Research & Policy Briefs From the World Bank Malaysia Hub No. 44 March 05, 2021 Distributional Effects of International Trade: Misconceptions about Losses and Gains Erhan Artuc International trade increases efficiency but also redistributes income, thus creating winners and losers. To account for the total impact and calculate redistributive effects correctly and fully, the different channels of gains and losses must be measured precisely. This Brief shows that measuring the gains is often much more challenging than measuring the losses, generating misconceptions and an overstatement of the adverse impacts of international trade. To assess the effects of trade shocks objectively, and to promote effective policy options, policy makers must be aware of the limitations in data and methodology surrounding the research on the distributional effects of international trade, and the misconceptions that ensue. Three Recurrent Misconceptions about the Distributional States (Autor et al. 2013; Artuc, Lopez-Acevedo, Robertson, and Samaan Effects of International Trade 2019). International trade is one of the oldest fields of modern economics. David Although journalists are not to blame for these misconceptions, their Ricardo started writing about international trade and the theory of tendency to oversimplify and search for striking results magnifies the comparative advantage only a few decades after Adam Smith’s confusion, even when they report only research findings. For example, pathbreaking work, Wealth of Nations, launched economics as a modern the work of David Autor, who is one of the leading academics in the field, social science (Ricardo 1817; Smith 1776). Economists have been thinking is often reported as showing that US workers lose from trade with China. about international trade for more than two hundred years as its Although it is true that many workers lose, he consistently points that importance is universally well understood: International trade can United States, as a whole, benefits significantly from trade with China increase efficiency, create knowledge spillovers, and kindle rapid (Rodriguez 2018). development, but at the same time it can redistribute wealth and create winners and losers (Stolper and Samuelson 1941). Therefore, garnering Two Main Channels of International Trade Effects support for policies that promote trade liberalization can be politically International trade affects workers directly by two main channels: First, it challenging. Policy makers must understand who loses and who wins with changes the prices of goods and services, and therefore the amounts and free trade, and also by how much, to design politically sustainable policies patterns of consumption. Second, it changes income and job that promote overall economic efficiency and welfare. opportunities. Despite the long history of international trade economics, our The first order immediate effects of free trade usually emerge as a understanding of the impact of international trade on workers has been decline in overall prices, especially for tradable goods. While prices of rather limited and unsatisfactory, partially due to lack of data but also due some goods and services might increase, they are more likely to be export to a lack of interest in the research community. goods and services. Most consumers would enjoy a decline in living costs if trade barriers were lifted, since they could consume more for a given Fortunately, two centuries after Ricardo, there has been a recent fixed budget thanks to lower prices. As a result, free trade has a positive spark of interest in the comparative advantage theory and the immediate impact on average consumption in most scenarios, especially redistribution of wealth across workers based on increasing trade across in the short run. nations. Most notably, the “local labor markets” approach taken by Autor, Dorn, and Hanson in their 2013 paper found that increasing imports from Unlike the favorable impact on average prices from the perspective of China caused income inequality across regions in the United States. Many consumers, it is impossible to generalize the immediate impact on other research and policy papers have followed. Despite this welcome income, because depending on the industry of employment or specificity surge in the number of research and policy papers, the discussions about of skill, incomes would increase for some workers and decline for others. the distributional effects of globalization through international trade are Those workers employed in exporting industries or who have skills used still riddled with much confusion and many misconceptions. intensively in exporting industries are likely to enjoy increases. However, workers employed in import-competing industries or who have skills This Brief will focus on three common misconceptions about relevant to those industries would most likely suffer declines. For those international trade and its impact on workers, outline sources of this whose income declines or who lose their jobs, the impact can be quite confusion, and explain how to interpret the results correctly with an large if their skill set becomes obsolete. awareness of the severe shortcomings in data and methodology. Although the main sources of misconceptions are technical in nature, the The precise impact would depend on the nature of trade liberalization economic intuition behind them is straightforward. This Brief will discuss and the country’s comparative advantage patterns, but in general the these intuitions. immediate impact on consumption is positive and small, while the immediate impact on income is heterogeneous and often unknown. After The first misconception about international trade is to think that all, people often have one job, but they consume many goods. For identifying both winners and losers from data are equally easy tasks. example, if a country stops producing apparel because of having Although free trade usually generates both, it is often much more difficult comparative advantage in other products, and imports all apparel from to identify winners than losers (Artuc, Porto, and Rijkers 2020). The abroad, most consumers would enjoy slightly lower overall prices as the second misconception is to assume that as number of academic research price of