Abstract
AbstractTrade liberalization is famously known for both creating winners and losers via processes of dislocation, sectoral reallocation, and specialization. This paper studies the conditions under which excess “losers” are generated during the process of liberalization with a focus on the role of institutions in economic transition. I contend that poor institutions, in particular property rights and democracy, can create unnecessary hardship in the transition to greater openness, generating a much higher burden on compensatory policies and making it more difficult to sustain open trade policies. Using a new dataset of trade openness, economic inequality, and institutions, and using 3SLS estimation to account for endogeneity, the analysis finds that this is indeed the case: high property rights and more democracy appear to help to mitigate trade‐related inequality. Moreover, poor institutions create a downward spiral, with greater inequality leading to lower trade openness. These results imply that basic institutions can help to minimize losses sparked by globalization, while other well‐meaning policies can actually increase disruptions.
Highlights
Trade as a percentage of GDP has increased substantially in both low- and high-income countries since 1990, levelling off somewhat after the global financial crisis but still approximately 2.5 times what it was in the early 1970s (Figure 1)
Accompanying this increase in trade (but not necessarily driven by it, see Ravallion (2018)) has been an increase in within-country inequality, shown in Figure 1, a result which might be predicted by economic theory (Burtless, 1995): in particular, it is well-known that the process of trade liberalization creates “winners” and “losers,” as the forces which are responsible for the gains of trade - increased competition, reallocation of capital and labour, shifts according to comparative advantage—are precisely those which can cause dislocation and hardship for segments of the population
These results show that, while democracy may encourage trade openness in general and inequality may be correlated with trade, prolonged inequality is detrimental in the long run for globalization
Summary
Trade as a percentage of GDP has increased substantially in both low- and high-income countries since 1990, levelling off somewhat after the global financial crisis but still approximately 2.5 times what it was in the early 1970s (Figure 1) Accompanying this increase in trade (but not necessarily driven by it, see Ravallion (2018)) has been an increase in within-country inequality, shown, a result which might be predicted by economic theory (Burtless, 1995): in particular, it is well-known that the process of trade liberalization creates “winners” and “losers,” as the forces which are responsible for the gains of trade - increased competition, reallocation of capital and labour, shifts according to comparative advantage—are precisely those which can cause dislocation and hardship for segments of the population. It is entirely possible that compensatory policies may be less effective in convincing the populace of trade's value if the number of losers reaches a substantial portion of the population or some critical mass (Morrissey, 1995) In this vein, it may be doubly difficult for compensatory policies to hold together a pro-trade coalition if the country's economic. An economy that generates too many losers from trade will find itself under constant political pressure to reverse its liberalization, and it is likely even more distortions will be introduced into the country's institutional system, leading to worse economic outcomes
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