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. Introduction – 2. 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 evidence – 5. Conclusions – 6. References.
4. How openness to trade impacts on poverty? From the economic theories to the empirical evidence
According to economic theories, when a country decides to way out from a self-sufficient regime, by opening up to international trade, generally improves its welfare. Empirical studies (DOLLAR and KRAAY, 2001) showed that no autarkic government performed high rates of growth. For instance, KANAAN (2000), reporting evidences from Tanzania's experience, proved that when this country decided to pass from an open economy to an autarkic regime it reduced its trade by 50%, collecting a series of negative performances (lack of raw materials, collapse in imports and exports, fall in fiscal revenue) and a significant decline in welfare (high levels of inflation, lack of goods and services, unemployment). Furthermore, DOLLAR and KRAAY (2001) explained that if a developing country is more open to trade, it may manage a faster growth. For instance, China and India grew a lot after their openness to international trade, contributing to relieve significantly their poverty level, thanks also to income redistribution generated by the growth. In contrast, those developing countries which did not take part in globalisation fell down their GDP, worsening poverty rate. Today, most economists agree with the theoretical argumentations and, over the years, they have attempted to confirm the connections between openness to trade and poverty alleviation by several empirical results. However, it also exists a wide literature which not always provided a convincing “scientific” support to the assumptions made by economic theories. Multiple studies confirmed the hypothesis that trade liberalisation and poverty reduction are not directly linked, but an important tool of connection between the two phenomena is represented by economic growth. In fact, trade liberalization helps growth and, in turns, growth leads to poverty reduction. So, how may we justify this statement? To bypass the existing difficulties about measurement of the aforementioned phenomena, WINTERS et al. (2004) investigated the channels that can affect the phenomena, attempting to find one or more links between trade liberalization and poverty reduction in developing countries, in order to allow governments to focus on policies targeted to improve welfare. As we saw in the previous paragraph, the authors identified four channels by which trade and poverty may be connected (1). Firstly, from the macroeconomic point of view, different opinions agree that international trade may contribute to growth. But, can the latter set upon the poverty, alleviating it? This matter is still an open question. WINTERS et al. (2004) sought to investigate how to relate the former with poverty alleviation, by analysing macroeconomic aspects tied to economic growth and then how to put them in practice, by trade or other kinds of policies, to reduce poverty. Specifically, by openness to trade, consequences involve, generally, investments, productivity, production, income and consumption in addition to imports and exports. The authors stated that trade-growth connection is a closely empiric question, listing a wide literature to support this thought. I disagree with this opinion because not always “scientific” evidence may clearly explain the reality, which depends on multiple variables (endogenous and exogenous) and the effects on developing countries may be different, and depending, for instance, on their geographical positions, government regimes, infrastructures and communication systems. Moreover, are we really sure that growth can alleviate poverty or have the authors intentionally considered evidence in favour of their aim? Often, the value of GDP is used as the sole index to evaluate the size of economic growth. So, when GDP increases then GDP per capita may increase as well. But, how much this increase may affect poverty alleviation? In addition, can we support the idea that increase in GDP per capita means that people, and especially poor, have an higher income than before? The matter is widely controversial. Indeed, an higher GPD means that one country is richer than before, but does not correspond to the extent that each person who lives in that country has a better income. That is not true for different reason. By way of non-exhaustive example:
- openness to trade may have both positive and negative effects on poor. Obviously, it depends on poor and on their capabilities to exploit new opportunities offered by international trade. And, though it is generally true that trade liberalization improve welfare, every change produces winners and losers;
- fiscal policies and, as a rule, all social policies may have a huge impact on income redistribution. So if the extra income produced by trade is equally redistributed, one may confirm that openness to trade relieves poverty. If not, one cannot state it, because if GDP per capita rises do not means uniquely that poor have a better income.
DOLLAR and KRAAY (2001) found that not all developing countries who opened up their markets to international trade enhanced the income of poor. In a first group of them (China, India, Malaysia, Thailand and Vietnam) both GDP per capita and income of poor rose, whereas in another one (Brazil, Mexico and the Ivory Coast) the former increased, while the latter declined. But, even in this case, the results were not so robust because, for instance, for the first group, the reasons might consist in the similar geographical area and so in their abilities of exploiting the proximity cooperation, easing, in turns, their integration in the world economy. The authors discovered that the differences in the income of poor between these two groups were due to the magnitude of growth. Hence, they concluded that a strong growth may cause a reducing poverty, while a weaker growth might produce the opposite effect. So, it is not so clear how international trade may affect the intensity of growth. To measure the degree of openness to trade, the authors compared two countries in the same geographical area and they found that it may depend on several factors such as fiscal policies, stabilisation, property rights and exchange rates. Secondly, the scholars considered households and markets. The former is an important keystone, especially in the developing world, from both the economic and social point of views. Indeed, poverty alleviation means essentially reducing poverty state of persons. And persons, single or in group, set up families. The latter is important as well, because markets mean new opportunities and, therefore, employment and salaries for workers. And this may improve welfare. Both households and markets are closely connected by price levels. As openness to trade may influence price variability, it may have, in turns, a negative impact either on markets (e.g., destroying it due to competition) or households (e.g., reducing their real wealth). Price levels is also a macroeconomic issue because linked to interest rates, which may affect investment, production and growth. POLLIN and ZHU (2005) showed that a low inflation rate is a policy as an end in itself, because policy makers are more interested in promoting growth and employment. The survey argued that there are no proofs that an high inflation do not support economic growth. Even within low income countries high growth levels can be compatible with a high inflation, especially if price fluctuation depends on “investment demand pressures in an expanding economy” (BRUNO, 1995). Hence, if prices fluctuate there might be a double final effect for poor:
- on one hand, by price changes, which impact on real income;
- on the other hand, by growth rates, which may affect earned income.
