For Richer, for Poorer

• Author: Nina Pavcnik

For Richer, for Poorer Finance & Development, December 2016, Vol. 53, No. 4

Nina Pavcnik

International trade can deepen inequality in developing economies

During the past three decades, developing economies have become ever more integrated into the world market. Fewer policy barriers to trade—combined with better communication and transportation—have helped companies reorganize and manage production facilities across borders, incorporating the relatively cheap workforces of developing countries.

These shifts are often blamed for growing inequality and the demise of manufacturing employment in developed economies and contribute to the current backlash against international trade.

In many developing economies, income inequality has also increased over the past three decades, especially in Asia. Pew Research Center polls indicate that 80 to 96 percent of people in emerging market economies such as Brazil, China, India, and Vietnam perceive inequality as a key problem facing their countries. However, only 1 to 13 percent of people in these countries view trade as inequality’s main driver.

This public perception agrees with evidence from academic literature surveyed in Goldberg and Pavcnik (2007), which finds that trade has contributed to growing inequality in developing economies but is not the main cause.

The effects of trade on inequality within a country are complex, as trade influences people’s earnings and consumption in several ways, and its uneven effects vary according to context. The nature of trade integration; how easily workers and capital move across firms, industries, and geographic regions; and where the people affected by trade fall on a country’s income distribution all play a role. This article highlights some insight into these issues from recent studies of trade’s uneven effects in several developing economies.

Earnings inequalityThe usual gains from trade occur when countries specialize and trade reallocates workers from import-competing industries to exporting industries. This leads to lower earnings of workers in import-competing industries and increased earnings for workers in export-oriented industries, at least in the short run.

Trade’s uneven effects on earnings also operate in other dimensions.

International trade can contribute to unequal earnings of comparable workers across companies in an industry. Firms differ in their performance, and those that do better are more likely to export. Two recent studies from Argentina and Mexico find that winning firms benefit from new export opportunities and share revenue gains with their workers in the form of higher earnings (Verhoogen, 2008; Brambilla, Lederman, and Porto, 2012).

In addition, more highly educated workers in companies that export to high-income countries get an additional earnings boost, relative to less-educated workers. Why? Consumers in high-income countries often demand higher-quality products than those in developing economies. The production and marketing of quality goods, in turn...