Inequality and Trade Policy: The Pro‐Poor Bias of Contemporary Trade Restrictions

• Published date: 01 November 2019
• Author: Beyza Ural Marchand
• Date: 01 November 2019
• DOI: http://doi.org/10.1111/roiw.12433

© 2019 Internation al Association for Re search in Inco me and Wealth

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INEQUALITY AND TRADE POLICY: THE PRO-POOR BIAS OF

CONTEMPORARY TRADE RESTRICTIONS

by beyza Ural MarchaND*

Departme nt of Economics,Un iversity of Alberta

This paper studies the pro-poor bias of trade policy in India by estimating the household welfare effects

of removing the current protection structure. The elimination of a pro-poor trade policy is expected to

have a negative differential welfare effect at the low end of the distribution. The paper first constructs

trade restrictiveness indexes for household consumption items and industries using both tariffs and

non-tariff barriers. The results indicate that Indian trade policy is regressive through the expenditure

channel as it disproportionately raises the cost of consumption for poorer households, while it is pro-

gressive through the earnings channel. Based on the net welfare effects, the elimination of the current

trade protection structure is estimated to reduce inequality. These results indicate that a trade policy

that is progressive through the earnings channel may induce a price effect that is regressive through the

expenditure channel.

JEL Codes: D31, F14, I30, O12

Keywords: consumption inequality, poverty, trade protection

1. INtroDUctIoN

This paper empirically evaluates the pro-poor bias of the current trade protec-

tion structure in a developing country, India. There is a large literature on the

impact of international trade on inequality in developing countries.1 However, lit-

tle is known about the pro-poor bias of contemporary trade policies. This paper

aims to determine the distributional properties of the existing trade protection

structure by estimating the impact of eliminating all tariff and non-tariff barriers

and moving to a free trade regime.

Within the past three decades, world trade has expanded rapidly from 36 per-

cent of global GDP in 1986 to 56 percent in 2016 (World Bank, 2016). The integra-

tion of developing countries has played an important part, as they now account for

1For extensive reviews of the literature, see Goldberg and Pavcnik (2007, 2016), and Winters etal.

(2004).

Note: I would like to thank the participants at the IARIW–ICRIER Conference in Delhi, India in

November 2017; the Empirical Investigations in Trade and Investment (EITI) Conference in Tokyo,

Japan in February 2018; the Institutions, Trade, and Economic Development (InsTED) Workshop at

Syracuse University in May 2018; the Department of Economics seminar at Ryerson University in May

2018; and the Western Economic Association International (WEAI) Conference in June 2018. The

project is funded by the Shastri Indo-Canadian Institute with the assistance of the Government of

Canada. The usual disclaimer applies.

*Correspondence to: Beyza Ural Marchand, Department of Economics, University of Alberta,

7–12 Tory Building, Edmonton, AB, T6G 2H4, Canada (beyza.ural@ualberta.ca).

Review of Inc ome and Wealth

Series 65, Numb er S1, November 2019

DOI : 10.1111 /roi w.124 33

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Review of Income and Wealth, Series 65, Number S1, November 2019

S124

© 2019 Internation al Association for Re search in Inco me and Wealth

43 percent of world exports (World Trade Organization, 2016). This rapid expan-

sion in world trade has been accompanied by negative changes in the attitudes

toward trade, especially in developed countries, and this pushback against free

trade appears to result from inequality concerns (Pavcnik, 2017; Frankel, 2018). It

is, therefore, important to understand whether the current trade policy is exacer-

bating or mitigating the inequality levels within countries. This paper answers the

following question: what would the distributional impact be if the country were to

move from the current trade policy to free trade? If the existing trade policy is pro-

poor, a complete trade liberalization should lead to higher welfare losses for poor

individuals, or in the case of gains, they should experience smaller gains, and as a

result, inequality should increase (Nicita etal., 2014).

Most of the literature on trade and inequality studies the sharp changes in trade

policies such as trade liberalization or free trade agreements. However, trade poli-

cies have evolved since countries went through major trade liberalization episodes,

especially developing countries such as China and India. The textbook predictions

based on the Heckscher–Ohlin model suggest that developing countries should

experience a reduction in poverty and inequality as a result of trade liberalization.

This is based on the prediction that an unskilled-labor-abundant country would

protect its skilled-labor-intensive sectors. In that case, removal of this protection

would lower relative returns to skilled labor, thus lowering inequality. However, in

some developing countries, including Mexico, Morocco, and Colombia, the initial

structure of protection was not consistent with this premise, as their trade liberal-

ization actually involved bigger tariff declines in unskilled-labor-intensive indus-

tries, leading to an increase in inequality (Goldberg and Pavcnik, 2007). Given their

initial protection structure, the increase in inequality observed in these countries

was consistent with the Stolper–Samuelson theorem. This implies that predictions

about trade and inequality that ignore the initial protection structure potentially

miss a crucial element that is driven by political economy mechanisms within that

country, or other dynamics not included in the model.

Following the literature on household welfare impacts of trade, the paper

examines the impact on households through their earnings and expenditures in a

unified framework in order to evaluate the contribution of these channels in the

overall pro-poor bias of trade policy (Deaton, 1997; Porto, 2006; Nicita, 2009;

Ural Marchand, 2012; Nicita etal., 2014). Changes in trade policy affect domes-

tic prices, which in turn influence production and consumption outcomes at the

household level. While the effect on wages is extensively studied, the effect on

household consumption is often overlooked (Goldberg and Hellerstein, 2013; Han

etal., 2016). This is a crucial component for household welfare, as the reduction in

consumer prices may overcompensate reduction in incomes so that the net welfare

effect may imply a larger consumption set for the household. The distributional

impact through these two channels may also be different, where a trade protection

structure may be pro-poor through its effect on household income and pro-rich

through its effect on household consumption. For instance, a trade policy that is

designed to protect unskilled labor may raise the prices of unskilled-labor-intensive

goods that have a higher budget share among poorer households. The net effect is

therefore determined by the relative magnitudes of these two channels across the

distribution.