Income Inequality, Trade and Financial Openness

Melbourne Institute Working Paper No. 07/14

Date: 2014

Author(s):

Guay Lim
Paul D. McNelis

Abstract

This paper examines the relationships between the Gini coefficient, trade-openness, foreign aid and foreign direct investment flows. Panel data estimates show that trade openness can be effective for changing income inequality, but its effectiveness depends on the stage of development. Simulation results show that the Gini and openness can be negatively or positively correlated — it depends on the capital intensity and on the degree of openness. Overall, the results suggest that trade and financial openness can be effective policies for reducing inequality in low income countries, if they significantly increase the marginal productivity of labour through capital intensive methods of production.