The Paradox of Trade Liberalization

From a brand new study in the Journal of International Economics:

Using household survey data for 54 low and middle income countries harmonized with trade and tariff data, this paper offers a quantitative assessment of the income gains and inequality costs of trade liberalization and the potential trade-off between them.

A stylized yet comprehensive model that allows for a rich range of first-order effects on household consumption and income is used to quantify welfare gains or losses for households in different parts of the expenditure distribution. These welfare impacts are subsequently explored by deploying the Atkinson social welfare function that allows us to decompose inequality adjusted gains into aggregate gains and equality (distributional) gains.

Liberalization is estimated to lead to income gains in 45 countries in our study, and to income losses in 9 countries. The developing world as a whole would enjoy gains of about 1.9% of real household expenditures, on average. These income gains are negatively correlated with equality gains, such that liberalization typically entails a trade-off between average incomes and income inequality. In fact, such trade-offs arise in 45 out of 54 countries, and are primarily the result of trade exacerbating income inequality. By contrast, consumption gains tend to be more evenly spread across households.

While trade-offs are prevalent, our findings also suggest that liberalization would be welfare enhancing in the vast majority of countries in our study: in a large part of the developing world, the current structure of tariff protection is inducing sizable welfare losses. Explaining what drives these patterns is beyond the scope of this paper but an interesting avenue for future research (pg. 16).

I’m sure this offers a bit of a conundrum for those who have conflated concerns over inequality with caring for the poor.1

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