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Trade, inequality, and the size of the welfare state

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  • Kohl, Miriam

Abstract

This paper investigates the effects of international trade in a general equilibrium model with heterogeneous firms where a welfare state redistributes income. We look at a very stylised progressive non-distortionary redistribution scheme. We show that for a given tax rate international trade increases income per capita, but also leads to higher income inequality. Two aspects of income inequality are examined. First, inter-group inequality between managers and workers is considered. Second, intra-group inequality within the group of managers is investigated. For a given tax rate the size of the welfare state and therefore the transfer per capita increases when going from autarky to trade. This second-round effect counteracts the primary increase in inequality, yet cannot outweigh it. Since the redistribution scheme is non-distortionary, it is possible to decrease trade-induced inequality by increasing the tax rate without jeopardising the gains from trade.

Suggested Citation

  • Kohl, Miriam, 2017. "Trade, inequality, and the size of the welfare state," CEPIE Working Papers 01/17, Technische Universität Dresden, Center of Public and International Economics (CEPIE).
  • Handle: RePEc:zbw:tudcep:0117
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    Keywords

    International trade; Income inequality; Redistribution; Heterogeneous firms;

    JEL classification:

    • D31 - Microeconomics - - Distribution - - - Personal Income and Wealth Distribution
    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation
    • F16 - International Economics - - Trade - - - Trade and Labor Market Interactions
    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies

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