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How does international trade affect lower-income households? While much ink and energy have been spent on the labor market impacts of trade, researchers have rarely explored the effects of trade on poor households as consumers. When economists do study the impact of trade on consumer welfare, they often consider these effects on a national level or model consumers as identical, representative agents.
These approaches could miss meaningful variation in how opening to trade—or putting up new trade barriers—can affect different households. In a Minneapolis Fed staff report, Monetary Advisor Michael Waugh models how lower trade costs play out for richer and poorer households (Staff Report 653, “Heterogeneous Agent Trade”). Waugh finds starkly different effects, with poor households (defined by their level of consumer spending) gaining much more as freer trade lowers prices.1
The reason is not that poorer households buy a larger proportion of imported goods. Rather, it is their higher marginal utility of consumption: Falling prices provide more value to households with tighter budgets, as evidenced by their sensitivity to prices. Low-income households react more strongly as trade drives down the prices of imports and competing domestic goods. These households increase their consumption more as their buying power increases, and they are quicker to substitute new products in pursuit of savings.
Waugh finds that all U.S. households benefit from a 10 percent reduction in U.S. trade costs. But the poorest fifth of households experience a welfare gain more than 4.5 times larger than the richest.
Recognizing the outsized benefits experienced by poor consumers also boosts the average gains from trade, compared with the findings of models with homogenous households.
The crucial household price elasticities in Waugh’s model are derived from barcode-scanner data on expenditures across hundreds of product categories. These spending patterns were captured by researchers in Switzerland in 2015, as an exchange rate appreciation abruptly dropped the price of imports and consumers responded. This micro-level data is combined in the model with macro-level trade flows from the U.S. and 18 trading-partner nations.
Importantly, any labor effects on households are turned off in the model, in the interest of isolating and elucidating the welfare effects via the consumer price channel. These evidently large gains-to-trade for low-income consumers could be weighed alongside our best understanding of employment effects to provide a clearer, balanced picture of how trade affects different households.
“Most surprising is how potent heterogeneous price elasticities are quantitatively,” Waugh writes. “The core idea is not that prices decline more for poor households vs. rich households. It’s that, in layman’s terms, a dollar price reduction is of higher value to the poor than the rich.”
Read the Minneapolis Fed Staff Report: Heterogeneous Agent Trade
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1 Reflecting its primary data source, this research bins households by their level of spending. For purposes of this overview article, “low-income” and “low-expenditure” households and consumers are considered to be largely the same.
Jeff Horwich is the senior economics writer for the Minneapolis Fed. He has been an economic journalist with public radio, commissioned examiner for the Consumer Financial Protection Bureau, and director of policy and communications for the Minneapolis Public Housing Authority. He received his master’s degree in applied economics from the University of Minnesota.
