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Trade, Ineqality and Costly Redistribution

Author

Listed:
  • Oleg Itskhoki

    (Princeton University)

  • Alonso de Gortari

    (Harvard University)

  • Pol Antras

    (Harvard University)

Abstract

This paper studies the welfare implications of trade liberalization in a model in which trade may increases income inequality, and in which redistribution policies are constrained by information frictions (as in Mirrlees 1971). We first consider an extreme case in which redistribution is not feasible, and study the model's quantitative implications for the effect of trade opening on aggregate income and on (standard measures of) inequality. Adopting a welfarist approach, we compute the welfare gains from trade according to social welfare functions featuring various degrees of inequality aversion. We next consider an environment in which redistribution is feasible but only via (non-linear) income taxation. More specifically, the government only observes agents' income but not their skills or other characteristics. We solve for the (constrained) optimal redistribution policy and show how it is affected by trade opening. We also re-compute the welfare effects from trade taking into account the redistributive and efficiency effects of the optimal tax policy. Even when evaluating the welfare effects of trade based purely on its effect on aggregate income, the resulting gains from trade are typically adjusted downwards whenever income taxes are set by an inequality-averse government.

Suggested Citation

  • Oleg Itskhoki & Alonso de Gortari & Pol Antras, 2015. "Trade, Ineqality and Costly Redistribution," 2015 Meeting Papers 1421, Society for Economic Dynamics.
  • Handle: RePEc:red:sed015:1421
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