Academic journal article European Research Studies

The Impact of International Trade on Income Inequality in the United States since 1970's

Academic journal article European Research Studies

The Impact of International Trade on Income Inequality in the United States since 1970's

Article excerpt

1. Introduction

The United States has experienced growing income inequality, especially since the late 1970's. The share of income for the top 1 percent has more than doubled, from 7.8% in 1970 to 17.85% in 2014 (World Top Income Database, 2014). In addition, the earnings of the top 1 percent households increased by about 275% (after federal taxes and income transfer) over the period between 1979 and 2007, while the income of the bottom 60 percent households only increased by less than 40% in the same period (Congressional Budget Office, 2011). It has been a large discussion among economists, politicians, and researchers regarding the causes of this problem that has brought United States to be the worst among industrialized countries in terms of income inequality. Among the factors contributing to income inequality, one of them is the participation of the country in international trade (Cline, 1997). This will be the main focus of this research.

Even though United States can be considered as a relatively closed economy (in terms of trade/GDP ratio), the trend towards more integrated world market in the beginning of 1980's has led countries in the world (including United States) to be continuously more open to trade. Based on the basic Ricardian model, United States can be considered to have comparative disadvantage in the production of goods that intensively use low-skilled labor. The new participants from emerging market since the last decade have become a threat for the low-skilled labor (which can be categorized as a low to middle class) in the United States. A cheaper labor and raw materials from countries like China and India hurt the low and middle class in the United States through a decline in domestic demand for unskilled labor and preference for import of products. At the same time, employers of large manufacturing companies in the United States get benefit from the supply of cheap labors and raw materials from developing countries by starting production overseas. The establishment of trade agreements such as NAFTA in 1994 and WTO in 1995 also made this problem more obvious. Regardless of the contribution on economic growth, these agreements have forced U.S. workers to compete directly against workers from countries with no or less labor protection. At the same time, these agreements protect U.S. big firms to offshore their production to those countries. This drawback of trade agreements can be shown to have worsened the wage gap between the upper class and the middle class in the United States. While the share of income for the top 10% households rose by 1.3 percent per year from 1981 up to the establishment of NAFTA and WTO, it doubled to 2.3 percent per year in the first 6 years of the establishment of these agreements (Pikkety & Saez, 2006).

According to those statistics, one thing that grabs attention to do this research is how this growing participation on trade happened at the same time when income inequality started to increase. This research will try to answer the research question: How is the impact of international trade, especially the openness to trade, on the income inequality in the United States since 1970?

2. Literature Review

As mentioned in the introduction, there should be a role of international trade on the income inequality in the United States. A question arises about why still countries trade with each other. In this section, some basic models of international trade will be used to explain the reason behind the U.S. engagement in trade. Then, some previous studies about the relationship between openness to trade and income inequality will be provided.

2.1. Illustration of the Basic Models of International Trade on the Case of United States

Ricardian trade theory suggests that relative difference in technology leads to trade and countries will gain from trade as long as this relative difference in requirements exists (Ricardo, 1821). …

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