The Distributional Effects of Capital Inflows

Abstract In this paper, I document empirical evidence indicating that an exogenous capital inflow shock increases income inequality in advanced economies and reduces income inequality in emerging market economies. To examine the effects of capital inflows on income inequality within countries, I estimate a panel structural vector autoregression model with annual data for 53 countries over the period 1990 to 2020. I identify the structural shocks in capital inflows using sign restrictions, thereby distinguishing the exogenous shocks driven by global financial conditions from other shocks. The findings of this paper indicate a remarkable difference in the results between advanced economies and emerging market economies, suggesting that the distributional effects of capital inflows vary depending on the economic conditions in the recipient countries. With respect to income class, a capital inflow shock is primarily associated with an increase in the income share of the high-income class in advanced economies and of the low-income class in emerging market economies. It is necessary for policymakers to pay attention to the distributional effects of capital inflows and to design tailored policy frameworks to address them.