The U.S. presidential campaign has sometimes sounded like a contest to prove who despises trade the most, as Willem Buiter and Anne Sibert point out in their recent Vox column. Media reports of job losses to China and the destructive effect of Wal-Mart on local business are ubiquitous. In recent weeks, Lawrence Summers and Martin Wolf have highlighted the dangers of having high-income countries turn against globalisation. This public debate has taken for granted that inequality in these countries has risen as a result of globalisation.
But has it really? In a recent paper, co-authored with John Romalis from the University of Chicago, I argue that it hasn’t.1 The reason is simple. How rich you are depends on two things: how much money you have and how much the goods you buy cost. If your income doubles but the prices of the goods you consume also double, then you are no better off. Unfortunately, the conventional wisdom on US inequality is based on official measures that only look at the first half, the income differential. National statistics ignore the fact that inflation affects people in different income groups unevenly because the rich and poor consume different baskets of goods.
Inflation differentials between the rich and poor dramatically change our view of the evolution of inequality in America. Inflation of the richest 10 percent of American households has been 6 percentage points higher than that of the poorest 10 percent over the period 1994 – 2005. This means that real inequality in America, if you measure it correctly, has been roughly unchanged. And the reason is just as dramatic as the result. Why has inflation for the poor been lower than that for the rich? In large part it is because of China and Wal-Mart!
Poor families in America spend a larger share of their income on goods whose prices are directly affected by trade – like clothing and food – relative to wealthier families. By contrast, the higher your income, the more you spend on services, which are less subject to competition from abroad. Since 1994 the price of goods in the U.S. has risen much less than the price of services – and, yes, this includes the recent surge in food prices. Paradoxically, focusing only in the last few quarters of high relative food prices misses the fact that the main trend we have observed for decades is exactly the opposite (Figure 1).
This trend can partly be explained by China. In U.S. stores, prices of consumer goods have fallen the most in sectors where Chinese presence has increased the most. Take canned seafood or cotton shirts, for instance. Exports of China to the rest of the world in these categories have increased dramatically over this decade. Inflation in these sectors has been negative over the last decade, while in other sectors with no Chinese presence inflation has been over 20 percent. Moreover, as China produces goods of relatively low quality, sectors with strong Chinese presence are disproportionately consumed by the poor.
The expansion of superstores – like Wal-Mart and Target – has also played an important role in accounting for the inflation differentials between rich and poor. Superstores sell the same products as traditional shops at much lower prices. Today the poor do roughly twice as much of their buying of non-durable goods in these stores than the rich. So poor consumers have been the biggest beneficiaries of Wal-Mart coming to town.
What is really worrying is that, despite these facts, we have had a backlash against China and Wal-Mart in America. Trade sceptics who suggest that there is no point in buying cheaper goods if you have lost your job should check America’s unemployment rate again. It’s around 5 percent, close to its record low.
We need to remind politicians and the public that the gains from trade are broadly shared. Every time the discussion over trade is diverted towards the problems facing specific producers, be they farmers in France or textile workers in the U.S., we miss the central point. Trading allows everyone, and especially the poor, to buy things that they could not otherwise afford. Without better public understanding of these facts, governments will not only keep supporting policies aimed against China and Wal-Mart but may receive the uninformed support of many consumers who are benefitting from trade.
Editors’ note: An abbreviated version of this column appeared in the Financial Times on 3 June 2008.
1 Christian Broda and John Romalis (2008). “Inequality and Prices: Does China benefit the Poor in America?” University of Chicago mimeograph.