September 6, 2016

Trade Deficits and Income Inequality - Summary Results

International trade has taken center-stage during the current presidential campaign in a manner rarely seen. From far left to far right, Americans are angry about the perceived loss of jobs to China and other low-wage countries. The most vocal opposition to trade and the TPP comes from those in lower income groups who have already lost jobs, or fear they will.

Is their concern valid?  Would expanded trade under the Trans-Pacific Partnership (TPP) actually hurt Americans? Free trade is supposed to be a rising tide that floats all boats. But what about those who have no boat – or whose boat is full of holes?

Recent research indicates that many Americans don’t have a “boat” that assures rising incomes when trade increases, especially if trade is already unbalanced. Under such conditions, the rising trade promised by agreements such as the TPP mean bigger trade deficits – deficits that directly cause greater income inequality.

These conclusions are based on micro-level analysis of the United States where the past forty years have been marked by trade deficits and rising income inequality, and on cross-country analysis of twenty-eight developed OECD countries, including the United States.

Micro-level U.S. Analysis

Those most at risk of stagnant or falling incomes because of expanding unbalanced trade are those least able to compete with workers in low-wage countries. This includes workers who (a) have less than a college education, (b) lack advanced manufacturing skills, (c) are older and cannot afford to pay for additional training, (d) work in factories producing textiles, apparel, footwear, furniture and other labor-intensive products, (e) work in regions dominated by plants producing similar at-risk products, (f) work in single-factory “company towns” where alternative jobs are scarce, (g) live in areas already suffering high employment and low wages, (h) live in isolated, traditional communities far from alternative sources of employment, and (i) those who are bound by poverty, families, illness, housing costs, or tradition to remain in their present communities. In short, those most likely to suffer a further relative loss of income from foreign imports are those already most likely to be relatively poor.

If trade were balanced, the problem would be less severe because international competition would drive America to expand production and jobs in areas where it has a greater comparative advantage. But if the dollar is overvalued, the price signals that would otherwise stimulate a move to more competitive production and better jobs are distorted. The result: more job loss and more poverty. Hence the direct causal link between trade deficits and increasing income inequality.

Global Experience

We cannot validate this conclusion by running a counterfactual model where the U.S. has had no trade deficits during the past forty years and look at the resulting income distribution. Instead we must look at the experience of comparable countries.

The graphs below plot the average current account balances (a reasonable proxy for trade balances) for twenty-eight non-FSU OECD members over the past thirty-five years against their current levels of income inequality as represented by the Gini coefficient.

Figure 1 shows in scatter-plot form the average current account balance for 1980-2015 and the current Gini coefficient for each of these OECD countries. Although the values are not clustered neatly because of wide differences in current account balances, the trend line indicates a clear correlation between greater external deficits and greater income inequality.

Figure 1


Figure 2 gets rid of the external deficit/surplus noise by calculating a least-squares average trend line of external deficits ordered by country income inequality. Here we see very clear evidence that larger external deficits tend to be associated with increasing income inequality.  The micro-level analysis above for America confirms that the line of causality runs from deficits to income inequality.

Figure 2

America Needs a Competitive Dollar - Now!

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