PART 2 IN THE REAL WORLD: CHANGES IN INCOME DISTRIBUTION WITH INCREASED TRADE The initiation of trade can inuence the distribution of in- come by means of changes in both production and consump- tion conditions. With the opening of trade, the relative price of export goods increases and the relative price of import substitute goods decreases. 0n the supply side, this will lead to an expansion of production of export goods and a con- traction of production of import-substitute goods. Conse- quently, there will be an increase in the demand for inputs used in export production and a reduction in demand for in- puts used in the domestic production of the import good. In the adjustment process, the price of certain factors or inputs will likely increase and the price of others will likely decline, leading to a change in income distribution. Estimates of such supply-side impacts will be discussed in Chapters 8 and 9, which deal with production and income distribution in the context of the supply-oriented theory of the determination of comparative advantage known as the HeckscherOhlin theo- rem. However, a study by Spilimbergo, Londoo, and Szkely (1999) examined 34 countries from 1965 to 1992 and suggested that, while relative factor endowments go a long way in explaining personal income distribution, distri- bution is also influenced by the degree of general openness of a country to international trade. The study concluded that reductions in trade barriers (becoming more \"open") de- creased income inequality in capitalaabundant countries but increased income inequality in skill-abundant countries. These provocative conclusions reinforce the notion that trade can inuence income distribution, although the mechanisms are likely much more complicated than suggested by the sim- ple HeckscherOhlin framework. In another study, Andrew Berg and Anne Krueger (2002) hypothesized that trade liberalimtion can benet the poorer segments of a country's population at least as much as liber- alization benets the average person. This hypothesized result occurs because, among other phenomena, greater openness of a country can reduce the power of domestic monopolies. In developing countries, greater openness can raise the wages of low-skilled workers as exports of low- skill-intensive goods increase. Further, increased exports of agricultural goods can augment incomes of the poor in the rural areas. Nevertheless, alter surveying existing literature examining the relationship of openness and income distribu- tion across many countries at a point in time, they concluded that no systematic relationship between the liberalization and the poor can be made. Studies of any given country over time might lead to more denite results, however. In addition, distribution effects occur in consumption. Because the price of export goods is rising with trade and that of import goods is falling, individuals who spend rela- tively more of their income on export goods will nd their real income relatively smaller compared to that of individuals who spend relatively more on import goods, other things being equal. To give an example of the magnitude of possible consumption-related income distribution eects, consider Susan Hickok's (1985, p. 11) estimates of the impact of the higher domestic prices caused by U.S. import restrictions on automobiles, sugar, and clothing in 1934. The protection- induced increases in expenditure on these products were equivalent to an income tax surcharge of 66 percent for low- income earners ($7,00(L$9,350 annually), 33 percent for those in the $14,050$16,400 range, 20 percent for those earning $23,400328,050, and only 5 percent for individuals earning $58,500 and above. Because these products absorb a higher percentage of individual expenditures of low-income earners than of high-income earners, increasing international trade by removing those tariff and quota barriers would clearly have had the elfect that low-income groups would benet relatively more than high-income groups. . NEOCLASSICAL TRADE TH EO RY the country, the people who gain from trade can compensate the losers and still be better off. This must mean, therefore, that there is a larger 'pie\" to split up after trade has been intro- duced. If the compensation is paid, then society is better off because the gainers have bene- fited even after compensating the losers. Everyone is at least as well OK as in autarky, and some people are better off. Thus, trade can yield higher welfare than autarky, but the reverse is never true. If the compensation is not actually paid, then society is described as being only \"potentially\" better off. It is potential because some people could be made better off and everyone else no worse off, but this would not happen without the transfer. Further consider- ation of this principle using our familiar community indifference curves is given in the appendix to this chapter