Inequality, Growth, and Trade Policy

If the world is often skeptical of what economists have to tell them about trade policy, it is at least in part because they suspect that economists live in some cloud-cuckoo-land of perfectly functioning markets and unlimited mobility. While this is broadly unfair, it is true that the standard models of trade do make these kinds of assumptions and perhaps for that reason, their predictions have, at best, an uncomfortable relation with the evidence. The most celebrated example of this disjunct is perhaps the observation, going back at least to the work of Wasssily Leontief in the 1950s, that most of trade is between rich countries with very similar factor endowments, while the Hecksher-Ohlin model, so much the work-horse of trade policy analysis, emphasizes the opportunities for trade between rich countries and poor countries, since they are the ones with the biggest differences in factor endowments.1 Perhaps the politically most sensitive prediction of Hecksher-Ohlin theory is that trade will reduce inequality in the capital scarce country and increase it in the capital abundant country. This follows from the fact that poor countries are labor abundant–trade allows them to take better advantage of their abundant factor, raising the rewards for workers. It is, however, not