A big part of the discussion of the effect of international trade on individuals’ well-being focuses on the production and employment aspects of international trade. To what extent is domestic production replaced by imported products? What are the effects on employment and wages? The latest research has shown that manufacturing employment was differentially reduced in the US and Canada as a result of increased imports from China. The affected workers tend to be less experienced and younger, and thus poorer, which is interpreted as a regressive effect of imports. In developing countries, opponents of free trade argue that the productivity differential with advanced nations is too great, so the increase in imports may lead to job loss in their economy.
While the labor market impact is important, it is only one part of the story, and, potentially, a smaller part. Another important effect of trade on individuals is through reduced prices. By definition, most imported products have lower prices in the rest of the world than domestically. If markets are able to transmit the price reductions to consumers, imports will reduce consumer prices. Individuals who are directly or indirectly affected by trade will benefit from the lower prices.
The extent to which the reduction in prices at the border is reflected in consumer prices may be limited for various reasons. Domestic producers may be imperfectly competitive, and they may be organized in a way that limits the responsiveness of their product prices to international competition. Import penetration may be low, so the amount of imports may be insufficient to induce a sizable effect. Consumers may prefer domestically produced varieties. Retailers may also be imperfectly competitive, limiting the price transmission to consumers. Finally, large parts of the country may be isolated from imported products due to weak infrastructure or other reasons. While these channels may limit the price effect on consumers, research shows that the effect of trade liberalization on domestic consumer prices is still significant and that consumers experience gains in well-being from these price reductions.
The benefits from lower prices tend to be larger for poorer individuals, as internationally traded products, such as food and manufacturing items, are more important in poorer individuals’ budgets. In India, for instance, the poorest percentile of households allocates almost its entire budget to food. Only after their nutritional needs are met, can they allocate some of their budget to items of secondary importance, such as shelter, education, and health services, which are, for the most part, not internationally tradable. For this reason, reduced prices of tradable items implies larger welfare gains for poorer individuals.
This approach would also allow us to understand the pro-poor bias of current trade policies. In most developing countries studied, research shows that existing trade policy tends to be pro-rich through its labor market impacts, as the import-competing sectors tend to be more intensive in skilled labor. On the other hand, overall, trade policy in these countries is pro-poor, due to the progressive impacts through agricultural sales and reduced cost of food products.
These findings show that policymakers need to take the consumption impacts of international trade into account when evaluating trade policy, as a disproportionate focus on wages and employment may present a picture that is not representative of the total costs and benefits of international trade. Trade liberalization tends to lower consumer prices, and in most cases studied, these price reductions have been more important for poorer individuals.
© Beyza Ural Marchand
Beyza Ural Marchand's full article "How does international trade affect household welfare?" is available here.
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