Third, it is hard to know what in the data constitutes trade liberalization. When the tariffs are 350 percent, there are no imports, so cutting them quite a bit might change very little. How do we distinguish relevant policy changes from irrelevant posturing? Moreover, such sky-high taxes invited defiance; people found creative ways to get around them. In response, the governments would often set up arcane rules to trap violators. A lot of these things changed when the country liberalized, but different bits changed at different speeds in different countries. How do we decide which country liberalized more, given that different countries chose different reforms?
All these are issues that make cross-country comparisons particularly fraught. The reason why different researchers get different answers about the effect of trade policy on growth has a lot to do with the different choices they make on each of these issues—how to measure changes in trade policy and which of the many possible sources of confusion about causality one is willing to tolerate.
For this reason, it is very hard to have a lot of faith in the results. There are always going to be a million ways to do cross-country comparisons, depending on exactly which brave assumption one is willing to swallow.
The same constraints get in the way of being able to test the other prediction of the Stolper-Samuelson theory. Does inequality fall in poorer countries when they open up to trade? There are relatively few cross-country studies on this subject, reflecting a pattern we will see again and again. Trade economists have tended to stay away from thinking about how the pie is shared, despite (or perhaps because?) Samuelson’s early warning that, in rich countries at least, trade could come at the expense of the workers.
There are exceptions, but not ones that inspire confidence. A recent research report by two members of the IMF’s staff finds that countries that are close to many other countries, and as a result trade more, tend to be both richer and more equal. They ignore the inconvenient fact that Europe is where there are many small countries that trade a lot with each other, and those countries tend to be both richer and more equal, but probably not primarily because they trade a lot.17
One other reason to be skeptical of this rather optimistic conclusion is that it flies in the face of what we know from a number of individual developing countries. In the last three decades, many low- to middle-income countries have opened up to trade. Strikingly, what happened to their income distribution in the following years has almost always gone in the opposite direction of what the basic Stolper-Samuelson logic would suggest. The wages of the low-skilled workers, who are abundant in these countries (and should therefore have been helped), fell behind relative to those of their higher-skilled or better-educated counterparts.
Between 1985 and 2000, Mexico, Colombia, Brazil, India, Argentina, and Chile all opened up to trade by unilaterally cutting their tariffs across the board. Over the same time period, inequality increased in all those countries, and the timing of these increases seems to connect them to the trade liberalization episodes. For example, between 1985 and 1987, Mexico massively reduced both the coverage of its import quota regime and the average duty on imports. Between 1987 and 1990, blue-collar workers lost 15 percent of their wages, while their white-collar counterparts gained in the same proportion. Other measures of inequality followed suit.18
The same pattern, liberalization followed by an increase in the earnings of skilled workers relative to the unskilled, as well as other measures of inequality, was found in Colombia, Brazil, Argentina, and India. Finally, inequality exploded in China as it gradually opened up starting in the 1980s and eventually joined the World Trade Organization (WTO) in 2001. According to the World Inequality Database team, in 1978 the bottom 50 percent and the top 10 percent of the population both took home the same share of Chinese income (27 percent). The two shares starting diverging in 1978, with the poorest 50 percent taking less and less and the richest 10 percent taking more and more. By 2015, the top 10 percent received 41 percent of Chinese income, while the bottom 50 percent received 15 percent.19
Of course, correlation is not causation. Perhaps globalization per se did not cause the increase in inequality. Trade liberalizations almost never take place in a vacuum; in all these countries, trade reforms were part of a broader reform package. For example, the most drastic trade policy liberalization in Colombia in 1990 and 1991 coincided with changes in labor market regulation meant to substantially increase labor market flexibility. Mexico’s 1985 trade reform took place amid privatization, labor market reform, and deregulation.
As we mentioned, India’s 1991 trade reform was accompanied by the removal of the industrial licensing regime, capital market reforms, and a general shift of power and influence to the private sector. China’s trade liberalization was of course the capstone of the massive economic reform undertaken by Deng Xiaoping, which legitimized private enterprise in an economy where it had been almost forbidden for thirty years.
It is also true that Mexico and other Latin American countries opened up exactly at the time when China was also opening up, and therefore they all faced competition from a more labor-abundant economy. Perhaps that was what hurt the workers in these economies.
Showing anything definitive about trade by just comparing countries is difficult, because both growth and inequality could depend on so many different factors, trade being just one of those ingredients, or indeed an effect rather than a cause. There have, however, been some fascinating within-country studies that do throw a shadow over the Stolper-Samuelson theorem.
THE FACT THAT COULD NOT BE
Looking at different regions within countries clearly reduces the number of potential things going on at the same time that might obscure the effects of trade; there is usually a single policy regime, a shared history, and common politics, making the comparisons more convincing. The problem is that the central predictions of trade theory, by their very nature, encompass every market and region in the economy, and not just the ones where imports come in or exports take off.
