Inequality, Openness, and Growth through Creative Destruction

Abstract:

We examine how inequality and openness interact in shaping the long-run growth prospects of developing countries. To this end, we develop a Schumpeterian growth model with heterogeneous households and non-homothetic preferences for quality. We show that inequality affects growth very differently in an open economy as opposed to a closed economy: If the economy is close to the technological frontier, the positive demand effect of inequality on growth found in closed-economy models may be amplified by international competition. In countries with a larger distance to the technology frontier, however, rich households satisfy their demand for high quality via importing, and the effect of inequality on growth is smaller than in a closed economy and may even be negative. We show that this theoretical prediction holds up in the data, both when considering growth in export quality at the industry level and when considering growth in GDP per capita.

Keywords: creative destruction, distance to frontier, dual economy, growth, inequality, infant industry protection, non-homothetic preferences, trade openness
JEL Classification: D30, F43, O15, O30, O40
Last updated on 04/01/2021