Trade liberalization, domestic reforms, and income inequality: Evidence from Taiwan

• Published date: 01 August 2022
• Author: Judith Liu,Mei‐Ying Lai,Zong‐Shin Liu
• Date: 01 August 2022
• DOI: http://doi.org/10.1111/rode.12875

1286 

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         Rev Dev Econ. 2022;26:1286–1309.

wileyonlinelibrary.com/journal/rode

Received: 14 April 2020 

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  Revised: 29 December 2021 

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  Accepted: 8 February 2022

DOI: 10.1111/rode.12875  

REGULAR ARTICLE

Trade liberalization, domestic reforms, and

income inequality: Evidence from Taiwan

JudithLiu1

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Mei- YingLai2

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Zong- ShinLiu3

This is an open access article under the terms of the Creative Commons Attribution- NonCommercial- NoDerivs License, which permits 

use and distribution in any medium, provided the original work is properly cited, the use is non- commercial and no modifications or 

adaptations are made.

© 2022 The Authors. Review of Development Economics published by John Wiley & Sons Ltd.

1Melbourne Institute: Applied Economic 

& Social Research, Faculty of Business 

and Economics, The University of 

Melbourne, Parkville, Australia

2Department of Regimen and Leisure 

Management, Tainan University of 

Technology, Tainan City, Taiwan

3Department of Economics, Feng Chia 

University, Taichung City, Taiwan

Correspondence

Judith Liu, Melbourne Institute: Applied 

Economic & Social Research, Faculty of 

Business and Economics, The University 

of Melbourne, Level 5, FBE Building, 

111 Barry Street, Parkville, Victoria 3010, 

Australia.

Email: judith.liu@unimelb.edu.au

Abstract

This paper estimates the effects of trade liberalization on 

household income  inequality and  investigates whether 

trade  liberalization  or  domestic  reforms  are  the  main 

factors  influencing  increasing  inequality  in  Taiwan,  a 

middle- income open economy. We construct an empiri-

cal model by decomposing the sources of household dis-

posable income in  the quintile ratio and separate  trade 

partners  into  OECD  (Organisation  for  Economic  Co- 

operation and Development) and non- OECD countries. 

Using time- series data to  estimate  the  long- run effect, 

we find that net exports to OECD countries increase ine-

quality, whereas net exports to non- OECD countries in-

significantly decrease  inequality.  This finding  diverges 

from  the  prediction  based  on  the  Stolper– Samuelson 

theorem. Overall, trade  liberalization increases income 

inequality,  and  the  effect  is  mainly  attributed  to  net 

exports to  OECD countries.  Moreover,  we provide  evi-

dence that domestic reforms, particularly technological 

progress  in  favor  of  skilled  labor  and  industrial  struc-

tural  change,  rather  than  trade  liberalization,  are  the 

main driving forces of income inequality.

KEYWORDS

income inequality, industrial structural change, middle- income 

open economy, technological progress, trade liberalization

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INTRODUCTION

Since  the  1980s,  income  inequality  has  increased  in  most  countries,  and  trade  liberalization 

has  also  rapidly occurred.  Many  studies  estimate  the  effect  of   trade liberalization  on  income 

inequality  using  either  a  cross- country  model  (e.g.,  Barro,2000;  IMF, 2007;  Milanovic, 2005; 

Reuveny & Li,2003; Savvides,1998) or an individual country model (e.g., Beyer etal.,1999; Chan 

etal.,1999;  Chen &  Hsu,2001;  Galiani & Sanguinetti, 2003; Kumar &  Mishra,2008;  Lai et al., 

2019; Mah, 2003;  Mcnabb  &  Said, 2013;  Sato  &  Fukushige, 2009; Wood, 1997).  However, the 

results are mixed, with some being inconsistent with the conventional Stolper– Samuelson  (S– S) 

theorem (Stolper & Samuelson,1941), which predicts that international trade increases the rela-

tive wage of skilled workers and decreases income inequality in developed countries, whereas it 

increases the relative wage of  unskilled workers and  improves income inequality in  developing 

countries.

Rather than  trade liberalization,  some studies  argue that  domestic reforms  (e.g., technolog-

ical progress  and  financial  liberalization)  might  be  the  main driving force  behind  income  in-

equality. Previous research has explored  the effects of  economic  freedom on income  inequality 

using a  cross- country model, where economic  freedom can  be measured  by a  composite index 

constructed with many policy components, such as international trade, government regulations, 

and taxation.1 When some or all of the policy components change over time, the  economic free-

dom index may change, and therefore, economic growth and income inequality will be affected. 

However, there is no  consistent empirical  evidence for  the association  between economic free-

dom and income  inequality. For example, Berggren  (1999) and Scully  (2002) find  a positive  re-

lationship between  economic  freedom  and  equality. In  contrast, Carter  (2006)  and  Bergh  and 

Nilsson (2010)  suggest that  economic  freedom increases  inequality. It is  worth  noting that  the 

findings using this model may not be applicable to an individual country. Furthermore, using the 

composite index to measure economic  freedom cannot reveal the  impact of  a specific policy on 

inequality (Carter,2006). Thus, a more thorough policy analysis in an individual country setting 

is needed.

This paper aims to  estimate the effects  of trade liberalization  on household income inequal-

ity  and  to  investigate whether  trade  liberalization  or  domestic  reforms  are  behind  increasing 

inequality in  Taiwan since 1980.  Taiwan adopted trade  liberalization policy  in the  early  1980s. 

Since then, trade  expansion has  led to economic  growth. The  income per capita  increased rap-

idly from  US$4,130 in  the  1980s to  US$23,131  in 2015  (National Development  Council,  2016). 

However, household income inequality has also increased over time. The quintile ratio of house-

hold disposable income, which is the relative disposable income of the highest 20% to the lowest 

20% income households,  increased from 4.2 in 1980  to more than  6.0 after  2001. In  addition to 

trade liberalization,  the  Taiwanese  government  has  implemented  various reforms  since  1980. 

We focus on  four reforms  that may  have influenced  income inequality:  (1) amendments  to in-

dustrial development policies, (2) massive expansion of  higher education, (3) financial reforms, 

and (4) large increases in government social welfare and social insurance expenditures. Previous 

research suggests that these reforms may have a larger impact on inequality than trade liberaliza-

tion (Goldberg & Pavcnik,2007; IMF,2007).

JEL CLASSIFICATION

D30; F14; O38