In the Stolper-Samuelson view of the world, there is one unique wage for every worker with the same skills. A worker’s wage does not depend on his sector or region, but only on what he brings to the table. This is because the steelworker in Pennsylvania who loses his job because of foreign competition should move immediately to wherever he can find a job, to Montana or to Missouri, to plating fish or making fisher-plates. After brief transitions, all workers with the same skills will earn the same.
If this were true, then the only legitimate object of comparison for learning about the impact of trade would be the entire economy. We would not learn anything by comparing workers in Pennsylvania with workers in Missouri or Montana because they would all have the same wage.
Rather paradoxically, therefore, if one believes the assumptions of the theory, it is almost impossible to test it, since the only impact one observes is what happens at the country level, and we just demonstrated the many pitfalls of cross-country comparisons and country case studies.
However, as we saw with migration, labor markets tend to be sticky. People do not move even when labor market conditions would suggest they ought to, and as a result wages are not automatically equalized across the economy. There are in effect many economies inside the same country and it is possible to learn a lot by comparing them, as long as the changes in trade policy affecting these subeconomies are not all the same.
One young economist, Petia Topalova, who was a PhD student at MIT at the time, decided to take this idea seriously, and to start from the premise that people may be stuck, both in a place and in a line of trade. In an important paper, she studied what happened in India after the massive trade liberalization of 1991.20 It turned out that even though we think of “India liberalizing,” there were very different changes in trade policy that affected different parts of the country. This is because, even though eventually all the tariffs were brought down to more or less the same level, since some industries were much more protected than others to st
art with, there were much bigger reductions in tariffs for some industries. Moreover, India has over six hundred districts that differ enormously in the kinds of businesses they are home to. Some are mainly agricultural; others have steel plants or textile factories. Since different industries fared differently, the liberalization led to very different reductions in tariffs in different districts. Topalova constructed, for each Indian district, a measure of how much it was affected by liberalization. For example, if one district mainly produced steel and other industrial manufacturing products, whose tariff dropped from almost 100 percent to about 40 percent, she would say this district was strongly affected by liberalization. If another district just grew cereals and oilseeds, whose tariff essentially did not change, it was almost unaffected.
Using this measure of exposure, she looked at what happened before and after 1991. The national poverty rate dropped rapidly in the 1990s and 2000s, from about 35 percent in 1991 to 15 percent in 2012.21 But, against this rosy backdrop, greater exposure to trade liberalization clearly slowed poverty reduction. Contrary to what the Stolper-Samuelson theory would tell us, the more exposed a particular district was to trade, the slower poverty reduction was in that district. In a subsequent study, Topalova found that the incidence of child labor dropped less in districts more exposed to trade than in the rest of the country.22
The reaction to her findings in the economics profession was surprisingly brutal. Topalova ran into a barrage of very unfriendly comments suggesting she had the wrong answer, even if her methods were correct. How could trade actually increase poverty? The theory tells us trade is good for the poor in poor countries, so her data had to be wrong. Blackballed by the academic elite, Topalova finally took a job at the IMF, which, somewhat paradoxically given the IMF had pushed for the massive liberalization in the first place, was more open-minded about her research than the academic community.
Topalova’s paper was also rejected by the top economic academic journals despite the fact that it eventually inspired a literature dedicated to the debate. There are now many papers applying Topalova’s approach in other contexts and, incidentally, finding the same results in Colombia, Brazil, and, as we will see below, eventually the United States.23 It was only several years later that she got some measure of vindication from academic economists when her findings won the Best Paper Award from the journal in which the paper had been published.
THE STICKY ECONOMY
Topalova had always insisted she had no intention of claiming anyone had been hurt by the trade liberalization. Since she was comparing regions within the same country, all she could say was that some areas (those most affected by trade) were less successful in reducing poverty than others. This is entirely consistent with the possibility, which her paper is careful to underline, that the tide of liberalization had lifted all boats, just some more than others. And her work does not imply that inequality increased in India as a whole, just that it went up more in the more trade affected districts. In fact, because the places most touched by liberalization tended to be somewhat richer to start with, the fact that they did not fare particularly well after liberalization, paradoxically, reduced countrywide inequality. In other papers, Topalova and her colleagues demonstrated some clearly positive economy-wide consequences of the Indian trade liberalization. For example, Indian firms, challenged to find new markets, started introducing new products they could now sell abroad. Moreover, the fact that they could import cheaper and better inputs, indeed ones they could not even find in India before, meant they could make new products for the domestic and international markets.24 This increased their productivity and, along with other reforms undertaken by the government in the early 1990s (and some luck with worldwide growth), contributed to the rapid growth of the Indian economy since the 1990s.
