Educational Quality Matters for Development: A Model of Trade, Inequality, and Endogenous Growth

This paper addresses the dynamics of income inequality, both within and across countries, using an endogenous growth model with North–South trade and endogenous educational choice. The dynamics of income inequality is found to depend on the ability of workers to adapt to new technologies, captured by the quality of education. For developing countries with low quality of education, I find Southern trade liberalization leads to: (1) an overall decline in effective human capital; (2) an inverted U-shape transition of income inequality, where within-country inequality increases in the initial periods following a reduction in trade barriers; and (3) divergence in terms of average income in the short and long run. However, in cases where the South has a high quality of education, workers are better equipped to adapt to new technologies, and trade liberalization induces an U-shape dynamic transition of within-country income inequality, where income inequality can decline in the transition. This paper highlights the critical role the quality of education plays in explaining the variations in the observed dynamics of income inequality in developing countries.