Who Rides the Storm? Political Institutions and Trade Adjustment

Both policymakers and scholars have expressed concern that trade has increased inequality in advanced industrialized countries (AICs). We argue that the impact of trade on inequality depends on the availability of public goods, such as educational opportunities, that allow displaced workers to upgrade their skills and adjust to trade. The provision of public goods, in turn, depends on political institutions: institutions that unify budgetary powers promote public-good spending while institutions that separate budgetary powers discourage it. Trade should thus increase inequality more (reduce inequality less) in countries with a high separation of budgetary powers. We test and find support for these hypotheses with a cross-sectional time-series analysis of fourteen AICs. Our results imply that trade can improve aggregate welfare without worsening economic inequities, but only if governments adopt complementary policies that facilitate human capital formation and labor-market adjustment.