Nova workboard

a blog from young economists at Nova SBE

A Flat and Unequal World

There was a time when the world was enormous, spanning the almost infinite boundaries of each closed country. In that time, trade was a challenge just for the bravest men who were able to face the unknown. Until the Fifteenth Century societies thought that the world was flat, that was when Columbus discovered how wrong they were. From then on, this round world has never been the same and all these technological advances strengthened the idea of the death of distance.

As a result of Globalization, most economies are linked by the crucial role International Trade plays in our lives. Thomas Friedman declares in his book “The World is Flat”, which doesn’t pretend to contradict geographical beliefs only stresses the decreasing role of distance on our modern economy.

Edward Leaman’s review of this book highlights an interesting point hidden behind the benefits of trade. By comparison to autarky, international trade does provide welfare gains, however, it means specialization with strong changes in the productive structure inside each country. In other words, some people will win and some will loose. Professor Adrian Wood presented this concept beautifully in his case study regarding North-South Trade and the effect on the labour market across different countries.

The central message of the Heckscher-Ohlin Theory is that countries tend to export goods whose production is relatively intensive in factors with which they are relatively abundantly endowed. Stolper-Samuelson theorem also states that opening to international trade, holding factor supplies constant, increases the real return of the factor used intensively in the production of exported goods, while lowering the real return to the other factor. The simple and relevant conclusion is that owners of a country’s abundant factors tend to gain from trade; meanwhile owners of a country’s scarce factors tend to lose.

Despite the well-known rigidities, this reasoning may be applied to the labour market considering high-skilled and low-skilled workers. According to theory, international trade would increase high-skilled real-wages in developed countries (who have high-skilled labour as the most abundant factor), while it decreases the low-skilled real-wages. By contrast, trade should decrease wage inequalities in developing countries, where high-skilled labour is relatively scarcer. The following graph presents some data about openness to trade and income inequality for low-skilled countries and high-skilled countries.

Trade & Inequality

There is some work relating trade liberalization policies and labour market changes and the answers remains unclear. There are two interesting papers trying to analyse this question: the first is about the 1991 Indian trade liberalization and the second about the impact of Chinese growing import competition on the U.S. labour market.

Empirically, it seems that international competition causes strong changes in both productive structures but it’s not enough to explain the reduction of poverty in India or the increase in U.S. inequalities. The case of India showed significant differences in poverty reduction across regions depending on their characteristics (if each region is more or less rural). The second paper demonstrated that import competition explains only one-quarter of the contemporaneous aggregate decline in U.S. manufacturing employment (while transfer benefits payments for unemployment, disability, retirement and healthcare reforms are the most relevant factors).

These adverse side effects have significantly increased unemployment, inequality, poverty and other forms of social erosion (as organized crime) at low-skilled activities and some developed countries are tempted to raise protectionist barriers. This is the worst possible response that governments may implement because it decreases welfare in both countries and creates deadweight losses. Rather, governments should implement long-term policies, such as investing on human capital or improving the educational system so that low-skilled workers can attain higher qualification levels and benefit from trade instead of being harmed by it.

This is the most efficient way to support the economic pattern transformation without the social and welfare costs that international trade usually creates.

Dino Alves #607
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Author: studentnovasbe

Master student in Nova Sbe

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