Trade, Inequality, and Poverty: What Do We Know?

The relationship between globalization and inequality or poverty has received considerable attention in recent years. The number of literature reviews alone is now so large that a review of literature reviews would seem appropriate. There are some common themes that emerge from this literature:

• Globalization is a catchall term that is used to describe phenomena as diverse as trade liberalization, outsourcing, increased immigration flows, removal of capital controls, cultural globalization, and generally faster transmission of international shocks and trends.
• Operational definitions of both inequality and poverty are associated with substantial conceptual and measurement problems.
• The evidence on the relationship between globalization and income inequality or poverty is mixed, and related empirical findings are subject to varying interpretations.

Given this state of affairs, we want to clarify how the focus of this study differs from previous surveys. Our primary goal is to cover those aspects of the relationship between globalization and income inequality and poverty that we have more hope of pinning down empirically. Accordingly, we concentrate on recent trade liberalization episodes in developing countries (especially Latin America) that consisted primarily of drastic reductions in tariff barriers. As we argue below, such tariff reductions provide fairly accurate measures of the magnitude of trade liberalization in these countries. Moreover, for the countries under consideration, tariff reductions constitute a big part of the globalization process. Second, we focus mostly on the short- and medium-term effects of these episodes, which are easier to relate to trade policy changes than long-term, general equilibrium effects that spread over several years. From a policy perspective, concern about the negative short-term effects of trade liberalization often impedes broad acceptance of free trade by the public and policymakers. Third, for identification reasons, we focus on the static link between trade policy and income distribution that operates through short- to medium-term changes in relative prices and wages rather than on the dynamic, indirect link from trade to growth, income inequality, and poverty. This focus does not by any means reflect a belief that growth is not an important channel through which increased openness affects the income distribution. However, the literature on the relationship between trade and growth is already vast and has failed to reach a consensus on the effect of trade on growth.¹ Finally, as a matter of methodology, our survey focuses primarily on case studies of particular countries that have analyzed microlevel data from household or plant-level surveys.

Definitions, Measurement Problems, and Some Common Ground

It is of value to start this discussion with an overview of the relevant definitions and conceptual issues associated with the measurement of trade liberalization, inequality, and poverty. We also review some of the commonly accepted facts regarding trends in inequality in developing countries.

Trade Liberalization

Even if one confines the analysis to trade liberalization, which is just one aspect of globalization, its measurement is not without problems. Trade protection has increasingly taken the form of nontariff barriers (NTBs) that are inherently hard to measure. Use of NTBs is particularly pronounced in developed countries, presenting a serious obstacle to any effort to measure the alleged increase in openness in the last three decades. The traditional approach to circumventing this challenge is to use imports, exports, or the sum of the two as proxies of a country's openness, and interpret their increase over time as the consequence of the fall of trade or transportation barriers. The obvious shortcoming of this method is that both imports and exports are determined simultaneously with the other variables that are the focus of the empirical analysis (for example, wages and prices) so that interpretation of the results is subject to potentially serious simultaneity bias.

Against this background, trade liberalizations in many developing countries in the late 1980s and early 1990s represent a major advantage from a measurement perspective. Because many...