Nevertheless, it is easy to see why trade economists felt threatened by Topalova’s paper. The benefits of trade in traditional theory come from the reallocation of resources. The very fact that Topalova finds any difference between more exposed and less exposed districts tells us resources (workers, but also capital) do not move easily, as we noted earlier. If they did, wages everywhere would have been more or less the same. And she is not the only one to find this; a number of other studies also found very little evidence of resource reallocation.25 But once we give up on the idea that people and money will chase opportunities, how do we hold on to our faith that trade is good?
If workers are slow to move across district boundaries, it is plausible they are also slow to move from one kind of job to another. This is entirely consistent with what we know about labor markets. In India, Topalova found the negative effect of trade liberalization on poverty was exacerbated in states where strict labor laws made it very difficult to fire workers and shrink unprofitable firms, allowing profitable ones to take their place.26
There is also a body of solid evidence showing that, at least in developing countries, land does not easily change hands. Capital also tends to be sticky.27 Bankers are slow to cut credit to firms that are not doing well, but also to lend to those firms that are doing well, for the interesting reason that many credit officers, the people who make lending decisions, are terrified of being held responsible for loans that go bad. The easiest way to avoid this is to make no decision; just rubber-stamp whatever decision has been made in the past, by someone else, and let yet another person deal with the loans in the future. The one exception, unfortunately, is when loans are about to fail—then bankers actually give the ailing firms new loans to pay back their old ones, in the hope of postponing the default and perhaps benefitting from a reversal of fortune. This is the phenomenon, in banking parlance, of “evergreening” loans, one of the main reasons why so many banks with seemingly impeccable balance sheets suddenly wake up to a looming disaster. Sticky lending means existing firms that should have been put out of their misery continue to hang on. At the same time, it also means new businesses have a hard time raising capital, especially in the middle of the uncertainty that comes with, say, a trade liberalization, because the loan officers shy away from taking on new risks.
Given these various forms of stickiness, it is plausible that when bad news arrives in the form of greater competition from outside, instead of embracing it and moving resources to their best possible use, there is a tendency to hunker down and hope the problem will go away on its own. Workers are laid off, retiring workers are not replaced, and wages start to drift down. Business owners take a big hit on their profits, loans get renegotiated, all in order to preserve as much as possible of the status quo ex ante. There is no improvement in efficiency, just a fall in the earnings of everyone associated with the industries that lose their protection.
This might seem extreme, but Topalova finds something like this in the Indian data. For one, there was very little migration out of the districts affected by liberalization.28 Even within a region, resources were slow to move among industries.
More strikingly still, this was true within firms. Many firms in India produce more than one product, so one would expect firms to close down product lines competing with cheaper imports and reorient production toward products facing less of a disadvantage. There is nothing to stop this even where labor laws make it hard to fire people, but Topalova’s research found very little “creative destruction.” Firms never seem to discontinue a product line that has become obsolete. Perhaps it is because the managers find the transition process costly: workers need to be retrained, new machines need to be purchased and installed.29
PROTECTION FOR WHOM?
These internal barriers notwithstanding, resources did eventually move (at least in some countries) and exports are a big part of the remarkable success stories of East Asia in particular. Despite what you hear from President Trump and others, it was not because rich countries were naively welcoming. Rich countries heavily regulate imports, which have to meet strict safety, labor quality, and environmental standards.
It has been argued that regulations often serv
e to keep imports out. California avocado producers successfully lobbied for a complete federal ban on Mexico Hass avocados from 1914 until 1997. This was on the grounds of keeping Mexican pests out, despite the facts that Mexico is territorially adjacent and that pests do not require visas to cross the border. In 1997, the federal ban was lifted but remained in effect in California until 2007. More recently, researchers found that during the 2008 crisis in the United States, the Food and Drug Administration suddenly became more likely to refuse, on food-safety grounds, shipments of imported foods coming from developing countries; for exporters from developing countries, the cost associated with shipments being refused quadrupled during the period! Obviously, the quality of shipments from Mexico could not have changed because of the subprime crisis in the United States, but because demand for avocados went down, it became all the more valuable to keep them out to protect local growers.30 Domestic pressures for protection mount during bad times and safety regulations are often used as an excuse to protect the domestic producers.
That said, some of these standards also reflect genuine consumer preferences for safety (e.g., some Chinese toys have been found to contain lead), the protection of the environment (e.g., pesticide use in agricultural products), or the condition of workers (e.g., child labor). Indeed, the success of the Fairtrade branding shows that many consumers are willing to pay more to intermediaries who can assure them that a product meets some environmental and ethical standards. And, partly inspired by this, many well-known brand names these days impose quality standards over and above any regulatory requirements, making it even harder for new exporting countries to enter.
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