Redistribution in the Open Economy: A Political Economy Approach

This paper develops a two-country model of international trade in which citizens who are heterogeneous with respect to their factor endowments vote over tariffs and income tax rates. In the politico-economic equilibrium, each country chooses its national policies by majority voting, taking the policy choice of the other country as given. By incorporating both income and trade taxes in a unified international-trade framework, we uncover the interplay between majority voting over these two instruments at the domestic level and strategic interdependencies between countries’ trade policies. Our main result is that greater inequality can be conducive to more redistribution via income taxation, more protectionist policies in capital-abundant countries, and less protectionist policies in labour-abundant countries. The model can accommodate the predictions of recent empirical studies on the relationship between inequality, protectionism, and redistribution.