National income and its distribution

This paper revisits the effect of national income on distributional equality. Although the link between the two has featured prominently in the literature, a causal effect has been difficult to pin down due to the endogeneity of these variables. We use plausibly exogenous variations in the incomes of countries’ trading partners weighted by the level of trade flows, and international oil price shocks, as instruments for within-country variations in countries’ real GDP per capita. Controlling for country and time fixed effects, our instrumental variables regressions show that increases in national income have a significant moderating effect on income inequality: a 1 % increase in real GDP per capita reduces the Gini coefficient by around 0.08 percentage points on average. We document that education is one possible channel that mediates this relationship, and explore the implications of our findings for the welfare effect of national income growth.