Trade liberalization, domestic reforms, and income inequality: Evidence from Taiwan

Abstract

This paper estimates the effects of trade liberalization on household income inequality and investigates whether trade liberalization or domestic reforms are the main factors influencing increasing inequality in Taiwan, a middle-income open economy. We construct an empirical model by decomposing the sources of household disposable income in the quintile ratio and separate trade partners into OECD (Organisation for Economic Co-operation and Development) and non-OECD countries. Using time-series data to estimate the long-run effect, we find that net exports to OECD countries increase inequality, whereas net exports to non-OECD countries insignificantly decrease inequality. This finding diverges from the prediction based on the Stolper–Samuelson theorem. Overall, trade liberalization increases income inequality, and the effect is mainly attributed to net exports to OECD countries. Moreover, we provide evidence that domestic reforms, particularly technological progress in favor of skilled labor and industrial structural change, rather than trade liberalization, are the main driving forces of income inequality.