Trade and income in the long run: Are there really gains, and are they widely shared?

Abstract

In the cross‐section of countries, there is a strong positive correlation between trade and income, and a negative relationship between trade and inequality. Does this reflect a causal relationship? We revisit the Frankel and Romer (1999) identification strategy, and exploit countries’ exogenous geographic characteristics to estimate the causal effect of trade on income and inequality. Our cross‐country estimates for trade’s impact on real income are consistently positive and significant over time. In addition, we do not find any statistical evidence that more trade increases aggregate measures of income inequality in the long run. A decile‐level decomposition reveals that the positive effect of trade on income decreases monotonically along the income distribution, suggesting that trade integration should be an integral part of long‐run development agendas under any reasonable social welfare function. Addressing previous concerns in the literature, we carefully analyze the validity of our geography‐based instrument, and confirm that the IV estimates for the impact of trade are not driven by other direct or indirect effects of geography through non‐trade channels.

Trade and Inclusive Growth

“…However, some critics debate the direction of causation (see reviews by Hanson andHarrison, 1999, andRodriguez andRodrik, 2010). To address this concern, a few studies use the exogenous component of trade openness based on geography and find that more open countries tend to have higher average per capita incomes (Frankel and Romer 1999;Cerdeiro and Komaromi, 2020). An increase in trade openness of 1 percent of GDP is associated with 2-6 percentage points higher per capita GDP.…”

“…In addition to boosting growth, investment, and FDI, trade liberalization prevented the steep rise in inequality experienced by countries that remained relatively closed to international trade (Beaton, Cebotari, and Komaromi, 2017). Cerdeiro and Komaromi (2020) exploit countries' exogenous geographic characteristics to estimate the causal effect of trade on inequality; they 3 The significance of the results depends on sample and controls. BCK (2017) find trade significantly reduces market inequality in EMDEs, but is not significant for net inequality.…”

Trade

“…However, some critics debate the direction of causation (see reviews by Hanson andHarrison 1999, andRodriguez andRodrik 2001). To address this concern, a few studies use the exogenous component of trade openness based on geography and find that more open countries tend to have higher average per capita incomes (Frankel and Romer 1999;Cerdeiro and Komaromi 2020). An increase in trade openness of 1 percent of GDP is associated with 2-6 percentage points higher per capita GDP.…”

Trade, Jobs, and Inequality

“…In contrast, countries that remained relatively closed to international trade experienced a pronounced increase in inequality. Cerdeiro and Komaromi (2020) use a different methodology, based on a gravity model. in which the geographic characteristics of a country (such as distance to trading partners) can be used as the exogenous component of trade.…”