The relationship between development, institutions, inequality, and trade

This thesis studies the relationship between development, institutions, inequality and trade by means of empirical analyses. Chapter 1 offers an introduction and a literature review. Chapter 2 investigates the interrelationship between institutional quality (political and economic institutions), economic development and openness to trade. To take account of the endogeneity of the variables included, an identification strategy called identification through heteroskedasticity (IH method) suggested by Rigobon (2003) is applied. The analysis suggests that economic development enhances economic but not political institutions. In contrast, openness to trade does not influence economic nor political institutions. Furthermore, examining the effect of institutions on economic development shows that political institutions are relatively more important than economic institutions. Openness to trade seems not to have an impact on economic development when institutions are controlled for. Chapter 3 contributes to the literature on the inequality-growth nexus and explores how different forms of income inequality affect subsequent economic performance. To do so, growth regressions are run which include quantile shares to control for the income distribution (instead of overall statistics like the Gini coefficient). In line with recent theoretical findings, it is shown that inequality is neither uniformly good nor uniformly bad for growth. More specifically, in a sub-set of richer countries, higher bottom-end inequality (i. e., a lower income share of the poorest segment of society) has a strong negative impact on subsequent growth while higher top-end inequality (i. e., a higher income share of the rich at the expense of the middle class) seems to promote economic performance. In poorer countries, however, higher top-end inequality is harmful while strengthen the middle class (at the expense of the rich) promotes economic growth. Chapter 4 analyzes the impact of income inequality on bilateral trade flows, again relying on selected quantile shares to capture inequality arising from different parts in the income distribution. From a demand-perspective, assuming that preferences are non-homothetic, income inequality should affect bilateral trade flows. Including only consumption goods and aggregating trade flows at the 3-digit level of the Standard International Trade Classification (SITC), gravity equations are estimated sector-by-sector (in total 69 sectors). The results show that countries with higher income inequality, in particular a higher income share of the richest segment of society, indeed import more goods that are sophisticated (e. g., manufactured goods) or that possess characteristics of luxuries. On the other hand, countries with higher income inequality, in particular a lower income share of the poorest segment of society, import substantially less goods that can be classified as necessities. Furthermore, a not negligible amount of sectors are classified as ambiguous, e. g., imports increase with both lower and higher inequality arising from different parts in the distribution.