This file describes how increasing trade barriers in the US can deteriorate the economic situation of poorer households and increase wealth inequality.

1. The welfare effects of blocking Asian imports on America’s poor
Carlos Madeira, Northwestern University, Dept of Economics
March 17, 2009
In recent years the US trade gap with China and other Asian countries has been
an increasing concern for American politicians, with some blaming a low valued yuan
as a source of unfair competition. Policy makers tend to think that cheap labor from
Asia is a strong substitute for less qualified workers in the US and has threatened
incomes of poorer American households since the 70s, creating a widening gap between
rich and poor. During the 90s Professor Robert Reich, former Secretary of Labor of Bill
Clinton’s administration, favored policy proposals for the re-qualification of American
workers affected by international competition and new trade agreements (1).
Some financial analysts – including NYU Stern’s Professor Nouriel Roubini(2)
and FED Chairman Ben Bernanke(3) – also view the large US deficit as one of the
underlying causes of the US financial crisis. Several politicians – including US
President Barack Obama and Secretary Timothy Geithner(4) – have given indications
that they may enforce new trade barriers against China if their government refuses to
depreciate the yuan currency.
Several economists and policy makers – including British Prime Minister
Gordon Brown in his recent visit to the US Congress – have commented on the dangers
of a new protectionist wave as countries try to protect their domestic markets(5). Such
“beggar they neighbor” policies can have dramatic cumulative effects as each country
tries to undo the harmful policies of its trade competitors by creating protective
legislation of its own. The uncertainty and distortive effects of a new wave of
protectionist legislation could have the consequence of breaking world trade and
blocking FDI (foreign-direct-investment) movements to developing nations. In the end a
protectionist policy of the United States could end up harming America’s most
competitive industries as other countries deny their access to foreign markets.

2. Another potential problem of protectionism – that has implicitly been pointed
out by Chinese Prime Minister Wen Jiabao(6) – is that the United States new expenditure
programs and bail-outs of American financial companies will require large emissions of
US government debt. A blocking of the largest export market for most Asian countries
(7)
would imply that their trade surplus and tax revenues would deteriorate . This would
create difficulties for Asian investors and central banks’ purchases of dollars and US
assets. The US government would lose some of its most reliable funders at the moment
it needs them most.
The fear of the loss of foreign investors for US bonds, however, seems less scary
than many analysts portray it to be. The fact is that US domestic markets are flush with
free money created by the expansionist policies of the FED in the last two years. US
domestic banks struggling with the fear of buying risky assets in a market downturn are
gobbling up Treasury Bills at unprecedented levels. In a market willing to buy Treasury
(8)
bills at negative yields it seems unlikely that US government’s debt will see a
shortage of interested buyers.
Yet, there is another harmful consequence of US protectionist policies that has
been largely forgotten in this policy debate: its unequal effect on America’s poorest
households. Although American unskilled workers are more likely to compete with
Chinese imports, poor households also tend to consume a larger share of imported
goods, especially in terms of lower and cheaper brand products produced by Asian
countries. This implies that poor households would bear most of the grunt from any
protectionist policies against Asian imports.
Could American policy makers be shooting their own feet by blocking Asian
imports? Recent economic evidence seems to point out that protectionist policies are of
a greater benefit for weak American businesses that lobby for support from failure,
rather than for workers and their families.
How strong would be the welfare loss of America’s poor households? There is
yet no exact study evaluating the welfare consequences of a protectionism policy and
their effects on the wealth distribution between rich and poor households. However,
some recent papers suggest that this effect could be quite large. Chicago Graduate
School of Business economics faculty’ Christian Broda and John Romalis(9) have
recently studied the welfare consequences of Chinese imports in the last 10 years. Broda

3. and Romalis (2008) used a detailed household consumption dataset collected by firm
ACNielsen from 1994 to 2005. This data shows the consumers products purchased by
each household and the prices they pay. Low income households are measured as the
10% lowest income earners and their expenditures are compared with the richest
households (the top 10% income earners).
From 1990 to 2006 the share of Chinese products in US imports increased from
3 to 18%. Overall, non-durable goods (such as the ones imported from China) represent
40% of the expenditure of low income households, while rich households spend only
28% of their income on non-durable goods and purchase more high-quality services. By
purchasing more goods with a Chinese origin, poor households in the US experienced
an inflation rate 6% lower than rich households during the last decade.
The benefits of Chinese imports were not just limited to cheaper goods, but they
also allowed poorer households to afford a larger variety of goods than they did before.
The number of non-durable goods consumed by poor US households increased 10% as
in the last decade. Since households are spending less on traditional industrial goods,
they can afford to purchase larger amounts of other products and earn gains through the
complementarities of each product.
The effects of cheaper priced Chinese goods on the utility of poor American
households are clear. Poor households’ income in the US increased less in the last
(10)
decade (Goldin and Katz, 2007 ), but their income could actually afford more goods
than before. Broda and Romalis find that Chinese imports contributed to a reduction in
2/3 of the growth in nominal income inequality in the last decade and the benefits
greatly offset their small effects on the wages of America’s unskilled workers. The fact
(11)
is that the vast majority of economic studies (see Krugman, 2000 ) conclude that
skill-biased technological change is the largest responsible for the fall in nominal wages
of less skilled American workers and not trade. Blocking Chinese imports would
therefore lead to even worse outcomes for America’s poor.
References:
(1)
Reich, Robert (Blog), “The heart of the economic mess”, July 25 of 2008

4. (2)
Roubini, Nouriel and Brad Setser (November, 2004), “The US as a net
debtor: The sustainability of the US external imbalances”, mimeo
(3)
Dow Jones Newswires, “FED chief Ben Bernake sees recession over this
year”, March 11 of 2009, by Brian Blackstone
(4)
New York Times, “Geithner hints at harder line on China trade”, January 23
of 2009, by Jackie Calmes
(5)
RGE Monitor, “The re-emergence of global protectionism: A newer version of
Smoot-Hawley?”, March 9 of 2009, by Arpitha Bykere and Rachel Ziemba; BBC News,
“Seize the moment, Brown urges US”, March 4 of 2009
(6)
New York Times, “China’s leader says he is “worried” over US Treasuries”,
March 13 of 2009, by Michael Wines, Keith Bradsher and Mark Landler
(7)
New York Times, “China losing taste for debt from the US”, January 8 of
2009, by Keith Bradsher
(8)
Bloomberg, “Money-market yields seen falling to less than zero”, December
10 of 2008, by Christopher Condon
(9)
Broda, Charles and John Romalis (March, 2008), “Inequality and prices:
Does China benefit the poor in America?”, mimeo
(10)
Goldin, Claudia and Lawrence Katz (September, 2007), “Long run changes
in the US wage structure: narrowing, widening and polarizing”, NBER WP 13568
(11)
Krugman, Paul (February 2000), quot;Technology, trade and factor pricesquot;,
Journal of International Economics, Elsevier, vol. 50(1)