Institutions and trade‐related inequality

Abstract

Trade liberalization is famously known for both creating winners and losers via processes of dislocation, sectoral reallocation, and specialization. This paper studies the conditions under which excess "losers" are generated during the process of liberalization with a focus on the role of institutions in economic transition. I contend that poor institutions, in particular property rights and democracy, can create unnecessary hardship in the transition to greater openness, generating a much higher burden on compensatory policies and making it more difficult to sustain open trade policies. Using a new dataset of trade openness, economic inequality, and institutions, and using 3SLS estimation to account for endogeneity, the analysis finds that this is indeed the case: high property rights and more democracy appear to help to mitigate trade-related inequality. Moreover, poor institutions create a downward spiral, with greater inequality leading to lower trade openness. These results imply that basic institutions can help to minimize losses sparked by globalization, while other wellmeaning policies can actually increase disruptions.