Global Economy
December 11, 2014

Trade and Inequality: Cause? Cure? Diversion?

By Edward Gresser

Federal Reserve Chairwoman Janet Yellen, in a speech delivered last October, makes an observation and poses a question:

“The past several decades have seen the most sustained rise in inequality since the 19th century after more than 40 years of narrowing inequality following the Great Depression. By some estimates, income and wealth inequality are near their highest levels in the past hundred years, much higher than the average during that time span, and probably higher than for much of American history before then. … I think it is appropriate to ask whether this trend is compatible with values rooted in our nation’s history, among them the high value Americans have traditionally placed on equality of opportunity.”

The phenomenon Dr. Yellen describes is well-known. For two generations, Americans have been growing apart. In response, she proposes four domestic-policy “building blocks,” meant to raise lifetime earning potential at middle- and lower-income levels: high-quality education in primary schools and high schools, improved access to college, small business formation to create wealth for lower-income families, and inheritances at middle-income levels.

Meanwhile, the Obama administration is negotiating two large new trade agreements, the Trans-Pacific Partnership and the Trans-Atlantic Trade and Investment Partnership, or “TPP” and “T-TIP” for short. The administration’s hope is to tap foreign demand and export more, helping to accelerate the return to normal growth in the aftermath of the 2008 financial crisis; to address global-economy problems such as trade in endangered species and child labor; to encourage the growth and unity of the Internet; and to strengthen political and policy ties to the long-time allies and new partners joined in these agreements.

Can these goals go together? Some fear that trade with other countries is a cause of inequality within the United States, and that trade agreements will make it worse. If so, we have a problem: how do we address a long-term challenge to equality of opportunity, and simultaneously take advantage of the growth and policy reform trade policy could bring? This essay is an examination of the question with three basic theses:

1. Trade growth is not a major cause of inequality. The leading modern study of wealth and income inequality, Thomas Piketty’s 2013 book Capital in the 21st Century (termed by Paul Krugman “the most important economics book of the year – and maybe of the decade,” and by Larry Summers a Nobel Prize-worthy” research accomplishment) suggests a basic cause of rising inequality in divergence between national growth rates and returns on investment. This phenomenon is unrelated to trade and unaffected by trade policy. As Piketty’s book observes, trade restriction will not reverse it.  Most earlier analyses, meanwhile, make trade at most a minor factor in inequality, and one whose effects are complex and multidirectional, rather than simply accelerating or slowing the growth of inequality.

2. Trade policy is not the major solution to inequality, but can provide useful support for a response rooted in domestic policy. Higher growth through exports, if Piketty’s hypothesis is correct, will help slow the growth of inequality though likely not reversing the trend. TPP and T-TIP are an important part of this.  Creative use of some existing agreements and policies, along with creatively negotiated TPP and T-TIP agreements, can help promote growth and affluence at middle- and lower-income communities by (a) offering more support to lower-income exporters and intellectual-property holders, consistent with Dr. Yellen’s domestic policy building blocks, and (b) reducing or eliminating discriminatory taxation of lower-income families through the tariff system, and (c) more generally helping to provide the American public as a whole with lower-priced goods.

3. Lowering U.S. trade barriers is more likely to ease than exacerbate inequality. Because U.S. tariffs are concentrated in taxation of cheap clothes, shoes, and other home goods rarely made in the United States, they are mostly ineffective as import limits and regressive as taxation. The main effect of reducing these tariffs through trade agreements would be to raise living standards for lower-income households and thus ease inequality. Future import growth does remains likely to create new competition and stresses, but mostly through the improvement of infrastructure, logistics, and Internet access, and through rising competitiveness in foreign countries. It needs to be met through a stronger national safety net, including a well-funded Trade Adjustment Assistance program, broader lifelong learning and adjustment programs for all dislocated workers, and national competitiveness programs in infrastructure, science, and other areas.

The full paper is available in PDF format at:  Inequality & Trade

And in 2-page summary version at:  Inequality & Trade Executive Summary