WHEREOF ONE CANNOT SPEAK, THEREOF ONE MUST BE SILENT14
This particular debate has no real resolution. There is only one India with its one history. How would anyone know whether pre-1991 growth would have continued had there been no crisis and the trade barriers not been brought down in 1991? To complicate matters, trade was being liberalized gradually starting in the 1980s; 1991 just sped that up (a lot).
Was the big bang necessary? We will never know unless we are allowed to rewind history and let it go down the other path.Unsurprisingly, however, economists find it very hard to let go of this sort of question. The issue is less about India per se. There is no way around the fact that there was a large shift in Indian growth, at some point in the 1980s or 1990s, associated with the move from socialism (of sorts) to capitalism. The growth rate before the mid-1980s was around 4 percent. Now it is closer to 8 percent.15 Such changes are rare and what is especially rare is that the change seems to have been sustained.
At the same time, inequality increased dramatically.16 Something very similar, if perhaps even more dramatic, happened in China in 1979, in Korea in the early 1960s, and in Vietnam in the 1990s. It is clear that the kind of extreme state control these economies operated under before liberalization was very effective at keeping inequality down, but at a high cost in terms of growth.
Where there is much more disagreement, and therefore more scope for learning, is about the best way to run an economy once a nation gives up extreme government control. How important is it to get rid of the remaining tariff protections India holds on to, which are significant barriers to trade, but nothing like what there was before? Will that further speed up growth? What will happen to inequality? Will the Trump tariffs derail growth entirely in the United States? And will they actually help the people he is purportedly trying to protect?
To answer such questions economists often compare countries.
The basic idea is simple: some countries (like India) liberalized trade in 1991 but others more or less like them did not. Which groups grew faster in the years immediately after 1991, in absolute terms or perhaps relative to their pre-1991 growth rates? Those who liberalized, those who had always been open, or those who stayed closed all along?There is a voluminous literature on this question, perhaps not surprisingly given the importance of free trade among economists and its popularity in the business press. The answers run the gamut from very positive assessments of the effect of trade on GDP to much more skeptical positions, though it must be said that there is little or no evidence for strongly negative effects.
The skepticism comes from three distinct sources. First, reverse causality. The fact that India liberalized trade, whereas another similar country did not, might reflect that India was ready for the transition, and would have grown faster than its comparator even without the change in trade policy. In other words, was it growth (or the potential for growth) that caused trade liberalization, and not the other way around?
Second, omitted causal factors. Liberalization in India was part of a much bigger set of changes. Among them was the fact that the government essentially stopped trying to tell business owners what they should produce and where. There was also a more nebulous but perhaps equally important shift in the attitude of the bureaucracy and the political system toward the business sector: the idea that business was a legitimate pursuit of honest people, something that could even be “cool.” It is essentially impossible to separate the effects of all these changes from that of trade liberalization.
Third, it is hard to know what in the data constitutes trade liberalization. When the tariffs are 350 percent, there are no imports, so cutting them quite a bit might change very little. How do we distinguish relevant policy changes from irrelevant posturing? Moreover, such sky-high taxes invited defiance; people found creative ways to get around them.
In response, the governments would often set up arcane rules to trap violators. A lot of these things changed when the country liberalized, but different bits changed at different speeds in different countries. How do we decide which country liberalized more, given that different countries chose different reforms?All these are issues that make cross-country comparisons particularly fraught. The reason why different researchers get different answers about the effect of trade policy on growth has a lot to do with the different choices they make on each of these issues—how to measure changes in trade policy and which of the many possible sources of confusion about causality one is willing to tolerate.
For this reason, it is very hard to have a lot of faith in the results. There are always going to be a million ways to do cross-country comparisons, depending on exactly which brave assumption one is willing to swallow.
The same constraints get in the way of being able to test the other prediction of the Stolper-Samuelson theory. Does inequality fall in poorer countries when they open up to trade? There are relatively few cross-country studies on this subject, reflecting a pattern we will see again and again. Trade economists have tended to stay away from thinking about how the pie is shared, despite (or perhaps because?) Samuelson’s early warning that, in rich countries at least, trade could come at the expense of the workers.
There are exceptions, but not ones that inspire confidence. A recent research report by two members of the IMF’s staff finds that countries that are close to many other countries, and as a result trade more, tend to be both richer and more equal. They ignore the inconvenient fact that Europe is where there are many small countries that trade a lot with each other, and those countries tend to be both richer and more equal, but probably not primarily because they trade a lot.17
One other reason to be skeptical of this rather optimistic conclusion is that it flies in the face of what we know from a number of individual developing countries.
In the last three decades, many low- to middle-income countries have opened up to trade. Strikingly, what happened to their income distribution in the following years has almost always gone in the opposite direction of what the basic Stolper-Samuelson logic would suggest. The wages of the low-skilled workers, who are abundant in these countries (and should therefore have been helped), fell behind relative to those of their higher-skilled or better-educated counterparts.Between 1985 and 2000, Mexico, Colombia, Brazil, India, Argentina, and Chile all opened up to trade by unilaterally cutting their tariffs across the board. Over the same time period, inequality increased in all those countries, and the timing of these increases seems to connect them to the trade liberalization episodes. For example, between 1985 and 1987, Mexico massively reduced both the coverage of its import quota regime and the average duty on imports. Between 1987 and 1990, blue-collar workers lost 15 percent of their wages, while their white-collar counterparts gained in the same proportion. Other measures of inequality followed suit.18
The same pattern, liberalization followed by an increase in the earnings of skilled workers relative to the unskilled, as well as other measures of inequality, was found in Colombia, Brazil, Argentina, and India. Finally, inequality exploded in China as it gradually opened up starting in the 1980s and eventually joined the World Trade Organization (WTO) in 2001. According to the World Inequality Database team, in 1978 the bottom 50 percent and the top 10 percent of the population both took home the same share of Chinese income (27 percent). The two shares starting diverging in 1978, with the poorest 50 percent taking less and less and the richest 10 percent taking more and more. By 2015, the top 10 percent received 41 percent of Chinese income, while the bottom 50 percent received 15 percent.19
Of course, correlation is not causation.
Perhaps globalization per se did not cause the increase in inequality. Trade liberalizations almost never take place in a vacuum; in all these countries, trade reforms were part of a broader reform package. For example, the most drastic trade policy liberalization in Colombia in 1990 and 1991 coincided with changes in labor market regulation meant to substantially increase labor market flexibility. Mexico’s 1985 trade reform took place amid privatization, labor market reform, and deregulation.As we mentioned, India’s 1991 trade reform was accompanied by the removal of the industrial licensing regime, capital market reforms, and a general shift of power and influence to the private sector. China’s trade liberalization was of course the capstone of the massive economic reform undertaken by Deng Xiaoping, which legitimized private enterprise in an economy where it had been almost forbidden for thirty years.
It is also true that Mexico and other Latin American countries opened up exactly at the time when China was also opening up, and therefore they all faced competition from a more labor-abundant economy. Perhaps that was what hurt the workers in these economies.
Showing anything definitive about trade by just comparing countries is difficult, because both growth and inequality could depend on so many different factors, trade being just one of those ingredients, or indeed an effect rather than a cause. There have, however, been some fascinating within-country studies that do throw a shadow over the Stolper-Samuelson theorem.