Trade Openness and Income Inequality in Developing Countries

This paper examines the relationship between trade openness and within country income inequality in developing countries, a topic that has produced mixed results in existing empirical literature. Using a panel dataset of 67 developing countries over the period 1980-2015, this study utilizes the Estimated Household Income Inequality (EHII) index under a dynamic panel model estimated with a Least Squares Dummy Variable Corrected (LSDVC) estimator to account for time persistence and endogeneity. The findings show that aggregate measures of trade openness do not have a statistically significant effect on income inequality. However, when trade is disaggregated by direction and country income classification, differences emerge. Trade with industrialized countries is associated with increases in income inequality, while trade with other developing countries being associated with reductions in inequality, particularly in developing countries classified as low-income countries. These results suggest that the composition and direction of trade flows play a critical role in determining income distribution outcomes in developing countries, rather than just trade openness itself.