Income distribution, multi-quality firms and patterns of trade

We provide a North-South Schumpeterian growth model endogenously generating demand-driven patterns of vertical intra-industrial trade. More precisely, we build a model featuring non-homothetic preferences and income differences, and show that such conditions guarantee the endogenous emergence of multi-location, multi-quality firms. The existence of such firms and wealth heterogeneity among consumers both across and within countries then generate and shape rich patterns of intra-industrial vertical trade and FDI, with the extent of income disparities also conditioning the incentives to invest in R&D of both incumbents and challengers, and by extension the long-run growth rate. We then investigate the impact of within-region redistribution and trade integration policies on the endogenous wage gap across regions, the length of the quality-life cycle and long-run growth. We particularly find that a larger income gap within regions contributes to lowering growth and increasing the inter-regional inequality level. We also find that trade integration boosts long run growth but increases the North-South wage gap.