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posted on 06 March 2017

World Trade Has Raised Incomes And Cut Inequality Globally

by The Indian Economist

-- this post authored by Anabel Gonzfllez and Ana Revenga

In the ongoing debate about the benefits of trade, we must not lose sight of a vital fact. Trade and global integration have raised incomes across the world, while dramatically cutting poverty and global inequality.

Within some countries, trade has contributed to rising inequality, but that unfortunate result ultimately reflects the need for stronger safety nets and better social and labor programs, not trade protection.

Merchandise trade as a share of world GDP grew from around 30 percent in 1988 to around 50 percent in 2013. In this period of rapid globalization, average income grew by 24 percent globally, the global poverty headcount ratio declined from 35% to 10.7%, and the income of the bottom 40 percent of the world population increased by close to 50 percent.

This big picture evidence is buttressed by compelling micro-econometric studies on pro-poor income and consumption gains.

- The 2001, US-Vietnam free trade agreement reduced poverty in Vietnam by increasing wage premiums in export sectors, spurring job reallocation from agriculture, forestry and fishing into manufacturing, and stimulating enterprise job growth.

- A study of 27 industrial and 13 developing countries finds that shutting off trade would deprive the richest 10 percent of 28 percent of their purchasing power, but the poorest 10 percent would lose 63 percent because they buy relatively more imported goods.

- In many developing countries, export growth has been associated with greater gender equality. Exporting firms generally employ a significantly higher share of women than non-exporters. In Cambodia’s export-oriented garment sector, which is one of the main providers of wage employment in Cambodia, 85 percent of all workers are women.

A retreat from global integration would erode these gains, especially in developing countries. For example, abandoning existing agreements in the Americas would have particularly large negative welfare effects in countries like Mexico (4 to 9 percent), El Salvador (2 to 5 percent), and Honduras (2 to 5 percent), according to early research at the World Bank.

Within countries there are invariably losers as well as winners from trade and globalization. Households are likely to be affected differently depending on their physical and human capital endowments, their consumption patterns, and their incomes. Among developing countries, which we study most closely at the World Bank, there are countries where the direct effect of trade on the wage distribution has been equalizing (e.g. Brazil), and others where it has been un-equalizing (e.g. Mexico). Trade also reduced the (relative) wages of the poor in India in the 1990s, so that poverty decreased less in rural districts more exposed to trade liberalization.

Work-in-progress by some of our colleagues in the World Bank’s Research Group seeks to quantify the potential tradeoff between the efficiency gains and inequality costs of trade liberalization using household survey data from 53 low and middle income countries (Artuc, Porto and Rijkers, “Trading-off the Income Gains and the Inequality Costs of Trade Policy," mimeo: World Bank, 2017, in progress). In spite of heterogeneity in the distributional impacts, hard trade-offs are found only in a relatively small number of countries (such as Burundi, Nigeria and Gambia). In the vast majority of countries (including Egypt, Pakistan, and South Africa) trade liberalization significantly raises incomes with at most trivial inequality costs.

Despite the potentially negative effects of trade on some, what happens to final incomes and hence to inequality, however, is not a given. Between 1990 and 2010, a period of rapid globalization, inequality (measured by the Gini index) increased in the United States from 43 to 47 but fell in Denmark from 31 to 26.

Consider why. US workers concentrated in communities which face high volumes of Chinese imports have experienced fewer jobs and falling wages. And yet, the US Trade Adjustment Assistance (TAA) program falls short of the challenge of helping people get back on their feet. The US spends just 0.1% of GDP on all its active labor market polices while the OECD average is 0.6%. Second, the TAA is designed to help only workers suffering direct trade-related job losses but wages losses are not limited to workers who are employed in import competing sectors. Third, the TAA requires active participation of eligible workers in retraining programs but many less educated and older workers, who are worst affected, fail to qualify because they have often already withdrawn from the labor force.

In Denmark, trade liberalization and offshoring also contributed to a decrease in low skill wages, and increase in high skill wages, thus potentially widening inequality. However, the Danish labor assistance system (called Flexicurity) may have helped to avoid any significant increase in inequality. The system targets all workers suffering from job losses, not just workers in sectors exposed to trade and offshoring shocks, and deals with any negative labor market shock, not just relating to trade. The system is based on: a flexible labor market allowing employers to hire and fire relatively easily; a generous unemployment benefit system; and strong activation policies encouraging job search and enhancing workers’ employability.

In countries where trade has created losers, policies that redistribute some of the gains from winners to losers are needed to ensure the benefits of trade are widely shared. They also need policies to better equip workers to benefit from the opportunities offered by trade. Better and more generous safety nets and other social protection policies, and more investments in skill acquisition, are the answer. Not protectionist trade policies that will blunt the engine of growth that has delivered prosperity for millions around the world. This insight guides our work in a World Bank Group dedicated to ending extreme poverty and boosting shared prosperity for all.

Anabel Gonzfllez and Ana Revenga are both Senior Directors at the World Bank Group.
This article first appeared on Agenda, the World Economic Forum Blog.

The Indian Economist is a content-sharing partner of Global Economic Intersection.

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