Working Paper: CEPR ID: DP7520
Authors: Reto Foellmi; Manuel Oechslin
Abstract: Globalization increasingly involves less-developed countries (LDCs), i.e., economies which usually suffer from severe imperfections in their financial systems. Taking these imperfections seriously, we analyze how credit frictions affect the distributive impact of trade liberalizations. We find that free trade significantly widens income differences among firm owners in LDCs: While wealthy entrepreneurs are better off, relatively poor business people lose. Intuitively, with integrated markets, profit margins shrink -- which makes access to credit particularly difficult for the least affluent agents. Richer entrepreneurs, by contrast, win because they can take advantage of new export opportunities. Our findings resonate well with a number of empirical regularities, in particular with the observation that some liberalizing LDCs have observed a surge in top-income shares.
Keywords: credit market frictions; top incomes; trade liberalization; wealth inequality
JEL Codes: F13; O11; O16
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Trade Liberalization (F13) | Income Inequality (D31) |
| Trade Liberalization (F13) | Income Differences among Firm Owners (D33) |
| Wealth Inequality and Financial Market Frictions (G19) | Heterogeneous Impacts of Trade Liberalization (F69) |
| Trade Liberalization (F13) | New Investment Opportunities for Rich Entrepreneurs (P12) |
| Increased Costs and Reduced Profit Margins for Poor Entrepreneurs (F61) | Widening Income Gap (D31) |
| Economic Integration (F15) | New Investment Opportunities for Rich Entrepreneurs (P12) |
| Economic Integration (F15) | Increased Domestic Borrowing Rates (F34) |
| Increased Domestic Borrowing Rates (F34) | Negative Impact on Small Firms (L25) |
| Trade Liberalization (F13) | Redistribution of Income from Less Affluent to Wealthier Entrepreneurs (D39) |
| Trade Liberalization (F13) | Increased Top Income Shares (D33) |