# **1 Introduction**

There has been widespread interest in the policy community in the distributional effects of trade liberalization. Recent anti-globalization rhetoric has focused on the potential negative impact of trade and outsourcing for unskilled wages in developed countries, while arguing that it may also hurt workers in poor countries. On the other hand, many economists regard trade liberalization as an instrument for increasing growth, but are less certain about the distributional effects of increased openness.

Driven in large part by continued policy interest, the relationship between trade openness and wages has also been an active topic of debate in the research community.<sup>1</sup> However, this literature focuses on the functional distribution of income, with less emphasis on household distribution issues.<sup>2</sup> The current literature has stressed theoretical linkages based on the Stolper-Samuelson theorem. In this context, tariff reductions in poor labor-abundant countries are expected to increase the real income of workers and hurt capital owners (or skilled labor). In developed countries the opposite effect is expected. The empirical evidence remains mixed and somewhat contradictory.

In this paper, we follow Bourguignon and Morrisson (1989, 1990) and Spilimbergo _et al._ (1999) and use an ownership matrix that allows us to move from functional to household income. We then obtain a general function of the personal income distribution in terms of endowments, tariffs and the ownership structure. Using this analytical framework, we analyze the impact of trade and tariffs on the household distribution of income in general equilibrium.<sup>3</sup> Treating equity issues as relevant, we work with Sen-type social welfare functions (Sen, 1974) and embed inequality indexes in social welfare functions. In particular, we work with the widely used Gini coefficient and with the Atkinson family of inequality indexes (Atkinson, 1970), although other indexes may be employed. Using this framework we are able to decompose the general equilibrium import protection effects into real income level and dispersion changes.

The efficiency properties of tariffs are well developed in the literature. What we highlight here is how distributional aspects of social welfare related to import protection may be examined alongside efficiency aspects. For government, this is manifested not only in special interest politics, but also through the direct impact of inequality on a government’s objective function. We find that equity considerations may serve to counter lobbying interests in both capital-rich and capital-poor countries, though with an opposite marginal impact on the final policy outcome. Although we focus our attention only on import tariffs, the main message that follows from this approach can be applied in a more general context of trade policy instruments. The precise distributional and efficiency components may change, but in essence the trade-off and interrelation between both economic outcomes is still present.

The paper is organized as follows. Section 2 develops a formal representation of social welfare inclusive

> 1Comprehensive surveys are provided by Richardson (1995), Cline (1997) and Feenstra and Hanson (2004).

> 2Recent papers on this topic include Edwards (1997), Higgins and Williamson (1999), Barro (2000) and Spilimbergo _et al._ (2001).

> 3Also see Anderson (2002). While the paper is focused on a different set of issues (his goal is to explore the public finance concept of the marginal cost of funds in general equilibrium), he also stresses the decomposition of general equilibrium welfare effects into a composition (i.e. efficiency) effect and a distributional effect.

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