Inequality, Underconsumption, and Trade Imbalances

Abstract

Does intra-country inequality contribute to international trade imbalances? Underconsumption theory and financial market development theories suggest rising inequality within countries drive imbalances between them. This paper investigates empirical evidence behind these theories through a panel data approach on two separate country samples. First, data on seven WWI belligerent countries from 1860-1914 are used to test for correlations. Second, I use a panel of 133 countries from 1971 to 2019 to run first differenced regressions as well as a system generalized method of moments (GMM) model as a robustness check. Results show some support for the underconsumption theory that within-country inequality contributes to larger trade surpluses. Additionally, I find support for financial market development theories that the effect of inequality on the current account is partially determined by levels of financial market development. These results have potentially important implications for formulating proper policy solutions to rebalance global trade.