By the way, that is a huge problem for the stability of a country and not only for poor, even if inflation rate tends to impinge more on poor than rich. As a matter of fact, stability is one of the most important target to reach during economic growth to prevent that price fluctuation nullify all benefits produced by an improvement in the income of poor. If not, instability takes the risk to create more “victims” among poor, mainly in the short run, when shocks due to growth create winners and losers among population. Empirical evidences (DOLLAR and KRAAY, 2001) observed that one of the positive effect by integration process of domestic economy in the world trade consists in declining the average inflation rate, while other authors (CHOWDHURY and MALLIK, 2001), examining four South Asian countries (Bangladesh, India, Pakistan and Sri Lanka), proved that there is a positive relationship between inflation and growth. Hence, why stability is so important for growth? Economic growth, in an extreme meaning, may be considered as a shock for the economy within developing countries, and therefore a factor of instability. Indeed, when one refers to a shock, the literature tends to associate it with a negative event. But economic growth is not a negative occurrence. Growth need to be combined by appropriate policies, otherwise it may be cause adverse effects. In other words, by way of non-exhaustive example, it may be promoting by:
- reducing inflation rate, in order to avoid of impinging on poor;
- social policies, in order to support poor who did not exploit the new opportunities due to economic development (e.g., unemployment insurance);
- exchange rate stability, in order to allow positive investment flows;
- political stability, in order to attract investment, both internally and from outside.
Thirdly, the academics took into account wages and employment. One might criticise this terminological setting, because it should be better talking about employment and then wages and not vice versa. Indeed, to evaluate the impact on poverty by trade, income seems to be is one of the most important variable used to determine poverty level. But it is not so. In a open-to-trade country, wages are not assessed internally, but they are an exogenous variable calculated outside the domestic borders. So, it will be the next adjustment process which will determine employment level. So, if the matter is pushing developing countries out of poverty, a simple finding might be fixing wage levels over the “poverty line”, but this solution does not mean that welfare improves. In addition, in developing countries the issue seems to concern only unskilled workers. So if policies want to relieve poverty, it might be sufficient increasing wage levels for unskilled labour force. According to both HECKSCHER-OHLIN’s theory and STOPLER-SAMUELSON’s theorem, trade liberalization should help poor countries to reduce poverty due to comparative advantages, by exporting labour intensive goods. This because least developing countries have an abundant endowment of unskilled workers and their economic systems are mainly agricultural. So, if the price of labour-intensive goods increases, both the production and real wage will rise as well. These economic theories are important because some scholars (KRUEGER, 1983) considered the matter of poverty strictly connected with the real wages of unskilled workers. In contrast, other authors (FEENSTRA and HANSON, 1995) argued that also the real wages of skilled workers rose relatively to those of unskilled ones. But in this case, the most interesting finding is not the increase in relative real wages for skilled workers, but that also the real wages for unskilled workers rose. Last but not least, the scholars examined trade liberalisation from the “political” point of view. In other words, they studied the effects on public revenues and expenditures by openness to trade and their impact on poverty. Generally speaking, the main result seems to consist in reducing revenues, but neither theories nor evidences supported this idea. Reducing in tariffs may affect negatively poverty because of revenues decline. But, in contrast, trade liberalization increases the size of the pie and by extending the tax base it may have a positive effect on public resources (with different taxes from tariffs, such as Value Added Tax) and, consequently, on poverty. The latter effect is only political, because it depends on government policies and, especially, on those targeted to support the income of poor (e.g., complementary policies to aid poor that are affected negatively by openness to trade).
(5) In a previous paper, WINTERS (2000) identified six trade-poverty links: 1) price changes; 2) factor markets; 3) changes in government revenue and expenditure; 4) changes in risk and vulnerability; 5) effects on economic growth; 6) adjustment strains.
(to be continued)
Author: Emanuele COSTA
Published by: Working Paper