Promoting Exports or Fostering Disparity? The Effects of Exchange Rate Undervaluation on Income Inequality

Abstract

Income inequality finds a prominent place in contemporary political and economic debates. I demonstrate that sustained exchange rate undervaluation increases inequality, building on research linking undervaluation with growth (Rodrik, 2008). I offer evidence that sustained undervaluation increases income inequality levels using fixed effects and dynamic panel estimators with country-level data. The relationship is robust to the inclusion of controls such as the political regime type, nature of the banking system, trade, and education levels. The adverse effects of inequality due to undervalued exchange rates imply that governments pursuing undervaluation-based strategies for spurring economic growth should consider the socioeconomic effects of such policies and the potential threat to political stability posed by rising societal disparities. The existence of a relationship between these variables also offers insights about the behavior of autocratic governments that undergo a sustained period of export-driven economic growth.