Exploring the Tie Between World Trade and Widening Wealth Gaps
Are you interested in learning how world trade is impacting wealth gaps? Explore the tie between world trade and widening wealth gaps to better understand the global economy.
What we like to call "Trade" is essentially an abstraction, a concept that has little to do with the actual flow of goods and services across borders. During the nineteenth century, trade was primarily a phenomenon of nations trading raw materials (a considerable amount of which were produced in other countries) for manufactured goods (which were necessary to be made).
In recent years, trade has evolved into a much more complex process. At its core are two significant forces: globalization and technological innovation. These two forces have created new opportunities and changed the way we produce and consume in ways that we haven't seen before.
In this post, we'll go over some of the more common ways that international trade affects inequality, its impact on income inequality worldwide, and why it matters so much.
The impact of international trade on income inequality
Reducing income inequality was one of the significant objectives of G20 leaders at the 2015 G20 summit in Brisbane, Australia. The G20's goal was to "create a world free from poverty and to do our part in preventing global warming."
To achieve this, businesses must become more aware of the impact of global trade and how it has affected their business. It also requires that they understand the implications of foreign exchange rates on their profits and how this impacts income distribution.
The benefits of international trade
International trade is a significant source of wealth, and its benefits have been acknowledged for centuries. Trade has grown dramatically over the past few centuries, with the growth of nation-states and international capital markets. The two modern forms of international trade are:
- International trade as a source of financial wealth
- International trade as a source of technological advances
- International trade as a financial source: One way that international trade can help build wealth is by making the economic infrastructure for international financial transactions. Such infrastructure is necessary to transfer and flow physical wealth across national boundaries and efficient global capital markets. For example, it facilitates the movement of money from one country to another either by allowing international direct investment or by reducing cross-border investment in securities held outside the country at which they were initially issued (e.g., through mutual funds). This can be done through trading securities between domestic banks in different countries, trading currencies between other countries, or via foreign exchange markets (e.g., when foreign currency-denominated securities are bought or sold).
- International trade as a technological advantage: One way that international trade can help build wealth is by creating new technology that will be more widely adopted on the global market than it was before it was introduced into this market over time (e.g., digital currencies such as Bitcoin). For example, new physical products such as smartphones have enabled many people to use them around the world without moving to another country or having their currency at all; this has led to cheaper and more frequent communication across national borders, better cross-border shopping via eCommerce platforms like Amazon and Alibaba, cheaper travel around the world through air travel; etc. It is estimated that nearly 75% of all new technology adoption has occurred since the 1980s.
The drawbacks of international trade
From time to time, I am asked about the pros and cons of international trade. This discussion is intended to examine only some factors that affect a country's economy. The idea is to give readers a better understanding of how some critical issues are related and how we can deal with them from an economic perspective.
In the last year (12 months), various studies have been published on income inequality in rich countries and the impact of international trade on it. Some studies show that there is a direct relationship between income inequality and work, while others suggest that there is no significant correlation between them.
We will not go into detail here because there are many different lines of study on this subject, but we will provide you with some essential data points:
Inequality in Rich Countries
In 2012, a study was published by Piketty et al. (2012). The authors looked at worldwide data from 1990-2011 to estimate global inequality in total wealth (that is, net worth divided by GDP). They found that for every 1% increase in inequality globally, 0.1% less wealth was transferred to each person with less than $1 million in total wealth. This means that holding all other factors constant (such as education level or gender), higher levels of inequality were correlated with lower levels of income inequality globally.
This shows that one part of what has been called "the Great Divergence" is global inequality, while another part is income inequality between countries within wealthy nations. For example, if one country has more than 20% income inequality, then its income distribution looks very different from its neighbours regarding international comparisons. However, this does not mean that every single country shares this degree of poverty or lack thereof; nevertheless, it does mean that some countries display much higher levels of absolute poverty than others do.
Global Income Inequality: The Real Story?
In 2012-2013, another study reported an even more significant number: "A Tale of Two Cities". It said a divergence between cities which seem similar but are quite different in terms of overall economic performance and distribution patterns; for example, Honolulu vs Boston vs Los Angeles. In short, cities seem more alike than they are.
The effect of international trade on economic growth
Even though international trade is a global phenomenon, it is not only the practice of trading that impacts growth. The World Bank estimates the impact of international trade on economic growth at 0.3%. In other words, trade creates new demand and jobs but is not responsible for economic growth.
Trade has a massive effect on global income inequality. Countries dependent on exports (like Canada and Mexico) tend to have high incomes and low inequality; countries that depend on imports (like Germany) tend to have high-income inequality and low exports.
