The relationship between globalization and poverty has long been the quest in both the academic and policy arena. As the problems of malnutrition and poverty continue to exist in many parts of the developing world, the inequality aspect of income distribution has recently become a focus in industrial countries. Frequently, inequality is associated with the by-product of globalization of consumption and production. Although the causality between inequality and economic performance remains largely unresolved, some anecdotal evidence suggest that inequality has risen steadily during the past few decades concurrently with the breathtaking pace in the process of international trade and financial integration. A number of explanations have been offered in previous studies, including consumption exposure to foreign products, import competition-driven employment allocation, and skill-biased technological progress.

For a small economy, openness to trade means the effects of domestic inflation are inevitably linked to terms of trade fluctuation, which in turn influences foreign competition in both product and labour markets. By and large, a significant strand of the literature examining the impact of inflation on poverty and inequality has documented a number of convincing theories and evidence on the welfare consequences of their relationship. According to an international poll in thirty-eight countries, inflation is the top concern of the poor, the uneducated, the unskilled worker, and high inflation rates tend to lower the share of the bottom quintile and the real minimum wage, thereby increasing poverty (Easterly and Fischer 2001). The cross-country correlation between inflation and income inequality has subsequently been rationalized, for example, in a political-economy model whereby the positive association is the distributional outcome of government policies (Albanesi 2007). While most of the previous studies are suggestive, so far the model and international evidence only aim at explaining an “average” country, grouping together countries of different size.

This chapter delves further into the relationship between terms of trade, international competition, and real wage inequality for a small open economy, thereby filling an important gap in the literature abundant with large country evidence, particularly the United States. While there is a garden variety of explanation for the role of globalization on inequality, I focus on the recent ones and offer some new evidence on their applicability in a context of Singapore.