1 September 2014

Trade and Poverty: an Infinite Challenge (first part)

The aim of this essay is to analyse the links between openness to trade and the poverty level in developing countries. In particular, this survey takes into account liberalisation as the key role to produce two benefits: economic growth and poverty alleviation. However, market liberalisation (thanks to the invisible hand) not always pushes the economic system to way out of the vicious circle of poverty. There are evidence in which public policies led to a worst situation than the existing state before their applying. As a matter of fact, public policies depend on both the scenario in which they are implemented and on others inner mechanisms which rule the market (such as, welfare policies, monetary policies, inflation, price levels, democracy index). The main finding is that not all scholars agree that both poverty alleviation and openness to trade are related by the theme of growth. Specifically, empirical evidence is often incomplete because of deficiency in variables considered in econometric models as well as Gross Domestic Product is not an appropriate index to measure poverty. The conclusion is that the discussion on this topic is widely open and far from a final solution.

Keywords: Developing Countries, Economic Development, Economic Growth, International Trade.
JEL Classification: F43, F63, I30, O10, O40.

Table of contents
1. Introduction2. Trade and poverty: is there a way out?3. Trade and poverty: are they really connected?4. How openness to trade impacts on poverty? From the economic theories to the empirical evidence5. Conclusions6. References.

1. Introduction
Trade liberalisation is considered by many scholars one of the channels by which least developing countries can achieve two objectives simultaneously: economic growth and poverty alleviationHowever, multiple studies have not explained yet, whether poverty reduction is a natural consequence of economic development or poverty relieving has to be considered the engine of economic growth (1). In any case, both phenomena are closely linked, even if, all over the world, there are examples of less developed countries which continue to have a high percentage of the population that keeps the status of poverty, while they are undergoing a period of growth. In addition, literature does not define in a sole way the status of poverty, in other words its measurement is not an easy task and can be referred either to a person or a country. One of the easiest ways to measure poverty is to determine it in monetary terms, that is a lack of economic means to meet the basic needs, but there are alternative methods that assess poverty either in terms of consumption (e.g., poor are those who have a low level of consumption or do not consume anything) or production (e.g., poor are those who have a low level of production or do not produce anything) (2). Moreover, as above mentioned, poverty is a word that can be referred either to a person or to a country. The method adopted is different. For instance, if poverty is expressed in terms of income, for a person it generally refers to the well-known poverty line, below which a human being is considered poor, whereas for a country it usually takes into account the Gross Domestic Product (henceforth GDP), although this measure is not always widely recognised as the best value to indicate wealth or well-being of a nation (3). Hence, it is pretty hard to define poverty as well as it is difficult to guess a suitable mechanism to measure it objectively. Generally, also the “poverty line” is only helpful to have an idea of the magnitude of this phenomenon, because it is not easy to state clearly what are the basic needs for a person (goods, services, physical and healthy state), keeping in mind that every human being is different from another one and it has a various priorities to be met. In this paper, I am going to analyse critically some empirical studies which identified different channels through which openness to trade in the developing countries might produce a positive impact on welfare. In a nutshell, I will investigate whether international trade can really create the conditions to push developing countries out of the vicious circle of poverty in which they are.

2. Trade and poverty: is there a way out?
Since 1993, as a member of Clinton’s Council of Economic Advisers (CEA), STIGLITZ has criticized the international policies adopted to solve the problems of less developed countries, leaving the market free to self-regulate by the “invisible hand”. In other words, according to the American economist, both trade liberalization and openness to trade for poor countries towards richest ones, were not the right policies of alleviating poverty. Effectively, the powerful position held by industrialized countries, together with those held by the international financial institutions, such as the International Monetary Fund (IMF), would led, in the long run, to worsen the economic situation within developing countries. According to STIGLITZ (2002), forcing poor countries to open up their markets to industrialized ones was a sort of “moral crime” (the economist often speaking in his articles of “moral deprivation”) because it would have pushed poor countries to be exploited by the richest ones, becoming over time poorer than before. Summing up, as well as AKERLOF (1970) stated that asymmetry leads markets to flop (4), then in STIGLITZ’s opinion the relationship between developing and developed countries will follow the same route, because it exists asymmetry information which will drive poor countries to failure. So the main question becomes: is there a way out?

3. Trade and poverty: are they really connected?
Several authors have investigated the existing connections between trade and poverty within poor countries, passing through economic growth, trying to find empirical evidence. Some scholars have attempted to relate trade and growth by considering some trade policy indicators (such as trade openness, macroeconomic stability, government consumption and rule of law). But all these models have been heavily criticized by others academics (LEVINE and RENELT, 1992 - RODRIGUEZ and RODRIK, 1999) because they took into account variables strictly connected among themselves, making it difficult to separate the effects of a policy rather than those produced by another one. Following another route, WINTERS et al. (2004) studied this statement by considering four view points (macroeconomic aspects, households and markets, wages and employment, government revenue and spending). Without any doubts, all these headings are affected by international trade and, at the same time, they influence poverty as well, through income redistribution policies. Anyway, it is worth noting that not all surveys turn in favour of this approach, so it is very hard arguing that empirical results are really robust. In addition, in the world of today, an increasingly important role is also played by the international financial Institutions, which hold a powerful position over all countries and, especially, over developing ones. Therefore, in their paper the authors did not take into account policies made by these Institutions as fifth heading, omitting an important channel that may involve both trade and poverty, though the importance of these Institutions significantly increased after the financial crisis of 2007, whereas the paper by WINTERS et al. (2004) was published before.

(1WINTERS et al. (2004) stated that existing difficulties in measuring trade and poverty, making it hard to find a convincing connection between the two phenomena. 
(2SEN (1981) argued that even if a country has a high level of production can be considered a poor country at the same time. This happen when its population do not have any means to access to basic goods and services. For instance, during the famine in 1974, Bangladesh recorded the maximum food production in the country.
(3FITOUSSI et al. (2010) attempted to study alternative methods to GDP to measure the well-being or wealth of a country. In fact, for instance, GDP do no take into account important factors, such as health, infant mortality, suicide rates, crime, loss of leisure time, income gap and, especially, poverty.
(4AKERLOF (1970) showed that market collapses due to asymmetric information.

(to be continued)

AuthorEmanuele COSTA
Published by: Working Paper

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