Because high-income consumers spend a relatively larger share of their income on services and manufactured goods, they benefit more from international trade. That is the central finding of research by Sergey Nigai, published in the June 2016 issue of the Economic Journal.
Analysing data on trade and income in the top 92 economies of the world, he finds that an increase in international trade leads to a bigger fall in the prices of manufactured goods than the prices of agricultural goods. Since high-income consumers spend more on manufactured goods, they stand to gain more from this.
International trade benefits consumers through lower prices of imported goods. The magnitude of such gains, however, is heterogeneous for different income groups because of the large differences in how consumers allocate their incomes between food, manufactures and services. This is why the gains from trade of an average consumer, which are routinely used as a measure of economic welfare for policy analysis, systematically overestimate trade-related benefits for the poor and underestimate them for the rich.
The new study quantifies heterogeneity in the welfare gains from trade in the context of a multi-country model of trade calibrated to the real data on trade and incomes for the 92 largest economies in the world.
The author finds that the prices of manufacturing goods fall relatively more in comparison with agricultural goods in response to an equivalent reduction in trade barriers. Because high-income consumers spend a relatively larger share of their income on manufactures and services, they benefit more from trade.
Under a hypothetical 15% reduction in non-tariff trade barriers, the welfare gains of the rich would be up to five percentage points higher than the gains of the average consumer, while the welfare gains of the poor would be up to 11 percentage points lower than the gains of the average consumer.
Governments may use tariff revenues for providing public goods or subsidising the poor. Elimination of tariff barriers to trade is likely to have two opposing welfare effects. On the one hand, removing tariffs reduces prices of tradable goods, which benefits consumers. On the other hand, elimination of tariff revenues hurts the poor relatively more as governmental subsidies constitute a larger share of their total income.
The study finds that global elimination of import tariffs is likely to increase consumption of the rich significantly while the poor may lose, especially in countries with low income and high inequality. In particular, the results suggest that the gains of the rich would be higher by up to 4 percentage points relative to the gains of the average consumer, whereas the gains of the poor would be up to 15 percentage points lower.
The intuition behind the main results of the study can be put into a context using a simple example of two types of goods: automobiles and apples. First, rich consumers spend a larger share of their incomes on automobiles, whereas the poor care relatively more about consumption of apples.
Second, productivity differences in producing automobiles across countries are larger than in growing apples, which means that the price differences between goods produced domestically and elsewhere are larger for automobiles than apples. Opening up to trade will entail a relatively larger drop in prices of automobiles, which, of course, will benefit the rich relatively more.
There are two important policy implications of the study relating to current debates. First, consumer benefits from free trade agreements, such as the Transatlantic Trade and Investment Partnership, will differ across different consumer groups. Taking account of such differences ex ante could help in evaluating how free trade will affect people along the income distribution.
Second, imposing import restrictions such as an embargo entails different costs to different consumer groups. For example, while prohibiting imports of luxury products will hurt the rich relatively more, an embargo on agricultural products is likely to have the most negative effects on the poorest population groups.
''On Measuring the Welfare Gains from Trade Under Consumer Heterogeneity'' by Sergey Nigai is published in the June 2016 issue of the Economic Journal. Sergey Nigai is at ETH Zurich.