clothing in the consumption basket declines. But specific papers on trade and inequality increases, the chances will improve for a individuals would severely suffer from income loss if they were employed more unbiased picture to emerge (Artuc, Bastos, and Lee 2021). The third in the apparel industry. Therefore, immediate gains would be spread misconception is to assume that compensation of losers from free trade thinly across all consumers, while immediate losses would be is prohibitively costly, even for developed nations such as the United concentrated on certain workers. Affiliations: Development Research Group, World Bank. Acknowledgements: The author thanks Norman Loayza, Young Eun Kim, Tobias Pfutze, Izzati Razak, Bill Maloney, Aart Kraay, Ryan Hahn, Bob Rijkers, Caglar Ozden, Guido Porto, Eunhee Lee, Paulo Bastos, Gladys Lopez-Acevedo, Raymond Robertson, and Daniel Samaan for their useful comments and suggestions. Objective and disclaimer: Research & Policy Briefs synthesize existing research and data to shed light on a useful and interesting question for policy debate. Research & Policy Briefs carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions are entirely those of the authors. They do not necessarily represent the views of the World Bank Group, its Executive Directors, or the governments they represent. Distributional Effects of International Trade: Misconceptions about Losses and Gains Figure 1. Distribution of Winners and Losers in One Sample Country Figure 2. Effect on Household Welfare in 54 Sample Countries after an (Ghana) after a Tariff Cut for One Agricultural Staple (Rice) Overall Unilateral Cut in Agricultural Tariffs As expected, most households are slightly or The tariff cut generates differences in the income effect, moderately better off. the consumption effect, and the overall effect that have 6 important ramifications. 0.3 Welfare gains, percent change in real income 0.2 4 0.1 2 0 Percent change 0 -0.1 -0.2 -2 -0.3 -4 -0.4 -0.5 -6 Welfare -0.6 Income -8 Consumption -0.7 -0.8 -10 4.0 5.0 6.0 7.0 8.0 9.0 10.0 2 3 4 5 6 7 8 9 10 11 Income per capita, log scale Income per capita, log scale Source: Author’s simulations based on Artuc et al. 2020. Source: Author’s simulations based on Artuc et al. 2020. Note: The figure presents polynomial fitted curves on points representing income Note: Solid blue line shows average gains, red dots show percentile of households and consumption effect for all households from all countries. The change in with losses, green dots show percentile of households with gains. welfare is equal to the sum of the changes in income and consumption. In a recent project, Artuc et al. (2020), develop tools to analyze the English, so they might be difficult for nonexperts to understand. However, impact of unilateral tariff reduction on households by identifying the the main intuition is quite the same: Group observations based on their impact on consumption and income channels separately for 54 affiliation to the variable of interest and compare the relative outcomes. low-income and middle-income countries, with a special focus on It should be noted that the results are almost always relative; absolute agricultural production. They construct a harmonized data set and results are rare in empirical economics and results are often derived web-based simulation tool for policy makers, which they make available through quantification of theoretical models and by using simulations. publicly online. Based on their simulation tool, one can zero in on the To calculate the impact of international trade on workers, economists effects of particular goods in particular countries. Figure 1, for example, must divide the population of interest into groups following the same examines the case of rice in Ghana. Short-run simulations conducted logic. For the income effects, the division is simple: Consider workers in using their web-based tool show that most households would be slightly the exporting, import competing, and nontraded industries. By or moderately better off, while some households would be severely worse comparing the workers in traded industries to workers in nontraded off (see figure 1). Because almost all Ghanaian households consume rice industries, economists can calculate the relative impact of trade on but only a small percentage of households rely on rice production, the workers’ income. results are not surprising. However, the division for consumption effects is not clear because Then, a more interesting question follows: “How would all households almost everybody consumes traded goods. Therefore, it is very difficult to in all 54 countries in the sample be affected if agriculture tariffs were identify the immediate consumption effects, which are often positive, unilaterally removed?” The partial equilibrium simulation for short run while it is easier to identify the immediate income effects, which can be impacts are illustrated in figure 2. The figure shows that for most either positive, negative, or neutral. The logic is simple: When we households the income effect is negative (red curve); the consumption consider the immediate direct effect, the gains are distributed thinly effect is positive (green curve); and the overall impact is positive (blue across the population, while the losses are concentrated. Alternatively, it curve). The positive effect (green curve) is more or less flat, meaning all could be theoretically possible to identify the changes in welfare over households are equally better off through the consumption channel, time, but big trade shocks often coincide with other shocks, such as while the negative effect (red curve) is angled, indicating that there is a technological progress, making identification through time-series great heterogeneity in the income channel. The curvature of these convoluted. As a result, thinly distributed positive effects make it different channels may seem unimportant at first, but it is the source of a practically impossible for both researchers and policy makers to identify very severe misconception, as explained in the next section. the gains from trade. This identification challenge can also shape public opinion about international trade negatively and feed into public Identification of Winner and Losers from International