Structural transformation and inequality: Does trade openness matter?

Abstract The purpose of this paper is to examine income inequality in the process of economic growth and structural transformation with emphasis on the role of economic openness using a new measure of trade openness (the price convergence index PCI), which is an alternative measure to the widely used trade‐to‐GDP ratio. The analysis is based on a multi‐country panel data covering 48 countries for the period from 1960 to 2010. The results suggest that an increase in the share of employment in manufacturing is associated with a reduction in income inequality. This inequality‐reducing effect is significantly greater for countries with more open trade regimes. In addition, the Kuznets‐type relationship exists between services employment share and income inequality, with inequality first increasing with the movement of workers from agriculture to services and then decreasing. This inequality‐increasing effect of services employment share is also larger for countries with more open trade regimes. The findings withstand the inclusion of relevant explanatory variables, an alternative measure of income inequality, and alternative estimator to address possible endogeneity.