Income Inequality, Trade and Financial Openness

Abstract

This paper examines the relationships of the Gini coefficient with trade-openness, aid and foreign direct investment flows. Panel data estimates are provided for the overall data set (42 low to middle income countries). We find empirically, that trade openness is more effective than either foreign direct investent or foreign aid for changing income inequality, but its effectiveness depends on the stage of development. We then develop a model of a small economy with varying degrees of openness. We find that countries with high labour intensity in production, and greater openness generate lower inequality in response to favorable shocks to export demand and terms of trade. Both our empirical and simulation results suggest that trade and financial openness can be effective policies for reducing inequality in low income countries, provided that the gains from capital are re-distributed