VoxEU Column International trade

The globalisation paradox: more trade less inequality

US income inequality has grown but not in a way that suggests trade with developing countries is the major reason. It’s not the least skilled who have fallen behind, but profits and the wages of the very richest Americans that have raced ahead.

It is fairly widely accepted that in the aggregate trade generates gains and promotes economic growth but it can also create winners and losers. In America’s case, trade with developing countries is viewed as particularly problematic because it could put downward pressures on the earnings of lower-wage workers. And indeed, it is precisely this type of trade that has expanded especially rapidly over the past decade, partly because countries such as China and India have emerged as major global competitors and partly because the US has vigorously implemented Free Trade Agreements with Mexico (NAFTA) and other developing countries.

Whereas most studies concluded that in the 1980s trade accounted for a relatively small share of the increase in US wage inequality, many now argue that the volume of trade has now grown to the point that much larger effects should be expected. For example, Paul Krugman recently wrote a Vox column making precisely this case.

It is true that by virtually all quantity and price indicators there were powerful globalisation forces operating during this period that might have been expected to increase wage inequality. Not only have imports from developing countries increased dramatically, but the relative prices of manufactured goods from these countries have declined steadily since the early 90s. Yet the big surprise is that over the past fifteen years wages of the least skilled Americans – the lowest 10 percent – have kept pace with the median.1 Moreover, since 1999, while real wage growth in general has been sluggish, most US relative wage and compensation measures indicate little evidence of increased inequality. This is true when workers are distinguished by skill, education, unionization, occupation and major sectors.

  • Apparently, the shocks from trade (or immigration) have not increased conventional wage inequality. This is surprising given the growing scale of the competition from low wage countries. There are two lines of explanation.
  • One is that the goods that the US imports are actually very sophisticated and produced in the US by relatively skilled workers. While it may cause displacement and could put downward pressure on wages generally, therefore, this competition does not increase wage inequality.
  • A second more benign view is that a significant amount of what America imports today is no longer produced domestically. Thus declining import prices simply yield consumer benefits but do not exert downward pressure on US wages nor cause dislocation of US workers. Paradoxically, globalisation is actually causing less inequality because specialisation is more advanced.

It appears that US trade today combines these two elements in proportions that are hard to disentangle, particularly at levels of disaggregation that allow for a sufficiently precise matching of products and the wages earned in producing them. At relatively high levels of aggregation the data indicate that manufactured imports overall, and even those from developing countries such as China, are concentrated in US manufacturing sectors which pay significantly higher than average US wages. This means that import displacement does not fall disproportionately on less skilled workers. While there has been considerable displacement from trade during this period, it has not increased wage inequality. At more disaggregated levels, however, the data suggests that goods imported from developing countries such as China are associated with relatively less skilled labor inputs and – judging by their unit values – qualitatively different from those produced by developed countries such as the US. This provides support for the view that much of this trade reflects more complete specialisation and as such does not result in either wage inequality or downward pressure on wages generally.

It will take more research to quantify the relative magnitudes of these two effects. Nonetheless, it does appear that over the past decade, US income inequality has continued to grow but not in a way that suggests trade with developing countries is the major reason. It’s not the least skilled who have fallen behind but profits and the wages of the very richest Americans that have raced ahead.




1 This article draws on a study on Trade and US Inequality to be published this fall by the Peterson Institute for International Economics.



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