Wednesday, 23 December 2020 14:44

The role of misallocation

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The role of misallocation in the relationship between trade and income inequality

Abstract: This paper introduces a new factor that mediates the impact of trade on income inequality within countries. In a sample of 18 European countries over the period 1999-2016, I find that the effect of trade openness on income distribution is conditional on the existing patterns of resource allocation. In case of an efficient allocation of resources within a country, more trade reduces income inequality. Under conditions of misallocation, however, the inequality-reducing effect of trade is weakened—and may even be reversed when misallocation is sufficiently high—albeit such countries tend to have lower income inequality, other things being equal.

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