Trade Liberalization and Inequality

The distributional implications of trade liberalization have long been of central interest to economists.  That may be why the Stolper-Samuelson Theorem is probably trade theory’s best known result.  For those new to trade it demonstrates that, as a result of an increase in the relative price of a good, factors used intensively in its production enjoy a real increase in their return whereas those not used intensively suffer a real decline.  Since the 1980s, trade liberalization between the developed world and developing Asia and Latin America, coupled with an increase in inequality in the developed world over the same timeframe, have revived interest in the role that trade plays in driving inequality.

The first wave of the literature focused on developed countries and the increase in inequality between high-skilled and low skilled labor.  Such an increase is in line with the Stolper-Samuelson Theorem if there is trade liberalization and developed countries are relatively well endowed with high skilled labor.  The consensus was that, while trade liberalization was partially responsible for the increase in inequality, technological change played a greater role.  Some argued that trade liberalization was itself responsible for labor-saving technological change, providing a greater indirect role for trade liberalization in driving inequality.

The second wave switched focus to developing countries.  Here the results have been less clear-cut.  First, there has been an increase in inequality which runs counter to the prediction of the Stolpher-Samuelson Theorem if the developing world is abundant in low-skilled labor.  Moreover labor market regulations are reckoned to be more stringent in the developing than the developed world, limiting labor mobility between sectors which violates a central assumption in the Stolper-Samuelson Theorem.  There appears to be some evidence that trade liberalization and technological change may have had opposite effects on inequality, with the positive technological change effects being dominant.  The consensus appears to be that, although skilled-biased technological change may have played a greater role in increasing the skill premium, technological change was itself an endogenous response to more openness so that globalization was indirectly responsible for the increase in the skill premium. Following the current trend in economics, the way forward seems to lie in more detailed models and datasets that facilitate careful examinations of the precise impulses that hit workers and how they responded.

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