Occupational Choice and Income Inequalities under Regional Integration

• Author: Xi Yang
• Date: 01 May 2014
• DOI: http://doi.org/10.1111/rode.12086
• Published date: 01 May 2014

Occupational Choice and Income Inequalities under

Regional Integration*

Xi Yang*

Abstract

In a setting with occupational choice and trade between two asymmetric regions, this paper explores the

impact of market size and economic integration on both regional inequality and local income inequality

within each region. It is shown that market access in a region affects income inequality measures,

working through the cutoff productivity for entrepreneurship. Compared with the smaller region, selec-

tion into entrepreneurship is more likely for individuals in the larger region with better firm market

access whereas the local income inequality is higher. Both regional inequality and regional disparities in

the local income inequality measures exhibit an inverted U-shaped pattern when the regional integration

level increases.

1. Introduction

It has been well documented in the trade and new economic geography (NEG) litera-

ture that market size and trade influence firm market access and relate it to the for-

mation of regional income inequalities (Hanson, 2005; Krugman, 1980, 1991; Redding

and Venables, 2004).1Additionally, recent empirical studies show that market size

affects local income distribution. At the country level, small economies such as

Norway or Belgium have lower income inequality than large economies such as

Japan, the UK and the US (OECD, 2011). At the city level, income inequality is posi-

tively correlated with city size (Behrens and Robert-Nicoud, 2008; Glaeser et al.,

2009; Korpi, 2008). Other studies support the role of market access in income distri-

bution and show that local income inequality is higher in larger regions with greater

market access (Fallah et al., 2011).

Despite these empirical findings, the theoretical analysis of the connection between

market size and income inequalities is far from complete. In particular, it remains less

well-known how market size and trade affect within-region income inequalities. This

paper fills this gap through examination of an occupational choice setup as in Lucas

(1978) with a two-region trade model. Individual heterogeneity is assumed in the

productivity of firm production management. Better firm management results in

higher firm productivity. Each individual chooses to be either a worker providing

homogenous labor inputs or an entrepreneur whose management leads to heteroge-

neity in firm productivity. Based on this setup, the following questions can be asked:

how does market size affect the cutoff productivity above which a person becomes an

* Yang: Department of International Economics and Business, School of Economics, Xiamen University,

Xiamen, 361005, P.R. China. Tel: +86-592-2186373; E-mail: yangxi0206@gmail.com. The author thanks

Shihe Fu, Nobuaki Hamaguchi, Noritsugu Nakanishi, Dao-Zhi Zeng, the editor and the anonymous referee

for constructive comments. Financial support from the National Natural Science Foundation of China

(Grant No. 71303202) and MOE (Ministry of Education in China) Major Project of Humanities and Social

Sciences (Grant No. 13JZD010) is gratefully acknowledged.

Review of Development Economics, 18(2), 313–325, 2014

DOI:10.1111/rode.12086

© 2014 John Wiley & Sons Ltd