Free trade helps the poor

[A] way of investigating the relationship between inequality and trade with poor countries implies that China may actually help the poor, suggests new work from University of Chicago economists Christian Broda and John Romalis.

Instead of focusing purely on what's produced outside of the country, Broda and Romalis turn their attention to an interesting but obvious relationship between imports and consumption within our border: The goods exported by poorer countries are typically consumed by lower-income Americans. Our typical methods of quantifying inequality, however, don't take this into account.

At the same time, inflation in the price of these goods has fallen behind inflation in services, which make up a greater portion of what wealthier people buy. Taken together, these trends imply that official measures may be overstating the rise in inequality.

Looking at trade data between 1994 and 2005, Broda and Romalis construct inflation rates for different income groups and find that rates for the richest outpaced rates for the poorest by about 4 percent over the period. Since income inequality between the top and bottom 10 percent of earners grew by about 6 percent, the different inflation rates among income groups wipes out about two-thirds of the rise in inequality.

China's role in this new way of analyzing inequality is large, accounting for about 50 percent of the total reduction.

(A very interesting aside. Broda and Romalis also find that the poor are more likely than the rich to buy newer goods. Because of the lag in how quickly the CPI tracks new products, the researchers argue that once this "new goods bias" which serves to keep official inflation rates higher than they actually are since newer goods are typically cheaper, is factored out, inequality between the rich and the poor between 1994 and 2005 may not have changed at all.)

Via Tyler Cowen