequality, and the labor market. J. Econ. Lit. 40(1), 7–72 (2002)

    Article  Google Scholar 

  • Aghion, P., Caroli, E., Garcia-Penalosa, C.: Inequality and economic growth: the perspective of the new growth theories. J. Econ. Lit. 37(4), 1615–1660 (1999)

    Article  Google Scholar 

  • Arkolakis, C., Costinot, A., Rodriguez-Clare, A.: New trade models, same old gains? Am. Econ. Rev. 102(1), 94–130 (2012)

    Article  Google Scholar 

  • Arkolakis, C., Costinot, A., Donaldson, D., Rodríguez-Clare, A.: The elusive pro-competitive effects of trade. Rev. Econ. Stud. 86(1), 46–80 (2019)

    Google Scholar 

  • Atkinson, A.B., Piketty, T., Saez, E.: Top incomes in the long run of history. J. Econ. Lit. 49(1), 3–71 (2011)

    Article  Google Scholar 

  • Behrens, K., Murata, Y.: Globalization and individual gains from trade. J. Monet. Econ. 59(8), 703–720 (2012)

    Article  Google Scholar 

  • Behrens, K., Pokrovsky, D., Zhelobodko, E.: Market size, entrepreneurship, sorting, and income inequality. CEPR working paper (2014)

  • Berg, A., Ostry, J.D., Tsangarides, C.G., Yakhshilikov, Y.: Redistribution, inequality, and growth: new evidence. J. Econ. Growth 23(3), 259–305 (2018)

    Article  Google Scholar 

  • Berman, E., Bound, J., Machin, S.: Implications of skill-biased technological change: international evidence. Quart. J. Econ. 113(4), 1245–1279 (1998)

    Article  Google Scholar 

  • Berry, S., Levinsohn, L., Pakes, A.: Automobile prices in market equilibrium. Econometrica 63(4), 841–890 (1995)

    Article  Google Scholar 

  • Bertoletti, P., Etro, F., Simonovska, I.: International trade with indirect additivity. Am. Econ. J. Microecon. 10(2), 1–57 (2018)

    Article  Google Scholar 

  • Bils, M., Klenow, P.J.: Quantifying quality growth. Am. Econ. Rev. 91(4), 1006–1030 (2001)

    Article  Google Scholar 

  • Boppart, T.: Structural change and the Kaldor facts in a growth model with relative price effects and non-Gorman preferences. Econometrica 82(6), 2167–2196 (2014)

    Article  Google Scholar 

  • Borusyak, K., Jaravel, X.: The distributional effects of trade: theory and evidence from the United States. London School of Economics Working Paper (2021)

  • Cingano, F.: Trends in income inequality and its impact on economic growth. OECD Social, Employment and Migration Working Papers No. 163 (2014)

  • Collard-Wexler, A., De Loecker, J.: Reallocation and technology: evidence from the US steel industry. Am. Econ. Rev. 105(1), 131–171 (2015)

    Article  Google Scholar 

  • Comin, D., Lashkari, D., Mestieri, M.: Structural change with long-run income and price effects. NBER Working Paper No. 21595 (2018)

  • Costinot, A., Vogel, J.: Matching and inequality in the world economy. J. Polit. Econ. 118(4), 747–786 (2010)

    Article  Google Scholar 

  • De Loecker, J., Warzynski, F.: Markups and firm-level export status. Am. Econ. Rev. 102(6), 2437–71 (2012)

    Article  Google Scholar 

  • De Loecker, J., Goldberg, P.K., Khandelwal, A.K., Pavcnik, N.: Prices, markups, and trade reform. Econometrica 84(2), 445–510 (2016)

    Article  Google Scholar 

  • Deaton, A., Muellbauer, J.: An almost ideal demand system. Am. Econ. Rev. 70(3), 312–326 (1980)

    Google Scholar 

  • Dhingra, S., Morrow, J.: Monopolistic competition and optimum product diversity under firm heterogeneity. J. Polit. Econ. 127(1), 196–232 (2019)

    Article  Google Scholar 

  • Eaton, J., Kortum, S.: Technology, geography, and trade. Econometrica 70(5), 1741–1779 (2002)

