Top Income Inequality, Aggregate Saving and the Gains from Trade

I study the implications of top income inequality for the gains from trade in a dynamic model. I argue that higher top income inequality among entrepreneurs can increase the gains from trade for workers. In the model, entrepreneurs face uninsurable idiosyncratic productivity risk, and thus save. Since the most productive entrepreneurs have the highest saving rate and are the ones that export, a reduction in trade costs increases their share of total prots and their savings, which leads to a large increase in the aggregate supply of capital. The welfare gains from trade for workers in the model are 6.4%, which are larger than in comparable benchmarks without top income inequality or capital accumulation. While the typical entrepreneur loses in consumption because of higher labor costs, aggregate consumption by entrepreneurs increases by 3.6%. Empirically, I find a strong relationship between trade openness and the national saving rate in a large sample of countries, consistent with the model. I find a much weaker relationship between trade openness and the investment rate.