Top Income Inequality, Aggregate Saving and the Gains from Trade
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Canonical studies of trade liberalization focus on its effects on aggregate income and on the distribution of income. The interaction between these two effects of trade liberalization has been less studied. In this dissertation, I study this interaction. More precisely, I study the relationship between international trade and income inequality, with a focus on the implications for aggregate saving and the gains from trade. I argue that accounting for the effects of international trade on income inequality among entrepreneurs can imply higher gains from trade for workers. In the second chapter, I construct a dynamic model of international trade with incomplete markets. In the model, entrepreneurs face uninsurable idiosyncratic productivity risk, and thus save. Since the most productive entrepreneurs have the highest saving rate and are the ones that export, a reduction in trade costs increases their share of total profits and their savings, which leads to a large increase in the aggregate supply of capital and increased capital accumulation. I calibrate the model using US data and examine the effects of international trade on aggregate output, the consumption of workers, and the consumption of entrepreneurs with heterogeneous productivity. In the model, international trade increases aggregate output by 2.5% and the wage of workers by 3.4%. On the other hand, while the aggregate consumption of entrepreneurs is unchanged by international trade, the increase in inequality of profits among entrepreneurs implies that the certainty-equivalent consumption of a typical entrepreneur actually decreases by 4.0%. Capital accumulation plays an important role in the model, accounting for 51.9% of the output gains from trade. To isolate the effects of the proposed mechanism, I construct a benchmark model with complete markets, in which firms with heterogeneous productivity are owned by a single entrepreneur. In this complete markets benchmark, the increase in aggregate output due to international trade is 1.8% while the increase in the wage of workers from trade is 2.7%. Therefore, the novel mechanism in my model increases the wage gains for workers by 25.9%, and the gains in aggregate output by 38.9%, compared to the complete markets benchmark. In the third chapter, I test the key predictions of the model using country-level data. Using fixed-effects (FE) regressions in a large panel of countries, I find a significant and positive correlation between trade openness and the aggregate saving rate. I find a much weaker relationship between trade openness and the investment rate. Furthermore, I show that greater trade openness has a stronger effect on the aggregate saving rate in a country where the initial top 10% share of total income (before any changes in trade openness) is higher. This is in line with my model where the increase in the aggregate saving is driven by top income earners. Additionally, I build on the gravity-based instrumental-variable (IV) approach pioneered by Frankel and Romer (1999) and extend it to a panel setting. I find a larger effect of trade openness on the aggregate saving rate in the fixed-effects panel regressions with IV than without IV. The results provide strong evidence that a supply-side channel of increased capital accumulation is operative following an increase in trade openness. In the fourth chapter, I study the relationship between the household saving rate and openness in China through the lens of the framework outlined in the second chapter. I show that there has been a large increase in top income shares both among entrepreneurs and workers over the past 30 years in China. Additionally, there is a very significant and positive correlation between top income shares and the household saving rate across Chinese counties. Using the setting of the 1992 liberalization episode, I find that provinces with a greater increase in openness experienced a larger increase in the household saving rate during the period. Taken together, the evidence is supportive of the hypothesis that greater openness increases the household saving rate in China, by increasing the share of total income received by the highest-income households who also have the highest saving rate.