Trade liberalization, inequality, and poverty reduction in Latin America

Latin America's trade liberalization in the late 1980s and early 1990s was accompanied in some countries by increases in skill premiums, wage and income inequality, and even in poverty: results unexpected by many. This paper argues that this was mainly the result of four factors. First, most Latin American countries are rich in natural resources (which in general are complementary with capital and skills) and more abundant in capital than other developing countries with large pools of unskilled labor, such as China and India, that were integrating into the world economy while Latin America was liberalizing. Second, dynamic effects of trade led to new goods being produced in the region through outsourcing, an acceleration of skill-biased technical change, and Schumpeterian creative destruction, resulting in an increase in demand for skills in most industries. Third, initial conditions and contemporary events make predictions based on a simple factor abundance model difficult to generalize. As an example of the latter, the pre-reform structure of protection was biased toward unskilled-intensive sectors in some Latin American and Caribbean countries and tariff reductions naturally led to a relative increase in demand for skills. Differences in consumption bundles across income groups, exchange rate movements, and the growing importance of a nontradable service sector also make predictions less straightforward. Fourth, imperfectly functioning labor markets-such as potential transitions in and out of unemployment and informality-as well as income volatility are likely to affect and sometimes change the direction of the impact of trade reforms on income inequality and poverty. Finally, the paper argues that the effect of trade on poverty (and income inequality) depends on complementary policies being implemented. The impact of trade on poverty reduction can be significantly enhanced (and the effects on inequality mitigated) by policies that increase the provision and access to skills and other productive assets to the poor.