Income Distribution, Learning-by-Doing, and Comparative Advantage

The paper examines the impact of the income distribution in a less-developed country (LDC) on its patterns of trade, through its influence on home market demand patterns. In a learning-by-doing model with nonhomothetic preferences, the authors show that import substitution under low inequality generates more focused learning and enhances trade potential more effectively. In addition, relative wages under trade are higher in a low-inequality LDC. The model predicts that high-inequality LDCs are more likely to remain exporters of unskilled/low-skilled goods, whereas low-inequality LDCs are more likely to mature into simple manufactures and beyond—a prediction that is consistent with world trade patterns of LDCs. The authors present descriptive and empirical evidence in support of this link between income inequality, domestic demand patterns, and dynamic comparative advantage.