Download An Overview of Trade and Poverty Reduction

Trade and Poverty Linkages: An
Overview
D R Khanal
Former Member, NPC
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1. What Trade Liberalization Means?
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greater external competition into protected domestic markets for removing all
type of discretionary practices through
-elimination of preferential treatment for a specific sector
-reduction in tariff rates and effective protection including reduction in the
dispersion of tariff and average tariff rates
-elimination in non-tariff barriers
-reduction in cumbersome administrative procedures for imports and exports,
and
-removal of distortions in the exchange rate and financial system
2. Routes and Channels
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multilateral (WTO routes)
unilateral move
regional and bilateral routes.
3. Gains of Trade Liberalization
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rapid industrial transformation,
fast changes in employment structure,
higher growth in output, and eventually
drastic reduction in poverty.
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Occurring through;
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factor productivity gains via higher specialization and exploitation of areas having
comparative advantages,
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scale of economies and expansion in markets for domestic firms leading to
increase in total factor productivity,
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stronger interaction with foreign firms and markets and hence technological
innovations and improved managerial practices,
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lessening of anti-competitive practices and rent-seeking activities leading to
reallocation of resources away from protected unproductive firms/sectors to more
efficient activities,
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tariff reduction decreasing imports prices and increasing purchasing power of
consumers, and
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spill over effect on both factor and product markets and creation of income and
employment opportunities leading to welfare gains and poverty reduction.
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Trade and Poverty Links: an overview
Trade Policy
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Income level and growth
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Income distribution
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Fiscal issues, Risk, Volatility
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Poverty
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Poverty-growth-income distribution
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Reduction due to
Growth
Reduction due to
distribution change
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4. Theoretical and Empirical Bases
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international trade theory of comparative advantages arguing countries gaining
due to differences in the relative cost of producing different goods and services.
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from developing country's perspectives Stolper-Samuelson and Heckscher-Ohlin
trade theories considered to be somewhat relevant as they argue:
-Income effect key to S-S theory –comparative advantages in the good that
intensively uses the relatively abundant factor and hence free trade increases
the relative price of that good leading to increased real return of relatively
abundant factor by an even larger percentage. It also argues that trade would
reduce the return to the relatively scarce factor, though to a small degree and
hence changes in commodity prices due to trade liberalization would magnify
the resulting changes in factor prices. This means that there would be rise in
relative returns to the abundant factor i.e. unskilled labor in the context of
developing countries. On the grounds of expansion in labor intensive
economic activities including employment, international trade is thus
considered to be contributing to reduce poverty in developing countries
markedly.
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5. Channels and Mechanism of Trade Liberalization Affecting Poverty
- Impact of trade liberalization is transmitted through the effect on;
a. prices and availability of goods (expenditure channel)
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lowering prices of imports as well as prices of substitutes leading to increase
people's real incomes.
removal of export taxes or prohibitions may also help poor if they are net
producers of exports (as is often true in agriculture).
but may not be that much straightforward and the effect depends on; creation or
destroying of local market, affect of lower prices of imports on small producers or
subsistence farmers (i.e. production and consumption), price responses
particularly in agriculture, transmission mechanism of border prices to the
domestic consumers and above all market condition (monopoly or carteling).
b. factor prices and employment (income channel)
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two factors may directly affect the wages and employment of the poor first, the
flexibility of labor markets constrained by labor regulations affecting the changes
in real wages and second minimum wage legislation prohibiting downward
adjustments in wages
in view of highly flexible labor market with high elasticity of labor (mostly
unskilled), adjustment to trade shocks would take place through changes in both
employment and relative wages. Under such conditions, the costs of trade reform
for the poor could be very large.
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c. government revenue and spending (transfers, tariff revenues and other taxes)
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reduction in tariffs would help raise revenue instantly but gradually may dampen
revenue with adverse effect on macroeconomic stability and more importantly on
social expenditures hurting the poor -short run adjustment costs (volatility, risk),
d. other external shocks (global liberalization and terms of trade)
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although trade liberalization would help diversify exports and reduce dependency on
domestic market so that domestic economic downturns could be offset by growth in
the international trade, abrupt changes in the terms of trade would affect growth.
