The Impact of Income Distribution on the Current Account

Abstract This paper analyzes the relationship between inequality and the current account, addressing the role of the functional distribution of income. Using panel data for 60 countries over the period 1975–2011, our results confirm that an increase in the wage share is associated with a decrease in the current account. We also analyze the effects of wage share on saving and investment, maintaining the same control variables. We find that the wage share is negatively correlated with saving and does not have a significant effect on investment. This result is consistent with the theories that connect higher wages with greater consumption and less saving. The relationship is stronger for developing economies, highlighting the structural differences between different groups of countries. Specifically, the relevance and sign of control variables like financial intermediation, fiscal balance, demographic ratios, capital account openness and growth expectations show important differences according to the level of development.