Trading off the Income Gains and the Inequality Costs of Trade Policy

This paper characterizes the trade-off between the income gains and the inequality costs of trade using survey data for 54 developing countries. Tariff data on agricultural and manufacturing goods are combined with household survey data on detailed income and expenditure patterns to estimate the first-order effects of the elimination of import tariffs on household welfare. The paper assesses how these welfare effects vary across the distribution by estimating impacts on the consumption of traded goods, wage income, farm and non-farm family enterprise income, and government transfers. For each country, the income gains and the inequality costs of trade liberalization are quantified and the trade-offs between them are assessed using an Atkinson social welfare index. The analysis finds average income gains from import tariff liberalization in 45 countries and average income losses in nine countries. Across countries in the sample, the gains from trade are 1.9 percent of real household expenditure on average. We find overwhelming evidence of a trade-off between the income gains (losses) and the inequality costs (gains), which arise because trade tends to exacerbate income inequality: 45 countries face a trade-off, while only nine do not. The income gains typically more than offset the increase in inequality. In the majority of developing countries, the prevailing tariff structure thus induces sizable welfare losses.