Similarly, shocks directly affecting certain sectors, such as agriculture or informal
production may have significant effects on the poor.
e. long term growth (investment/productivity gains)
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Reduction in anti-export biases and more efficient allocation of resources leading to
higher investment and productivity gains would have positive effect on an economy's
long-term growth.
the relationship may not be straightforward and would depend up on the existence of
other, complementary macroeconomic and structural policies and the appropriate
institutions. One example could be overvaluation of exchange rate that may inhibit
growth. More importantly, pattern of growth that disproportionately benefits the rich
may lead to worsening of income distribution.
Important Key Factors for Positive Outcomes
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existing initial conditions and structure of an economy,
features, sequencing and their processes,
state of market institutions and capacity to implement, and
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parallel policy measures including a mechanism to compensate potential losers.
6. What Developing Country Experiences Indicate?
Economic Growth and Poverty
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if openness pushes countries into less dynamic sectors (e.g. primary extraction)
and hence hurts growth.
despite uncertainty about the size of the effect, the best estimate is that trade
restrictions are harmful to long-run growth.
most of the empirical studies show a positive impact on poverty reduction. But
emerging consensus is that trade liberalizations generally worsens inequality.
a recent World Bank study ( 2005) on Latin America by reviewing the evidence
on the effects of trade reform episodes on income inequality, wage inequality,
skill premiums and demand for skills shows that in the late eighties and early
nineties there were clear cut evidence of big increase in wage inequality and
some moderate increase in the income inequality. Market failures (e.g., absence
of access to credit or insurance), have increased both inequality and poverty
indicating for the necessity of strengthening market institutions accompanied by
effective redistributive policies.
- poverty effect of trade liberalization depends on the price changes impinging on
poor households given their consumption and production bundles. Generally
poor farmers could lose from higher prices or price variability. Border price
shocks, market creation or destruction and household response determine the
extent of positive and negative effect.
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Wages and Employment
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Unlike traditional international trade theory labor supply in developing countries is
perfectly elastic. In this case the wage will be fixed exogenously and moving
workers into the formal sector will alleviate poverty only if the loss of labor in
subsistence agriculture is so large that the workers remaining in that sector
increase their ‘wage’. The employment effect of manufacturing is also found to
be ambiguous.
Although liberalization would generally raise the demand for relatively unskilled
workers in many developing countries and so, on average, be poverty alleviating,
there are bound to be exceptions e.g. possibly where natural resources dominate
exports and where out-sourcing is important – as well as cases where
segmented import-competing sectors suffer adverse shocks.
Recent study show that despite skill intensity gains being apparent in developing
countries, gains are generally outstripped by welfare loses owing to unskilled job
losses and wage vulnerability.
Government Revenue and Spending
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Although reduction in tariffs may lead to an increase in trade tax revenues,
subsequent move toward intensive trade liberalization may have losses in trade
related tax revenues.
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7. Conclusions and Policy Implications
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A thorough review of empirical studies does not help derive definite conclusions.
But generally, increased demand for skills with possible employment or real wage
losses to the unskilled. Moreover, the external and internal shocks emanating
from absolute price rise or relative changes in prices may increase the
vulnerability of the poor including marginal and small farmers. In many cases
there has been market destroying effect with detrimental impact on small
producers in both agriculture and non- agricultural sectors. All in all wage
inequality, poverty traps and rising income inequality are some of the
phenomenon observed in many countries.
Under these circumstances, compensatory policies and programs would be
essential to reverse the present unwarranted trend. The major steps to be taken
are:
-Broad-based reforms for progressive transformation of society
-Consistency in Macroeconomic Polices through a Priory Ex-ante Impact
Analysis.
-Complementary reforms:
- Infrastructure Development
- Development of Markets
- Suitable Labor Policy
- Social Safety Nets
- Asset Redistribution and Access to Social Capital
- Government Actions in Key Areas
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THE END
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