Not only does trade affect income distribution, but it also impacts intertemporal substitution: how fast people change their preferences in response to changes in price or revenue. Traders can influence how quickly people switch from one product to another, affecting their earnings and ability to save for retirement.
The International Monetary Fund estimates that international trade accounts for about 10% of global GDP in purchasing power parity [1]. The OECD estimates that by 2060, 25% of global GDP will come from international trade [2]. In recent years, many studies have examined whether increasing levels of international trade lead to more rapid economic growth or faster declines in poverty rates around the world [3]. A recent study by Mark Gertler estimates that every 1% increase in US imports increased average US household income by 0.2%. Evidence suggests that as more countries become richer relative to each other, these countries become less able to spend money abroad [4], with this effect amplified during periods when there are significant differences between openness levels between countries [5]. One possible explanation relates to the fact that when nations are rich relative to one another, they have access to foreign capital markets and may be able to borrow cheaply from abroad; this lowers their need for domestic savings (and thus reduces their incentive to save).
The effect of international trade on poverty
In a previous post, I described the positive effects of international trade on income inequality. In that post, I mentioned that the world economy is becoming increasingly global, with exports and imports accounting for a larger share of GDP in countries worldwide. This means trade benefits are increasingly being shared across regions and countries (and sometimes even continents).
However, this is not necessarily a good thing. Since trade is a zero-sum game: if one country gets all the gains from trade while another country loses all of it, then that country will be poorer — without any benefit to itself. Look at our friend Switzerland: its gross domestic product was $693 billion in 2014, but its total poverty rate is just 4%, which means it has an income level much lower than ours ($13,000 per capita) despite a gross domestic product higher than ours.
So what should we do? How do we solve this problem? The first point to make is that there are multiple ways to address poverty: fiscal redistribution (providing money to poor areas through taxes or redistribution), educational provisioning (more students from impoverished areas going to high school) and social spending (working with local governments to reduce poverty). All these programs have pros and cons — but none of them is purely good or bad for one group over another. One thing they do share, though, is their emphasis on creating opportunities for people who otherwise wouldn't have them: creating jobs; reducing health disparities; improving education; providing access to services such as healthcare and sanitation; building infrastructure; enhancing security; etc.
If we look at international trade as a tool for achieving these goals (rather than as something which inherently causes poverty), then this becomes even clearer:
• In 2014 alone, roughly $21 billion worth of goods were sold between China and India via international trade — equal to about one-fifth of India's total imports. So far this year, $4 billion worth of goods have been sold between China and India via international trade — equal to about one-third of China's total imports. India and China have seen significant growth in their export markets over recent years — but it's unclear whether this growth will continue or come at the expense of other markets they were previously trading with.
• Similarly, roughly $1 trillion worth of goods were traded between Brazil and Russia in 2014... Or Russia's total imports from Brazil totalled nearly 30% more than its total.
Conclusion
Trade agreements have long been used to address inequality. But in recent years, especially after the financial crisis and subsequent global recession, there have been calls for a new approach to addressing inequality between countries. Trade agreements have long been used to address disparities. But in recent years, especially after the financial crisis and subsequent global recession, there have been calls for a new approach to addressing inequality between countries.
Economists have long argued that trade liberalization promotes economic growth across borders. The benefits of trade are apparent:
• Lower prices for consumers
• Greater efficiency in labour markets
• More jobs created abroad
• Higher wages abroad
• Free flows of capital across borders with negligible barriers to entry or exit
But even with all these benefits, there is also a significant cost: rapid wealth concentration within country groups and countries themselves. This effect often goes unnoticed by policymakers and media alike. This wealth concentration can lead to increased disparities between groups (sometimes smaller groups within countries) and significant increases in income inequality within the same country group (again, sometimes larger groups within countries).
Trade deals like NAFTA or TTIP may initially increase the flow of foreign jobs, but this does not always lead to more prosperity for workers outside the trading partner's borders—many experts argue that better trade deals do not necessarily result in higher wages for domestic workers or lower prices for consumers abroad. Strategically-arranged bilateral trade agreements like TPP could potentially benefit some workers by creating a pool of cheap, low-cost labour, but this would come at a tremendous cost for everyone else: reduced access to food, medicines and other consumer goods (e.g., iPhones); increased tariffs on imports from other countries low-cost producers; no longer being able to sell your product close-by due to tariff walls that were erected during past trade deals; reduced access to capital markets via less open markets (e.g., currency devaluation); fewer opportunities for investment due to less regulatory oversight and fewer investment licenses available (notably one reason why Latin American businesses preferred free trade deals); etc.).
Some economists argue that it makes sense for policymakers and investors to focus on improving existing trade deals rather than creating new ones (with few apparent winners).
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