opposition of trade liberalization policies. Put differently, because the Trade gains from trade are often not concentrated, they are easily overlooked by both public and researchers. The public faces the same identification Although economists often use sophisticated statistical and mathematical challenges as the econometricians when they form their opinions based models in economics, the main intuition behind the scientific method has on their own observations. Further misconceptions and confusion may been unchanged for centuries. While Sir Francis Bacon is often considered also stem from the identification challenges surrounding the effects of the father of the scientific method, its roots were established by Middle labor mobility, which also generates winners and losers. These are Eastern philosophers during the Middle Ages, such as Alhazen. The discussed next. intuition is quite simple. Researchers divide the sample into groups: one control group and at least one treatment group, and then look at how each group is affected. In the natural sciences and experimental Labor Mobility and International Trade economics, this process is implemented by actually grouping subjects. In Although relatively easier to identify than consumption effects, income most fields of economics, however, the process is implemented by effects can only be identified in certain special situations when it is economists using computers to group economic observations in data difficult to take full advantage of trade liberalization due to large frictions. using complex statistical methods, rather than grouping subjects in real In fact, labor mobility frictions and distributional effects of trade are life. The methods are always explained by equations rather than plain deeply connected: Imagine a world where workers can switch industries 2 Research & Policy Brief No.44 Figure 3. The Widespread Impact of International Trade on Workers’ Welfare in Brazil a. The effect of changes in exports on workers’ welfare b. The welfare effect of remoteness of the labor market from export centers Workers in regions with a higher concentration of export industries are directly affected and better off. Workers in regions neighboring areas with a concentration of 60 export industries also benefit. Change in lifetime utility as a percentage of the 25 50 percentage of the annual wage, percent 20 Residual change in lifetime utility as a annual wage, percent 15 40 10 5 30 0 -5 -10 20 -15 -20 10 -25 -40 -20 0 20 40 60 2.5 3.0 3.5 4.0 4.5 Change in exports, percent Remoteness of the labor market Source: Artuc et al. 2021. Source: Artuc et al. 2021. Note: Change in exports in micro-regions of Brazil plotted against welfare gains. Note: Remoteness of micro-regions of Brazil plotted against welfare gains (net of gains that can be attributed to exports). instantaneously without any costs. In this utopian world, wage would be Now, consider the utopian scenario, where workers are perfectly equal in all industries because workers would move from one to the other mobile across industries and regions. It would be impossible to until all wages are equal everywhere. Moreover, workers’ initial industries differentiate between wages in the import-competing sectors and would be inconsequential. If workers in the import-competing sectors exporting sectors because wages would always be equal everywhere due lose their jobs because of trade liberalization, they would find new jobs in to perfect labor mobility. Then, measuring the impact of trade on workers exporting sectors immediately. In this scenario, the economy could adjust based on recent popular methods, such as Autor, Dorn, and Hanson’s to any shock. Gains from trade would be maximized due to the lack of (2013) local labor markets approach would not work because workers’ frictions and workers would not be split in their attitude toward free trade industry or region would not matter. Therefore, researchers often use based on their industries. This thought experiment illustrates why it is labor market frictions to capture income effects. However, this introduces crucial to consider labor mobility to calculate the distributional effects of a bias, as Artuc et al. (2021) show. In situations with low fictions, trade. researchers will have a hard time identifying income effects scientifically based on data; they can only speculate and make educated guesses, The first research paper on labor market frictions in the empirical unless high-frequency time-series data are available. Thus, due to the international trade literature was by Artuc, Chaudhuri, and McLaren nature of identification and the scientific method, researchers and policy (2010). They estimate labor mobility costs and show how labor mobility makers can expect to see more scientific research papers on income shapes the distributional effects of international trade in the United effects when labor market fictions are high and thus income effects are States. Following their intuition, in successive papers, labor and trade less likely to be favorable. Because of this identification challenge, economists have considered regions (or commuting zones in the United international trade is destined to be perceived as more harmful (or less States) and grouped workers based in their location to identify the impact helpful) than the reality when economist use common empirical of trade on workers (Autor et al. 2013; Kovak 2013; Dix-Carneiro and methods, such as the recent local labor markets approach. The Kovak 2017; Hakobyan and McLaren 2016). Because export and identification challenge regarding the gains from trade is not a pure import-competing industries are clustered in different locations and econometric or technical problem; it is also a policy design and political workers cannot move across locations easily, the impact of international economy problem. trade on workers usually depends on the workers’ initial geographical location. The Difficulties in Identifying and Compensating the More recently Artuc et al. (2021) have used data from Brazil, covering Losers from 2003 to 2015, to show that the impact of international trade on Identifying the impact of globalization on workers based on their location workers can spill over across regions and industries. They look at export has