Trade With China Is Great For Low-Income Americans

Trade With China Is Great For Low-Income Americans by David R. Henderson, Foundation For Economic Education

Trade With China – Cheaper Goods Help People with Less to Spend

In a recent post, I challenged Mark Kleiman’s view that low-income people do not benefit at all from international trade. He wrote:

But the bottom line is that all of the gains, not merely from trade but from economic growth, have been concentrated in the hands of a relative few.

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That struck me as highly unlikely, and I gave my reasoning about why.

Commenter Aaron McNay pointed out evidence that I understated the gains to low-income Americans from trade. The evidence is in Christian Broda and John Romalis, “The Welfare Implications of Rising Price Dispersion,” July 4, 2009.

Broda and Romalis show that the prices of the items in the market basket that low-income families buy have increased less than items in the basket that high-income families buy. They write:

Using scanner data on household consumption of non-durable goods between 1994 and 2005, we document that the relative prices of low-quality products that are consumed disproportionately by low-income households were falling over this period.

This implies that non-durable inflation for the 10th percentile of the income distribution has only been 4.3 percent between 1994 and 2005 (0.4 percent per annum), while the non-durable inflation for the 90th percentile has been 11.9 percent (1.0 percent annually), and 13.4 percent (1.2 percent annually) for the richest 5 percent of households in the sample.

Over the period 1994 – 2005, the conventionally measured ratio between real household income at the 90th and 10th percentile rose by 5.7 percent (0.5 percent per annum) and the 95th/10th ratio rose by 7.5 percent (0.7 percent per annum). This suggests that the inflation differential in non-durable goods (around 30 percent of total consumption) is enough to offset almost 40 percent of the rise in both of these inequality ratios over this period.

In the case of other common inequality measures, the 80/20th and 95/20th income ratios, the non-durable inflation differential is enough to offset over 80 percent and 50 percent, respectively, of the rise in these indicators. Moreover, we provide evidence that suggests that the increase in price dispersion is not limited to the products in our sample nor to our time period.

If differences in income-group specific inflation rates in our sample are representative of the broader economy, then real income growth in the US has been much more substantial and equal than suggested by standard measures. In that case, “real” inequality may have actually fallen between 1994 and 2005. (italics in original)

First, independent of trade, this is interesting in its own right. It shows that the increase in income inequality in the United States has been dramatically overstated and, in fact, that income inequality might have fallen between 1994 and 2005.

Second, one reason prices rose less for low-income people is that they were buying goods from China. Broda and Romalis write:

We have found a strong negative correlation between the changes in prices by product module and the change in Chinese trade in that same module over this time period. This strongly suggests that trade with China may have partly driven the increase in inflation differentials by income-group.

This post first appeared at Econlog.

China’s GDP growth forecasts