Political economy and income inequality: How did trade liberalization affect the middle classes across the world?

The current state of the research on the relationship between globalization and income inequality is inconclusive. The results vary depending on measures of globalization used, as well as countries analyzed and the time period covered. The Stopler-Samuelson theorem provides the theoretical foundation that globalization may worsen income inequality in some countries. While this issue has been addressed with varying implications theoretically since then by scholars such as Acemoglu, Grossman, Helpman and Redding among others, there is still lack of substantial comprehensive empirical evidence. In a seminal empirical work, Acemoglu & Ventura (2002) examine the world income distribution depending on degree of trade freedom. In subsequent analyses, while Zhou, Biwas, Bowles & Saunders (2011) find evidence that globalization had a significant effect in reducing income inequality, Warner, Rao, Griffiths & Chotikapanich (2014) conclude that globalization does not contribute to inequality globally when measured in purchasing power parity.

The evidence on the impact on income inequality of other dimensions of economic and political freedoms than trade freedom is also inconclusive. This is considered an open question in the literature since the empirical evidence has been relatively contradictory (Berggren, 1998, 1999; Scully, 2002; Carter, 2007; Ashby & Sobel, 2008; Bergh & Nilson, 2010; Bennett & Vedder, 2013; Apergis, Dincer & Payne, 2014). Theoretically too, there is some ambiguity on the relationship between political and economic freedoms and income distribution (Berggren, 1999; De Soto, 1989, 2000). Data sources include the World Bank Poverty and Equity database, United Nations (UN) Comtrade database, Freedom House, Heritage Foundation, and the World Bank.

We explore the impact of changing political and economic freedoms on income inequality. Particular attention is paid to the income levels of middle classes in response to expanding trade freedoms. The analysis covers 157 countries at different stages of economic development. Analysis used are the univariate OLS estimation in levels and log-log forms and the principle component analysis. Results suggest a positive impact of trade freedom across all income groups. The impact was higher in percentages for lower income groups, but not sufficient enough to reduce income inequality. The effects of other economic and political freedoms generally varied across income groups and the country's development level. We conclude with the strategic implications of the results for managers of multinational companies.