Income inequality has been in the spotlight at least since Thomas Piketty published Capital in the Twenty-First Century in 2013. Piketty argued that our increasingly globalized economy delivered not just global inequality but also domestic inequality as well, with social democracies unable to adequately adapt to these changing times.
Recent research from MIT largely concurs, suggesting that international trade can exacerbate domestic income inequality. The study focused on Ecuador and aimed to hone in on the connection between the country’s economy and international trade. It finds that this international trade generates gains that are around 7% higher for those in the 90th income percentile as for those with average income levels.
“Trade in Ecuador tends to be something that is good for the richest, relative to the middle class,” the researchers explain. “It’s pretty neutral in terms of the middle class relative to the poorest. The [largest benefits] are found both among those who have founded businesses, as well as those who are well off and work as employees. So, it’s both a labor and capital effect at the top.”
Generating inequality
The researchers found that most Ecuadorian exports are commodities and raw goods. These tend to help the middle classes or the less well-off. The country’s imports, by contrast, tend to benefit those who are already well-off. With imports tending to have a bigger effect, inequality was formed.
“There is a horse race between the export channel and the import channel,” the authors explain. “Ultimately, what is quantitatively more important in the data, in the case of Ecuador, is the import channel.”
Suffice to say, pinpointing the price impact international trade has on a country’s income distribution is extremely difficult, as it’s not like country-size experiments can be undertaken to allow studies to be completed with and without trade. Instead, the researchers reconstructed trade-related activity in Ecuador, resulting in an examination of 1.5 million firms between 2009 and 2015. In total, the researchers collected data on revenue, payments to labor, income data, and education levels from across the country.
The researchers then gathered customs data, VAT on purchases, and trade between firms to try and gain an understanding of the import and export picture in the country.
Trading picture
The results show that the bulk of the country’s trade was in oil, which accounted for 54% of all exports. Most of the remaining were raw materials, such as fruit and seafood, while the most common imports were manufactured products, such as machinery and chemicals.
This commodities out/manufactured goods in the composition of imports and exports was crucial to the relationship between trade and inequality. For instance, companies that employ well-educated, well-paid individuals tend to be those that benefit most from trade because they were able to buy manufactured goods relatively cheaply. This in turn then bolsters the demand for more educated workers.
“It’s all about whether trade increases demand for your services,” the researchers explain. “The thing that is happening in Ecuador is that the richest individuals tend to be employed by firms that directly import a lot, or tend to be employed by firms that are buying a lot of goods from other Ecuadorian firms that import a lot. Getting access to these imported inputs lowers their costs and increases demand for the services of their workers.”
Changing the story
This is interesting, as traditionally most stories of global trade would suggest that Ecuador would gain in terms of its portion of lower-skilled workers.
“It’s not what a standard theory would have predicted,” the researchers explain. “A standard theory would be one where [because] Ecuador has [a] relatively scarcity, compared to a country like the U.S., of skilled workers, not unskilled workers, as Ecuador turns to trade, the low-skilled workers should be the ones benefitting relatively more. We found the opposite.”
What’s more, it’s not uncommon for trade theories to propose the notion of “perfect substitution”, whereby similar goods are traded between countries, with wages leveling off as a result. This didn’t appear to be the case in Ecuador.
“This is the idea that you could have a country making a good and other countries making an identical good, and ‘perfect substitution’ across countries would create strong pressure to equalize wages in the two countries,” the researchers continue. “Because they’re both making the same good in the same way, they can’t pay their workers differently.”
While the research inevitably excludes the informal economy, which contributes around half of the country’s entire economic activity, the authors believe their findings are applicable to other countries, and especially to middle-income countries that usually export commodities in exchange for manufactured goods.
“That pattern of participation [in global trade] is important, and exporting could be very different across countries,” they conclude. “But it would be very easy to know, if you just found the data.”
