Like every Friday, from Raj Nallari and Breda Griffith's teaching notes.
Open trade is good for overall economic growth and by extension poverty reduction, but what effect does it have on inequality? Trade liberalization tends to reduce monopoly rents and the value of personal connections with bureaucrats and politicians, thereby reining in the rich. In developing countries, it may be expected to increase the relative wage of low-skilled workers, who are likely to be scarcer in the world economy than at home. Multilateral liberalization of agricultural trade may increase rural incomes but expose urban dwellers to higher food prices. And, in many countries, trade openness may have adjustment costs with which the poor are ill-equipped to cope. At first glance, therefore, the relationship between trade and inequality is unclear.
Trade reform in developing countries took off from the late 1970s. Until then, developing countries had pursued inward-looking policies by promoting import-substituting industrialization strategies. The aim was to encourage domestic production and restrict foreign investment by multinational firms in order to support the growth of domestic firms. But not only do inward-looking policies create many distortions, as discussed above, they also tend to benefit relatively rich and powerful groups at the expense of the poor (Dollar 2004).
Since the late 1970s, developing countries have become more integrated with the world economy through foreign trade, foreign investment, and immigration. Integration has been driven by technological advances in transport and communication and by deliberate policy changes. China’s ratio of trade to national income has more than doubled since it opened to the world in the early 1980s, and countries such as Bangladesh, India, Mexico, and Thailand have seen large increases as well.