Trade, financial development, and inequality: Evidence from US railroads in the 19th century!

Recent decades happen to be characterised with a high amount of trade integration, supported by increases both in earnings and wealth inequality. An increasing body of labor has contended that elevated trade exposure might have heterogeneous effects across households. What’s the impact of lower trade costs on inequality? So how exactly does the amount of financial development modify the response of inequality to reduce trade costs?

Within my employment market paper, I answer these questions from the historic perspective. I read the results of lower trade costs on wealth inequality while using growth of the railroad network within the U . s . States within the 1800s being an empirical laboratory. Railroad track mileage elevated from 9,000 miles in 1850 to roughly 50,000 miles in 1870 (figure 1). Railroad network expansion is really a natural empirical setting to review the result of trade costs as railroads drastically reduced the price of transporting goods inside the U . s . States. In contrast to shipping goods via wagons, railroads were a purchase of magnitude cheaper. The 1800s within the U . s . States can also be a perfect setting to review wealth inequality because of the accessibility to wealth data for those households. Recently digitized complete-count census schedules of 1850, 1860, and 1870 provide data on property wealth for each individual within the U . s . States, and also the 1860 and 1870 censuses provide data on property and private wealth.

Figure 1: The United States Railroad Network in 1850 and 1870

Following Donaldson and Hornbeck (2016), a county’s market access is understood to be a trade cost-weighted sum over populations in most other counties, also it captures how cheaply goods could be transported out of this county to any or all buying and selling partners. A county has greater market access when it’s cheaper to do business with another county, specially when that other county includes a bigger population. The development from the railroad network across the nation reduced trade costs drastically and therefore elevated counties’ use of other markets. While railroad construction is potentially endogenous and could rely on local economic conditions, alterations in county market access are mainly because of alterations in the railroad network elsewhere, instead of local railroad construction. The identification assumption is the fact that counties with relative increases in market access would certainly have altered much like nearby counties.

I estimate the elevated county-level market access caused through the expanding railroad network brought to some significant rise in county-level wealth inequality. From 1850 to 1870, a 1 standard deviation rise in county market access results in a .023 point rise in the Gini coefficient along with a 3.24 percentage point rise in real estate wealth share from the top tenPercent. This finding is robust to presenting different measures of wealth inequality, controlling for time-different county characteristics, and modifying for results of the Civil War and westward migration.

Then i reveal that an engaged general equilibrium model featuring heterogeneous households, entrepreneurship, financial frictions, and trade can rationalize this result. Railroads are modeled like a device that results in a loss of trade costs. I calibrate the model to complement data moments within the U . s . States in 1850. I personally use the calibrated model to review the way the growth of the railroad network affected earnings, wealth, and inequality. Both earnings and wealth are greater throughout the economy with lower trade costs. Lower trade costs result in bigger gains towards the top of the distribution, growing both earnings and wealth inequality. My calibrated model implies that the empirically observed reductions in average trade costs can explain roughly 60% from the observed rise in real estate wealth share from the top tenPercent between 1850 and 1870.

Two key channels drive the differential aftereffect of lower trade costs over the wealth distribution within the model. First, much like Melitz (2003), the elevated contact with trade induces high productivity entrepreneurs to export, yet still time forcing less productive entrepreneurs who have been marginally lucrative before railroads to exit. This feature mechanism reallocates market shares and therefore incomes toward more lucrative (and wealthier) households. Second, financial frictions distort household decisions around the extensive margin by reduction of the amount of households that prefer to get entrepreneurs and exporters. This occurs since these choices require high amounts of wealth to function in a lucrative scale. Financial frictions also affect household decisions around the intensive margin by distorting their production scale. When trade costs go lower, restricted entrepreneurs wishing to benefit from elevated buying and selling possibilities face a comparatively steeper cost when compared with unconstrained (wealthier) entrepreneurs.

I validate the model by checking that it is implied predictions are in conjuction with the empirical results. First, there’s a reallocation of wealth toward the wealthier households. The model implied response from the wealth shares held by various areas of the distribution to some loss of trade costs is quantitatively in conjuction with the empirical findings (figure 2). Second, financial frictions limit lower wealth households from benefiting from lower trade costs. The result of lower trade barriers on inequality is attenuated inside a more financially developed economy. My empirical results indicate the impact of market access on top 10% wealth share is less strong in states with greater existing financial development , as measured by per person quantity of banks, quantity of loans, or quantity of bank capital in 1850. This outcome is in conjuction with the concept that greater credit availability might help low-wealth individuals make the most of elevated economic possibilities.

Figure 2: Results of Trade Costs over the Wealth Distribution

When it comes to welfare, I’ve found that many households within the model economy profit from the railroad caused loss of trade costs. The typical household gains .65% in consumption-equivalent units. Lower trade costs increase wages, which help the poor, and help the wealthy by letting them expand production and go into the export market.

My estimates highlight that lower trade costs promote economic growth but at the expense of greater inequality. My results also claim that, in the existence of credit constraints, the result of elevated trade openness on wealth distribution depends upon financial development throughout the economy . My quantitative framework may be used to study tax policies that may alleviate the development versus inequality trade-off and be sure equitable growth when confronted with declining trade barriers.

References

Donaldson, D. and Hornbeck, R. (2016). Railroads and American Economic Growth: A “Market Access” Approach. The Quarterly Journal of Financial aspects, 131(2):799-858.

Melitz, M. J. (2003). The Outcome of Trade on Intra-industry Reallocations and Aggregate Industry Productivity. Econometrica, 71(6):1695-1725.

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