Trading off the Income Gains and the Inequality Costs of Trade Policy

Abstract

This paper characterizes the trade-off between the income gains and the inequality costs of trade using survey data for 54 developing countries. Tariff data on agricultural and manufacturing goods are combined with household survey data on detailed income and expenditure patterns to estimate the first order effects of the elimination of tariffs on household welfare. We assess how these welfare effects vary across the distribution by estimating impacts on the consumption of traded goods, wage income, farm and non-farm family enterprise income, and government transfers. For each country, the income gains and the inequality costs of trade liberalization are quantified and the trade-offs between them are assessed using an Atkinson social welfare index. We find average income gains from liberalization in 44 countries and average income losses in 10 countries. Across countries in our sample, the gains from trade are 1.8 percent of real household expenditure on average. We find overwhelming evidence of a trade-off between the income gains (losses) and the inequality costs (gains), which arise because trade tends to exacerbate income inequality: 46 countries face a trade-off, while only 8 do not. These trade-offs are typically resolved in favor of lower tariffs. In the majority of developing countries, the prevailing tariff structure thus induces sizeable welfare losses. * We thank R. Adao, I. Brambilla, A.1 Using an Atkinson Social Welfare function (Atkinson, 1970), we assess the trade-off between the income gains and the inequality costs. Our joint study of the gains from trade and their distribution across households contributes to an incipient strand of literature including Antras, de Gortari and Itskhoki (2017) and Galle, Rodriguez-Clare and Yi (2017).It is useful to put our methodological approach into context. Arkolakis, Costinot and Rodriguez-Clare (2012) quantify the gains from trade by deriving a sufficient statistic to compare autarky with the status quo. Subsequent literature has developed extensions allowing for imperfect competition (Arkolakis, Costinot, Donaldson and Rodriguez-Clare, 2015), labor market frictions (Caliendo, Dvorkin and Parro, 2016), and productivity advantages (Melitz and Redding, 2015). Work on the distributional effects identifies instead winners and losers from trade. Much of this literature builds on Deaton's (1989) first order effects approach, both on expenditures and incomes. Porto (2006) studies the distribution of the household welfare effects across the income distribution, Nicita, Olarreaga and Porto (2014) explore the poverty bias of trade policy (the welfare effects of the poor relative to the welfare effects of the rich), and Atkin, Faber and Gonzalez-Navarro (2016) investigate the distribution of the household welfare effects from FDI. Another branch of the literature examines distributional effects in a Arkolakis, Costinot and Rodriguez-Clare (2012) setting. Fajgelbaum and Khandelwal (2015) introduce non-homothetic preferences and focus on expenditures only. Costinot, Donal...

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“…Source: World Bank (2016) 33_Using data from the Ministry of Finance, Wagle (2011) shows that VAT revenue coming from imports exceeded 60 percent in the 10 years before this study. In a recent contribution, Artuc, Porto and Rijkers (2017), look at income gains and inequality costs of trade reforms using survey data for 54 developing countries including Nepal. They combine tariffs on agricultural and manufacturing goods with household survey data on income and expenditure patterns, and estimate the first order effects of the elimination of tariffs on household welfare.…”

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