    Article  Google Scholar 

  • Edmond, C., Midrigan, V., Daniel Yi, X.: Competition, markups, and the gains from international trade. Am. Econ. Rev. 105(10), 3183–3221 (2015)

    Article  Google Scholar 

  • Espoir, D.K., Ngepah, N.: Income distribution and total factor productivity: a cross-country panel cointegration analysis. Int. Econ. Econ. Policy 2021, 1–38 (2021)

    Google Scholar 

  • Faber, B., Fally, T.: Firm heterogeneity in consumption baskets: evidence from home and store scanner data. UC-Berkeley Working Paper. Rev. Econ. Stud. (2021, Forthcoming)

  • Faber, B.: Trade liberalization, the price of quality, and inequality: evidence from Mexican store prices. UC-Berkeley Working Paper (2014)

  • Fajgelbaum, P.D., Khandelwal, A.K.: Measuring the unequal gains from trade. Quart. J. Econ. 131(3), 1113–1180 (2016)

    Article  Google Scholar 

  • Fieler, A.C.: Nonhomotheticity and bilateral trade: evidence and a quantitative explanation. Econometrica 79(4), 1069–1101 (2011)

    Article  Google Scholar 

  • Foellmi, R., Zweimüller, J.: Income distribution and demand-induced innovations. Rev. Econ. Stud. 73(4), 941–960 (2006)

    Article  Google Scholar 

  • Foellmi, R., Wuergler, T., Zweimüller, J.: The macroeconomics of model T. J. Econ. Theory 153, 617–647 (2014)

    Article  Google Scholar 

  • Foellmi, R., Hepenstrick, C., Zweimüller, J.: International arbitrage and the extensive margin of trade between rich and poor countries. Rev. Econ. Stud. 85(1), 475–510 (2018)

    Google Scholar 

  • Fuentes, R., Mishrab, T., Scaviac, J., Parhi, M.: On optimal long-term relationship between TFP, institutions, and income inequality under embodied technical progress. Struct. Chang. Econ. Dyn. 31, 89–100 (2014)

    Article  Google Scholar 

  • Galor, O., Moav, O.: From physical to human capital accumulation: inequality and the process of development. Rev. Econ. Stud. 71(4), 1001–1026 (2004)

    Article  Google Scholar 

  • Grossman, G.M., Helpman, E.: Growth, trade, and inequality. Econometrica 86(1), 37–83 (2018)

    Article  Google Scholar 

  • Grossman, G.M., Rossi-Hansberg, E.: Trading tasks: a simple theory of offshoring. Am. Econ. Rev. 98(5), 1978–1997 (2008)

    Article  Google Scholar 

  • Grossman, G.M., Helpman, E., Kircher, P.: Matching, sorting, and the distributional effects of international trade. J. Polit. Econ. 125(1), 224–264 (2017)

    Article  Google Scholar 

  • Hayes, K.J., Nieswia, M., Slottje, D.J., Redfearn, M., Wolff, E.N.: Productivity and income inequality growth rates in the United States. In: Contributions to Economic Analysis, vol. 223. Elsevier, pp. 299-327 (1994)

  • Helpman, E., Itskhoki, O., Redding, S.: Inequality and unemployment in a global economy. Econometrica 78(4), 1239–1283 (2010)

    Article  Google Scholar 

  • Hottman, C.J., Monarch, R.: A matter of taste: estimating import price inflation across US income groups. J. Int. Econ. 127, 103382 (2020)

    Article  Google Scholar 

  • Hummels, D., Klenow, P.J.: The variety and quality of a nation’s exports. Am. Econ. Rev. 95(3), 704–723 (2005)

    Article  Google Scholar 

  • Jackson, L.F.: Hierarchic demand and the Engel curve for variety. Rev. Econ. Stat. 66(1), 8–15 (1984)

    Article  Google Scholar 

  • Kim, R., Vogel, J.: Trade and Welfare (across Local Labor Markets). Working paper, UCLA (2020)

  • Klepper, S., Thompson, P.: Submarkets and the evolution of market structure. RAND J. Econ. 37(4), 861–886 (2006)

    Article  Google Scholar 

  • Krugman, P.: Scale economies, product differentiation, and the pattern of trade. Am. Econ. Rev. 70(5), 950–959 (1980)

    Google Scholar 

  • Li, N.: An Engel curve for variety. Rev. Econ. Stat. 103(1), 72–87 (2021)

