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PSIA: Key Issues in Trade Policy Reform or How to Measure the Linkages between Trade Growth and Poverty Maurizio Bussolo DECPG The World Bank March 2006 Based on the PSIA note on Trade Policy reform authored by Maurizio Bussolo and Alessandro Nicita. Intro Assessing the sign and the strength of the trade and poverty links is a complex task No clear consensus/generalization has yet emerged, thus we should not push one-size-fits all policy advice However important lessons are being learned: Distributional effects need to be addressed Country specific detailed studies are useful Trade policy can only play a part in a comprehensive development strategy Trade and Poverty Links: an overview Trade Policy 3 Income level and growth 4 Income distribution 1 2 Poverty Fiscal issues, Risk, Volatility 1st group of studies: the growthinequality-poverty regression approach Many recent studies [de Janvry and Sadoulet (1995,2001), Ravallion and Chen (1997), Dollar and Kray (2000)] focused on the statistical relationship between growth and poverty across countries and time periods Main conclusion: growth strongly reduces poverty, Ravallion and Chen find an ε of 3; Policy implication: if the ε is sufficiently high, poverty reduction strategies based mainly on growth may be justified. The regression approach: some refinements This approach postulates a constant ε across countries/time periods Such an approach entails a naïve model that does not take into account the existence of an identity that links poverty reduction with growth and changes in the income distribution A graphical representation… Poverty-growth-income distribution Z Reduction due to Growth Reduction due to distribution change 10 15 20 25 30 35 Trade and Poverty Links: an overview Trade Policy 3 Income level and growth 4 Income distribution 1 2 Poverty Fiscal issues, Risk, Volatility Trade Reforms Reduction of protection of domestic markets by elimination of quantitative restrictions (quotas), by lowering tariff rates, and regulate the use of Non Tariff Barriers (NTBs) Typology: Multilateral liberalization (WTO negotiations) Unilateral liberalization Discriminatory liberalization (regional, bilateral agreements) Different institutional arrangements and different effects 0 .2 .4 .6 Income distribution implications of Multilateral and Regional liberalizations, an example for Nicaragua -5 0 5 10 percentage gain Full CAFT A Kernel Distribution of Gains for Nicaraguan households for a multilateral (full) and a CAFTA liberalization scenarios Trade and Poverty Links: more details a. goods prices b. c. d. e. f. (expenditure channel) factor prices, employment (income channel) government fiscal position (transfers, tariff revenues, other taxes) Investment/productivity changes (long term growth) Short run adjustment costs (volatility, risk) Other external shocks (global lib., TOT) Standard small country H-O-S model main predictions (focus on a. and b., magnification effect, type of lib.) 2 other groups of studies +1 a. partial equilibrium / cost of living analyses (detailed micro) b. general equilibrium (macro top-down approach) c. micro-macro synthesis These are all quantitative studies, data requirements can be a limitation in their implementation Partial equilibrium / cost of living analyses: intro Based on real households rather than representative ones Have a central equation of this form: output input w cons W c p p w p j j k k f f c W The change in welfare is function of: a) the change in output prices, b) inputs prices, c) factor prices and d) consumption goods prices Partial equilibrium analyses: advantages/disadvantages the ’s are household specific: full heterogeneity is included Key characteristics of the poor inform the analysis Problems: Examples: Ethiopia export/food crops regional segmentation, and own consumption in Nicita Olarreaga (2003); Madagascar booming textile in Nicita Razzaz (2003) price changes are partial equilibrium no substitutability (i.e. no quantity response) Extensions (panels, ex-post studies: Winters on Vietnam, McCulloch on China’s province) General equilibrium analyses: advantages/disadvantages Based on representative households, disaggregated in many groups as to minimize the intra-group income heterogeneity Generate GE consistent prices, accommodate different degrees of resource mobility and substitution, perfect identification Many studies, starting Adelman and Robinson (1978) for Korea, up to a recent one for Brazil (Harrison, Rutherford and Tarr 2003) Main result: poorest household earn 4 times more than richer households Decomposition exercises; test different type of liberalization Problems: Within group variance is fixed No heterogeneity across the poor Perfect price transmissions Micro-Macro synthesis Top-down sequential approach Inclusion of the full household sample in the CGE model Feed-back full models Top-Down sequential approach: an example Macro model is a global multi-sectoral CGE model Link variables are commodity and factor prices (from CGE model to micro data) For the incidence analysis we use four household surveys—Brazil, Chile, Colombia and Mexico Two policy experiments: FTAA and multilateral global liberalization Global trade reform can reduce poverty more than proportionately (Poverty elasticities generated by household microsimulation linked to global trade reform scenario) 14 13 12 11 10 9 8 7 6 5 4 3 2 1 0 Low labor mobility Distributionally neutral elasticity Brazil Chile High labor mobility Colombia Source: Staff simulations with Linkage model and country micro-simulation modules. Other approaches CGE + more complex micro model: Bourguignon, Robilliard and Robinson (2002) on Indonesia and Bussolo and Lay (2003) on Colombia CGE+full household sample: Cogneau and Robilliard (2000) on Madagascar, Cockburn (2002) on Nepal Full feed-back models: Savard (2003) on Philippines Off-the-shelf methods simSIP PovStat Poverty Analysis Macroeconomic Simulator (PAMS) Both the above methods assess the (ex-ante or ex-post) effect of aggregate economic growth on poverty Maps macroeconomic results (differential output, employment, labor revenues across sectors) into poverty effects 123PRSP Difficulties As Kanbur (2001) puts it: trade and openness is the archetypal, emblematic, area around which there are deep divisions, and where certainly the rhetoric is fiercest Level of aggregation Time horizon Market structure Domestic policies (regulation and competition) Dynamic gains from trade: Increasing integration in global markets is associated with faster growth (Average annual per-capita GDP growth, 1980-2003, percent) Increasing export share in GDP 1.6 1.2 Decreasing export share in GDP 0.8 0.4 0.0 Source: World Development Indicators and DECVP staff calculations Much is left out of the analysis… (Real income gains for developing countries in $billion) Merchandise trade vs. services, GTAP5 (1997) 1000 Trade barriers Competition Merchandise trade and productivity, GTAP 6 (2005) Efficiency Static Dynamic 160 900 140 800 120 700 600 100 500 80 400 60 300 40 200 100 20 0 0 Services Merchandise Low income Middle income Source: Left panel, GEP 2002. Right panel, Anderson, Martin and van der Mensbrugghe (2006). Other elements in a good PSIA: Stakeholders analysis Trade policy is an economic inefficient but politically efficient re-distributive tool Trade policy normally favors import-competing sectors (and factors) rather than export-oriented ones (for historical reasons revenues collection) Predictive analysis of the distributional effects is crucial for a successful and sustainable trade policy reform: Approach 1: the factor endowments model Approach 2: the sector specific model Institutions Globalization and governance Coordination across different public institutions WTO commitments Effects on domestic institutions Bonaglia, Braga, Bussolo (2002) Example: trade liberalization in Colombia Trade reform as part of a larger development agenda Conclusions Poverty impacts are different across countries and scenarios We show that at least for one case, Mexico, a simple approach is detecting a reduction in poverty, in contrast to an increase, as shown by an approach considering distribution Strong distribution effects can dominate the average growth effects Useful information for the design of trade reforms (capture, rent seeking) and compensatory measures (targeting); different emphasis for the short run and the long run Volatility and risk (Loyaza on Managing Volatility Handbook) MDG context: Halving poverty requires about 5% yearly reductions, with full trade lib, in the good cases, we get about 2% (static gains only)