On the Distributional Effects of Trade Policy: Dynamics of Household Saving and Asset Prices

Abstract:     
This paper studies the effect of trade liberalization on inequality. We develop a theoretical framework that generates economy-wide distributions of wealth and income for different levels of trade protection. The model unambiguously determines the short-term and long-term effect of liberalization on inequality; and rationalizes why larger inequality can be the outcome of a welfare enhancing policy, as households reduce their buffer savings when liberalization lowers the price of food. The framework reconciles the increase in inequality, the fall in the value of land, and small farmers' opposition to freer trade, that have featured in different liberalization episodes. We also present empirical support for the model's predictions.

Number of Pages in PDF File: 36

Keywords: Free trade, trade liberalization, inequality, heterogeneous agents, subsistence

JEL Classification: E60, F13, F40, O13, Q17

working papers series