Redistribution, trade and corruption: an empirical assessment

ABSTRACT

This article explores the role of institutional quality in the trade and inequality nexus. Does corruption shape the relationship between trade and inequality through its impact on redistribution? Our answer to this question builds on the hypothesis that trade raises inequality and that governments may want to intervene through appropriate redistribution schemes that aim at taxing the gains from trade in a way that offsets the negative effects of trade on inequality. Moreover, we argue that this mechanism may be distorted by corruption and bad institutions in general. Quite to the contrary to common wisdom, we find that trade reduces inequality in countries with high institutional standards by means of a low level of corruption but increases inequality in countries with low levels of institutional quality.

KEYWORDS:

• International trade
• redistribution
• income inequality
• corruption
• institutional quality

JEL CLASSIFICATION:

• F14
• F15
• F16

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ Easier access to rich firm-level data that comprises information on both firms and workers provides the foundation of an in debt analysis of labour market outcomes in exporting firms. The seminal papers by Bernard, Jensen, and Lawrence (1995), Bernard and Jensen (1999) and Bernard et al. (2003) motivated a large and growing literature that sheds light on the determinants of the exporter wage premium. Schank, Schnabel, and Wagner (2010) argue that part of the premium can be explained by unobserved worker heterogeneity.

² Foreign and domestic establishments compete over market shares within a particular country (e.g. Melitz 2003; Egger and Kreickemeier 2009a).

³ Empirical evidence for these results can be found in Baumgarten (2013), Bernard, Redding, and Schott (2007).

⁴ See also for example Baumgarten (2013), Card, Heining, and Kline (2013), Hauptmann and Schmerer (2013) and Felbermayr, Hauptmann, and Schmerer (2014) for more recent empirical evidence on the exporter wage premium in Germany, as well as Sampson (2014) and Monte (2011) for an analysis of workers’ within-group inequality in the presence of globalization. All studies show that wage dispersion is higher in more open economies.

⁵ Acemoglu and Verdier (2000) investigate the interaction between the intervention of governments to handle market failures and corruption. If bureaucrats are characterized by a certain level of heterogeneity, it could be optimal to tolerate a certain level of corruption, due to the fact that preventing corruption can be associated with excessive high cost. This phenomenon is noticed in industrialized countries, where corruption is observable, but not excessive.

⁶ The channel tested in our study is at odds with the results discussed in Itskhoki (2009), who is unable to find a redistribution scheme that allows tackling income inequality induced by trade without completely eliminating the aggregated welfare gains.

⁷ Similarly, De Jong and Bogmans (2011) and Thede and Gustafson (2012) find a total negative effect of corruption on international trade.

⁸ The effect of institutional quality and the homogeneity of institutional quality on bilateral trade is estimated by a gravity equation. The World Bank Government indicators are used as proxy for institutional quality. Homogeneity of institutional quality is measured by a dummy variable that takes the value 1, if the difference of a respective institutional quality measure between two countries does not exceed a previously defined share of the sample SD.

⁹ The dependent variable in their study is the difference between market Gini and net Gini, which is positively correlated with openness.

¹⁰ ‘Age dependency ratio is the ratio of dependents–people younger than 15 or older than 64–to the working-age population–those ages 15–64. Data are shown as the proportion of dependents per 100 working-age population.’ World Bank, 2016.

¹¹ Solt (2016) uses a customized algorithm that calculates missing values on the basis of data from the national statistical offices, regional data collection and other academic studies.

¹² The CPI is a worldwide accepted aggregated corruption measure. It is constructed from indexes of diverse sources (e.g. World Economic Forum, Institute for Management Development, Freedom House and PriceWaterhouseCoopers). Additionally, evaluations from previous years find consideration to reduce variations provoked by random effects. According to Kaufmann and Kraay (2007), advantages of aggregated corruption measures are higher country coverage, summary of high number of individual indices and reduction of measuring errors due to average out.

¹³ Trade including imports and exports, FDI, Portfolio Investment and income payments to foreign national as per cent of GDP, respectively.

¹⁴ Concealed import barriers, mean tariff rate, taxes on international trade in per cent of current values and capital account restrictions.

¹⁵ Low-income countries are defined as economies with GNI per capita lower or equal to 1025 USD. Lower-middle-income economies comprise countries with GNI per capita between 1026 and 4035 USD, while GNI per capita of upper-middle-income economies ranges from 4036 to 12,475 USD. High-income economies are associated with a GNI per capita of more than 12,476 USD.

¹⁶ Kuznets (1955) argues that a structural change from an agricultural-orientated to an industrialized economy leads to changes in the distribution of income. First, only a small share of individuals switch from agricultural to higher wage industrial sector, which tends to increase inequality. In course of development the main part of individuals is employed in the industrial sector that leads to adjustment in wages and a more equally distributed income.

¹⁷ Redistribution is defined as the difference between market Gini and net Gini.