Assessment of the distributive impact of trade reforms in Uruguay: Fernando Borraz, Daniel Ferrés and Máximo Rossi
From a theoretical perspective, the impact of trade on wage inequality could go in either direction. In a Heckscher-Ohlin model, workers should see wages increase relative to capital owners’ rents (alternatively, unskilled wages should
go up relative to skilled wages) in a developing country relatively well endowed with labour (or unskilled labour). In that case, workers would benefit relative to capital owners (or more skilled workers) and income distribution would improve. Under a specific factors model, however, workers that are unable to relocate to labour-intensive industries would lose, and the distributional impact of trade liberalisation is ambiguous. Moreover, empirical studies show that the wage gap between skilled and unskilled workers may increase after trade and investment reform. This could occur, for example, if foreign-owned firms that begin operating in a developing country bring with them technology that increases the demand for skilled workers. In that case, the distributional impact is adverse. The project will study the link between trade, poverty and inequality by analysing the impact of trade liberalisation through two main transmission channels: prices and income. The first possibility is that the new tariff levels that result from trade reforms explain price changes. Price changes may affect individuals in different ways, for example, depending on the share of each good in their consumption basket, as suggested earlier, or if individuals are net producers (as in the case of farmers) or net consumers. A second possibility is changes in household income. This effect is explained by the fact that trade liberalisation implies a reallocation of resources between sectors, resulting in changes in factor prices in the process. In this study we restrict the analysis to four trade goods: food and beverages (FB), clothing and footwear (CF ), house equipment and electronics (HQ), other traded goods (OT); and four non-traded goods: health and education (HE), transport and communications (TC), housing (HO) and other non-traded goods (ON). To analyse the distributional impact of Mercosur on Uruguayan households we use a model based on Dixit and Norman (1980). The variation in exogenous income (Y0) needs to compensate household i to keep the same utility after a change in the price of trade good k (k = 1, . . ., 4) because of the trade reform can be approximated by the following equation:
where Yi0 is the exogenous income of households i, nk is the tariff for traded good k, Sik is the budget share spent on the good k by household i, Pk is the price of trade good k, Pn is the price of non-traded good n, Sin is the budget share spent by household i, awiPk is the wage price elasticity with respect to traded good k and kwi is the share of labour income in total household income. The first term in equation (8.1) shows that for a given increase in the price of the trade good k, the higher the share the higher will be the income necessary to compensate the consumer. The budget share approximates the consumption effect. The second term of (8.1) shows the compensation generated by the change in the price of non-traded good that is explained by the trade reform. Their importance is related also to the share spent on non-traded goods. The first
and second term in (8.1) approximate the consumption effect of the Mercosur. Finally, the last term is the labour effect. The trade reform, change the price of trade goods that change household wages. In order to assess the distributional effect to Mercosur we have to estimate the three terms of the previous equation.