This IMF Working Paper examines the relationship between income inequality and a country's external liabilities. The authors find that higher income inequality is associated with a greater equity share in external liabilities. They develop a theoretical model that explains this observation by showing that entry barriers in nontraded industries lead to lower entrepreneurial activity and higher income inequality. This, in turn, reduces external borrowing and creates opportunities for foreign firms to operate in the domestic market, which can attract equity-type capital inflows. The empirical results support this conjecture. The paper contributes to the literature on the effects of inequality on economic development and international capital flows.