become by far the most popular method in the international trade growth in Brazil and show that workers in regions with a higher literature in the last decade. In a recent work, Artuc et al. (2019) show concentration of export industries are directly affected and better off that the rapid export growth in India increased wages of workers in (figure 3, panel a). But the growth of exports can also have positive districts that are specialized in exporting industries. The wage increase is spillovers on workers who are in other regions because workers can move especially high for skilled and experienced workers, as shown in figure 4, across regions (albeit slowly and subject to large frictions). Therefore, panel a. Another impact of exports is the decrease in informality, as workers who are closer to the regions experiencing a surge in exports are illustrated in panel b. While the impact of exports is favorable for most more likely to be better off, even after discounting the direct effects, worker types, the positive impact comes from the increase in wages for because moving to those regions is easier for them (figure 3, panel b). skilled and older (more experienced) workers, and from the reduction in Based on overwhelming evidence from the literature, it is clear that labor informality for unskilled and younger (inexperienced) workers. mobility is an important determinant of the impact of trade on workers (Dix-Carneiro 2014; Caliendo, Dvorkin, and Parro 2019). In fact, without Unlike Artuc et al. (2019), most recent papers in the literate focus on frictions, all workers would be affected in the same way—all better off or imports rather than exports, which is why they tend to identify losses. In all worse off—so there would not be any spatial or sectoral distributional their seminal work, Autor et al. (2013) look at the impact of growth of effect to speak of. China’s export on US workers. They find that $1 worth of exports cause a 3 Distributional Effects of International Trade: Misconceptions about Losses and Gains Figure 4. Changes in Wages and Informality for Different Types of Workers as Exports Increase in India a. Changes in wages b. Changes in informality The decrease in informality is greatest for female, low-skilled, older, Female, better-skilled, experienced, and urban workers benefit the most. and urban workers. Male Female Low-skill Other-skill Young Old Rural Urban 20 0 -1 Percent increase in wages 15 Percent change in informality -2 10 -3 5 -4 0 -5 -5 Male Female Low-skill Other-skill Young Old Rural Urban -6 Source: Artuc et al. 2019. Source: Artuc et al. 2019. Note: Impact on a district at the 75th percentile of exposure to exports relative Note: Impact on a district at the 75th percentile of exposure to exports relative to the 25th percentile. to the 25th percentile. 4-cent income loss for workers, on average. Note that, as discussed in the overstated. Second, recent popular empirical methods for identifying beginning of the Brief, the calculations are only possible for the income distributional effect of trade, such as the local labor markets approach, channel, and the positive impact of increasing exports is often ignored. can only be implemented when labor market frictions are large. However, Therefore, the calculations are the upper bound for income loss; the this methodological limitation introduces a bias. The gains from trade are change in income could well be positive on average, in reality. suppressed in the case of large labor market frictions and research cannot identify the cases with highest potential gains. Third, compensating the After taking the number of workers and the amount of imports from losers from international trade could be economically feasible, but the China into account, the total loss for workers in the United States due to correct identification and measurement of losses is extremely trade with China is calculated to be less than $21.5 billion per year, which challenging. is less than 0.1 percent of US GDP. To put that number in context, Bill Gates has noted that he had paid $10 billion in taxes and would happily To design an effective and sustainable trade policy, policy makers double that amount (Martin 2018). His contribution alone could often seek public support. However, the misconceptions summarized in compensate almost all losses. Of course, developing nations face severe this Brief make it difficult for the public and policy makers to reach an budget constants and it may not be possible for them to fund such levels unbiased understanding about the impact of international trade on of compensation. But the loss of workers from trade on average is not as workers. One possible solution proposed in the literature is gradual large as one would expect. The major problem is the concentration of liberalization of trade policy as opposed to “shock therapy,” which can losses in some locations or skill groups, and the lack of identification smooth the concentration of losses and make unanimous support feasible methods and compensation mechanisms. (Artuc, Chaudhuri, and McLaren 2008). Although recent evidence shows that it might be possible to compensate losses from globalization, Conclusion identifying those who lose is an extremely challenging task. Precisely targeting safety nets based on industry of employment, such as the This Brief identifies three misconceptions surrounding the distributional approach taken by the US Trade Adjustment Assistance Program, cannot effects of international trade literature. First, the gains from international be effective in the face of the mobility of workers across industries. trade are often distributed thinly across the population while the losses Instead, more inclusive labor market policies, such as the “flexicurity” are concentrated. Because they are not concentrated, gains from trade model of Denmark, have more potential in light of recent research (Artuc are easily overlooked by both public and researchers, and losses may be et al. 2021). References Artuc, E., P. Bastos, and E. Lee. 2021. “Trade, Jobs and Worker Welfare.” World Bank, Washington, DC. Dix-Carneiro, R., and B. Kovak. 2017. “Trade Liberalization and Regional Dynamics.” American Economic Unpublished. Review 107 (10): 2908-46. 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