March 16, 2016 Print

Photo credit: Clean Wal-Mart (License: CC BY 2.0)

Protectionists, opponents of globalization, and other people who argue against free trade often claim that trade makes the rich even richer at the expense of lower classes. The opposite is actually true, explains John C. Goodman, president of the Goodman Institute for Public Policy Research and senior fellow with Atlas Network partner the Independent Institute, in a recent commentary for Research shows that the poor gain the most from trade, and that the more free trade there is, the more the inequality gap narrows.

“Of course, trade creates winners and losers,” Goodman writes. “The most common opinion expressed on TV talk shows and in the current presidential campaign is that the winners are on Wall Street and the losers are ordinary people. However, the latest research suggests the opposite is true. The biggest winners from free trade are in the bottom half of the income distribution. What’s more, these gains are so large that if real income were measured properly, inequality in the US has been falling not rising — precisely because of increased trade.”

One of the predominant reasons this is true is that increased free trade leads to lower prices for consumer goods, especially inexpensive imported goods, allowing the money they save to expand other sectors of the economy.

“Millions of American’s are paying less for goods at Walmart than they otherwise would have paid,” Goodman writes. “That means their incomes stretch farther. That means their standard of living is higher. Thanks to Bernie Sanders and Donald Trump, a lot of attention has been given to the job losses. Almost no attention has been given to the job gains or to the increase in our standard of living.”

Goodman cites research from Christian Broda and John Romalis, economists with the University of Chicago and the National Bureau of Economic Research (NBER), which finds that the consumer goods most often purchased by lower-income households have consistently low prices over time in large part thanks to import markets that exist because of expanding free trade. In effect, the rate of de facto inflation for lower-income households is far lower because of this phenomenon than inflation for richer households. These results have not been captured in prior studies because earlier research did not differentiate between product details for different income levels at such a fine level of detail, the economists explain.

“However, using household data on non-durable consumption, we document that the relative prices of low-quality products that are consumed disproportionately by low-income consumers have been falling over this period,” the study continues. “This fact implies that measured against the prices of products that poorer consumers actually buy, their ‘real’ incomes have been rising steadily.”

Goodman points to another more recent study from economists Pablo Fajgelbaum with UCLA and NBER, and Amit Khandelwal with Columbia and NBER, focusing on the differing gains from trade seen by those at different income levels.

“We find a pro-poor bias of trade in every country,” the study explains. “On average, the real income loss from closing off trade is 63 percent at the 10th percentile of the income distribution and 28 percent for the 90th percentile. This bias in the gains from trade toward poor consumers hinges on the fact that these consumers spend relatively more on sectors that are more traded, while high-income individuals consume relatively more services, which are among the least traded sectors. Additionally, low-income consumers happen to concentrate spending on sectors with a lower elasticity of substitution across source countries. Larger expenditures in more tradeable sectors and a lower rate of substitution between imports and domestic goods lead to larger gains from trade for the poor than the rich.”

Dynamic market activity can seem scary to many people because the value of specific jobs, skills, goods, and services isn’t reliably stable or secure over time. Economic sectors and opportunities shift over time, and not everybody adapts quickly or easily. The overall effect, though, is to raise living standards for nearly everybody — especially for those who are most needy.

“There will always be winners and losers from trade,” Goodman concludes. “But on the whole, trade appears to make incomes more equal, not less so.”