International trade exacerbates national income inequality, at least in some circumstances, according to an empirical study that two MIT economists helped co-author.
The research, focusing on Ecuador as a case study, delves into income data at the individual level while examining in detail the links between the Ecuadorian economy and international trade. The study finds that trade generates income gains that are approximately 7% higher for those at the 90th income percentile, compared to those at the median income, and up to 11% higher for the top income percentile in Ecuador.
“Trading in Ecuador tends to be a good thing for the wealthy, relative to the middle class,” says Dave Donaldson, a professor in MIT’s Department of Economics and co-author of a published article detailing the findings. “It’s quite neutral in terms of the middle class compared to the poorest. The [largest benefits] are found both among those who have created businesses and among those who are well off and work as employees. So it’s both a labor effect and a capital effect at the top.
The study also identifies the dynamics that generate this result. Ecuadorian exports, mostly commodities and raw materials, tend to help the middle class or less well-off, while the country’s import business generally helps the already well-off – and overall, import has a greater effect.
“There is a horse race between the export channel and the import channel,” explains Arnaud Costinot, also a professor in the economics department at MIT and co-author of the article. “At the end of the day, what is quantitatively most important in the data, in the case of Ecuador, is the import channel.”
The article, “Imports, exports and income inequality: measures of exposure and estimates of incidence”, appears online in the Economics Quarterly Review. The authors are Rodrigo Adao, associate professor at the University of Chicago Booth School of Business; Paul Carillo, professor of economics and international affairs at George Washington University; Costinot, who is also associate director of the economics department at MIT; Donaldson; and Dina Pomeranz, assistant professor of economics at the University of Zurich.
Goods issued, machines entered
The effect of international trade on a country’s income distribution is difficult to pin down. After all, economists cannot design a country-wide experiment and study the same country, with and without trade, to see if any differences emerge.
As an alternative strategy, the researchers developed an unusually detailed reconstruction of trade-related economic activity in Ecuador. For the period from 2009 to 2015, they looked at the earnings of 1.5 million businesses with tax IDs and the earnings of 2.9 million founders and employees of those businesses. The researchers collected data on earnings, payments to work, and broke down individual earnings data by three levels of education (ending before high school, high school graduates, and college graduates) in the 24 provinces of Ecuador.
Digging deeper, the research team compiled customs records, VAT (value added tax) data on purchases, and internal trade data between businesses, to develop a broad and detailed picture of the value of imports and exports, as well as business. transactions that took place domestically but were related to international trade.
Overall, oil accounted for 54% of Ecuador’s exports between 2009 and 2011, followed by fruit (11%), seafood (10%) and flowers (4%). But Ecuador’s imports are mainly manufactured goods, including machinery (21% of imports), chemicals (14%) and vehicles (13%).
This composition of imports and exports—commodities outside, manufactured goods inside—turns out to be crucial for the relationship between trade and greater income inequality in Ecuador. Firms that employ well-educated, higher-paid people also tend to benefit the most from trade, as it allows them to buy manufactured goods more cheaply and prosper, increasing the demand for more educated workers. .
“It’s about whether trade increases demand for your services,” Costinot says.
“What happens in Ecuador is that the richest people tend to be employed by companies that directly import a lot, or tend to be employed by companies that buy a lot of goods from other Ecuadorian companies which matter a lot. Access to these imported inputs reduces their costs and increases the demand for their workers’ services.
For this reason, ultimately, “income inequality is higher in Ecuador than it would be in the absence of trade,” as the paper states.
Reconsider business ideas
As Costinot and Donaldson observe, this fundamental conclusion runs counter to what parts of established trade theory would expect. For example, some earlier theories predicted that Ecuador’s openness to trade would bolster the country’s relatively larger proportion of low-skilled workers.
“It’s not what a standard theory would have predicted,” Costinot says. “A standard theory would be one where [because] Ecuador has [a] relatively rare, compared to a country like the United States, of skilled workers, not unskilled workers, as Ecuador turns to trade, low-skilled workers are expected to benefit relatively the most. We found the opposite.
Moreover, Donaldson notes, some trade theories incorporate the idea of “perfect substitution,” whereby similar goods will be traded between countries – with resulting level wages. But not in Ecuador, at least.
“It’s the idea that one country makes one good and other countries make the same good, and a ‘perfect substitution’ between the countries would create strong pressure to equalize wages in the two countries,” Donaldson says. . “Because they both manufacture the same good in the same way, they cannot pay their workers differently.” However, he adds, while “the first thinkers [economists] I didn’t think that was literally true, it’s always a matter of how strong that force is. Our results suggest that the strength is quite weak.
Costinot and Donaldson recognize that their study must take into account various complexities. For example, they note, about half of Ecuador’s economy is informal and cannot be measured using official records. Additionally, global “shocks” can affect business models in any given country at any given time – something they test and incorporate in the current study.
And while business patterns may also change more gradually, data from 2009-2015 is stable enough to suggest that researchers have identified a clear and continuing trend in Ecuador.
“People don’t change jobs very often and the income distribution doesn’t change much,” Donaldson says. “We made sure to check that – in the sample, the stability is very high.”
A global model?
The study also naturally raises the question of whether similar results could be found in other countries. In the article, the authors list many other countries to which their methods could be applied.
“Ecuador is certainly very different from the United States, but it is not very different from many middle-income countries that mainly export commodities in exchange for manufactured goods,” Costinot says. Donaldson, for his part, is already working on a similar project in Chile.
“This model of participation [in global trade] is important, and exporting can be very different from country to country,” says Donaldson. “But that would be very easy to find out, if you just found the data.”
Research support was provided, in part, by the US National Science Foundation, the Center for Economic Policy Research, the UK Department for International Development and the European Research Council.