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Does Trade Fuel Inequality?

Summary:
To explain the rise in inequality that began in the 1980s and has accelerated since the turn of the century, many have pointed out that indicators of globalization, such as the trade-to-GDP ratio, have also been rising rapidly over the same period. But does that correlation imply a causal link between trade and inequality? CAMBRIDGE – Inequality has become a major political preoccupation in the advanced economies – and for good reason. In the United States, according to the recently released World Inequality Report 2018, the share of national income claimed by the top 1% of the population rose from 11% in 1980 to 20% in 2014, compared to just 13% for the entire bottom half of the population. Qualitatively similar, though less pronounced, trends characterize other major

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To explain the rise in inequality that began in the 1980s and has accelerated since the turn of the century, many have pointed out that indicators of globalization, such as the trade-to-GDP ratio, have also been rising rapidly over the same period. But does that correlation imply a causal link between trade and inequality?

CAMBRIDGE – Inequality has become a major political preoccupation in the advanced economies – and for good reason. In the United States, according to the recently released World Inequality Report 2018, the share of national income claimed by the top 1% of the population rose from 11% in 1980 to 20% in 2014, compared to just 13% for the entire bottom half of the population. Qualitatively similar, though less pronounced, trends characterize other major countries such as France, Germany, and the United Kingdom.

To explain the rise in inequality that began in the 1980s and has accelerated since the turn of the century, many have pointed out that indicators of globalization, such as the trade-to-GDP ratio, have also risen since 1980. But does that correlation imply a causal link between trade and inequality?

There are certainly reasons to doubt it. The global trade-to-GDP ratio peaked in 2008 at 61%, after a 35-year climb, falling back to 56% by 2016 – at precisely the time when fear of globalization reached political fever pitch.

What if we look at the world as a whole, rather than individual countries? As Columbia’s Xavier Sala-i-Martin pointed out in 2002 and 2006, even as inequality has risen in nearly every country, inequality across countries has decreased, owing largely to the success of developing countries like China and India in raising their per capita incomes since the 1980s.

Multiple factors, including urbanization, high savings rates, and improved access to education, undoubtedly underlie these countries’ impressive performance. But, if one uses geography to isolate exogenous determinants of trade, it becomes apparent that trade has been among the most powerful drivers of Asia’s economic success, and thus the convergence between the developed and developing worlds.

For someone like US President Donald Trump, this would indicate that Asia’s success has come at America’s expense. This view of trade as a zero-sum game was a feature of the mercantilist theory that reigned three centuries ago, before Adam Smith and David Ricardo made the case that trade would normally benefit both partners, by enabling each to take advantage of their comparative advantages.

Jeffrey Frankel
Jeffrey Frankel, a professor at Harvard University's Kennedy School of Government, previously served as a member of President Bill Clinton’s Council of Economic Advisers. He directs the Program in International Finance and Macroeconomics at the US National Bureau of Economic Research, where he is a member of the Business Cycle Dating Committee, the official US arbiter of recession and recovery.

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