Abstract: We develop a dynamic trade model to understand the effects on within-country inequality of trade in intermediates, also known as international unbundling of production. We consider a world economy where countries only differ in their productivity and consume final good varieties from all country origins. Each variety is produced using a bundle of intermediate inputs. The production of intermediate inputs requires capital and labor in different proportions. Capital can be accumulated over time, while labor supply is fixed. We characterize two steady-state trade regimes: (i) without unbundling (an equilibrium in which only varieties can be traded), and (ii) with unbundling (an equilibrium where intermediate inputs can also be traded). We show that unbundling of production generates an increase in within-country inequality in all countries and that this change in inequality is U-shaped in the productivity of the country. The reason is that high-productivity countries specialize in capital-intensive intermediates, accumulate more capital and end up with a larger share of capital income in the new steady-state. The same qualitative results hold when countries are ex-ante identical.

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