Trade, Integration, and Interregional Inequality

We study the effect of international trade and freeness of trade (openness) on interregional inequality within countries. We estimate a model derived from a structural economic-geography approach in which interregional inequality depends on weighted trade shares and trade costs. In addition to the standard trade-to-GDP ratio, we derive and propose an aggregate freeness-of-trade measure based on phiness of trade. Both measures are instrumented by proxies constructed from estimates of a gravity model of bilateral trade, which covers 208 countries for the period 1948-2006. For our study we use Gennaioli et al.’s (2013) cross-country data set, which covers 110 countries (1569 sub-national regions) for the year 2005, and the panel data set of Lessmann (2014), which covers 56 countries (835 sub-national regions) for the period 1980-2009. The IV and dynamic panel regressions provide evidence that trade increases interregional inequality, but that the coefficient of the freeness-of-trade variable is ambiguous. Because the latter is an indicator for integration in the world markets, we conclude that more integration may neutralize the negative interregional distribution effects of trade.