    Article  Google Scholar 

  • Matsuyama, K.: The rise of mass consumption societies. J. Polit. Econ. 110(5), 1035–1070 (2002)

    Article  Google Scholar 

  • Matsuyama, K.: Engel’s law in the global economy: demand-induced patterns of structural change, innovation, and trade. Econometrica 87, 497–528 (2019)

    Article  Google Scholar 

  • McCalman, P.: International trade, income distribution and welfare. J. Int. Econ. 110, 1–15 (2018)

    Article  Google Scholar 

  • Melitz, M.J.: The impact of trade on intra-industry reallocations and aggregate industry productivity. Econometrica 71(6), 1695–1725 (2003)

    Article  Google Scholar 

  • Melitz, M.J., Ottaviano, G.: Market size, trade, and productivity. Rev. Econ. Stud. 75(1), 295–316 (2008)

    Article  Google Scholar 

  • Murphy, K.M., Shleifer, A., Vishny, R.: Income distribution, market size, and industrialization. Quart. J. Econ. 104(3), 537–564 (1989)

    Article  Google Scholar 

  • Mussa, M., Rosen, S.: Monopoly and product quality. J. Econ. Theory 18(2), 301–317 (1978)

    Article  Google Scholar 

  • Nigai, S.: On measuring the welfare gains from trade under consumer heterogeneity. Econ. J. 126(593), 1193–1237 (2016)

    Article  Google Scholar 

  • Novy, D.: Gravity redux: measuring international trade costs with panel data. Econ. Inq. 51(1), 101–121 (2013)

    Article  Google Scholar 

  • OECD. Promoting Productivity and Equality: A Twin Challenge. In: OECD Economic Outlook, Volume 2016 Issue 1 (2016)

  • Parenti, M., Ushchev, P., Thisse, J.-F.: Toward a theory of monopolistic competition. J. Econ. Theory 167, 86–115 (2017)

    Article  Google Scholar 

  • Paul, P.: Historical patterns of inequality and productivity around financial crises. Working Paper. Federal Reserve Bank of San Francisco (2020)

  • Picard, P.M., Tampieri, A.: Vertical differentiation and trade among symmetric countries. Econ. Theor. 71(4), 1319–1355 (2021)

    Article  Google Scholar 

  • Piketty, T.: Capital in the 21st Century. Harvard University, Cambridge (2014)

    Book  Google Scholar 

  • Pollak, R.A.: Additive utility functions and linear Engel curves. Rev. Econ. Stud. 38(4), 401–414 (1971)

    Article  Google Scholar 

  • Simonovska, I.: Income differences and prices of tradables: insights from an online retailer. Rev. Econ. Stud. 82(4), 1612–1656 (2015)

    Article  Google Scholar 

  • Wuergler, T.: Income distribution and product quality versus variety. SSRN Working Paper 1645855 (2010)

Download references

Author information

Authors and Affiliations

Authors

Corresponding author

Correspondence to Wen-Tai Hsu.

Additional information

Publisher's Note

Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.

We are grateful to the Co-Editor Costas Arkolakis and two anonymous referees for their comments and suggestions that substantially improved the paper. We also thank Madhav Aney, Pao-Li Chang, Fali Huang, Nicolas Jacquet, Jing Li, Andres Rodriguez-Clare, and Ping Wang for their helpful comments. We thank Xin Yi for his excellent research assistance.

Rights and permissions

Springer Nature or its licensor holds exclusive rights to this article under a publishing agreement with the author(s) or other rightsholder(s); author self-archiving of the accepted manuscript version of this article is solely governed by the terms of such publishing agreement and applicable law.

Reprints and Permissions

About this article

Verify currency and authenticity via CrossMark

Cite this article

Hsu, WT., Lu, L. & Picard, P.M. Income inequality, productivity, and international trade. Econ Theory (2022). https://doi.org/10.1007/s00199-022-01456-y

Download citation

  • Received:

  • Accepted:

  • Published:

  • DOI: https://doi.org/10.1007/s00199-022-01456-y

Keywords

  • Trade
  • Income heterogeneity
  • Product quality
  • Mean-preserving spread
  • Selection
  • Aggregate productivity

JEL Classification

  • F12
  • L11