Globalization, Growth & Development
Literature
L1: Winters, McCulloch & McKay (2004)
Trade liberalization and poverty: the evidence so far
Introduction
- Relatively open economies contribute significantly to development
- But there are fears that trade liberalization harms people in the short run (leave the poor
behind)
- This paper examines the evidence about whether developing countries’ own trade
liberalizations have reduced or increased poverty (decompose the link between them)
- Evidence divided into four sections:
o Macro-economic aspects (growth and fluctuations)
o Households and markets
o Wages and employment
o Government revenue and spending
- Concern of this paper is mainly with poverty, not inequality
Economic growth and stability
- Sustained growth requires increases in productivity, and most of the evidence suggests that
TL operates through this route
- But: this link also provides short-run risks for factor owners if productivity increases faster
than output
- The researchers stress out the importance from the existence of markets: trade reforms can
both create and destroy markets
- If the poor are mostly in completely unskilled labor families, while it is semi-skilled labor that
receives the boost, poverty will be unaffected
- Even if favorable in the long run, static gains from trade rely largely on adjusting a country’s
output bundle
- Effects of liberalization on productivity growth is generally strong, and its consequences for
macroeconomic stability are mixed
Does trade liberalization enhance growth and hence alleviate poverty?
- Long run: economic growth is key to alleviation of absolute poverty
- Governments will have scope for stronger redistributive measures
- Liberal trade is usually only one of several indicators of openness used, and one that often
seems to weigh rather lightly in the overall results
- Difficult to establish link between liberal trade regime and income or growth
o Measuring trade is difficult (tariffs, quantitative restrictions, levels of credibility)
o Causation difficult to establish
Actual openness, usually measured by imports plus exports relative to GDP,
is likely to be endogenous
o If you want long-term or permanent effect on growth, TL requires to be combined
with other appropriate policies as well
1
, Encourage investment, allow effective conflict resolution, promote human
capital accumulation
From growth to poverty
- Growth does not have identifiable systematic effects on income distribution
- Openness is associated with significantly higher income growth everywhere except in the top
quintile, and that the greatest effects proportionally are for lower quintiles; that is, openness
appears to be progressive
- Relationship between inequality and growth can be different because you can use data based
on income or based on consumption
- There is an increasing body of evidence that income distribution (and by association,
poverty) determines growth rates (and hence mean incomes)
Simple Hechscher-Ohlin trade theory suggests that in relatively unskilled-labor-abundant countries TL
will relieve poverty. In practice, other factors may need to be considered.
If the unskilled are primarily employed in non-traded sectors, while exports draw mainly on the semi-
skilled, a liberalization accompanied by a real-exchange-rate depreciation could have adverse effects.
Trade liberalization and productivity
- Improved productivity is necessary for sustained economic growth and development
- Thus, for example, if higher productivity reflected declining inputs rather than increasing
outputs, its short-term effect could be to reduce employment and hence exacerbate poverty
- Many studies show that reductions in trade barriers were followed by significant increases in
productivity, generally because of increased import competition
- There are problems with causation: efficiency and exporting are highly correlated because
efficient firms export
The immediate effect of an increase in productivity could be to reduce inputs as well as to raise
output. The net effect on employment will then depend on the relative sized of the output and
productivity shocks and will be influenced by factors such as the flexibility of labor and credit
markets.
Are open economies less stable?
- Macroeconomic volatility is one of the most important sources of risk for all households,
both poor and non-poor
- The presumption is usually that open economies are less stable
- Open capital markets should be associated with smoother consumption but more volatile
investments
- Open goods markets should be associated with greater output volatility
Households and markets
- Treat households are the basic unit over which poverty is defined
o Investigate price changes because of reforms, their effects on consumption and
production of households
2
, - Greatest challenge in poverty assessments: constructing the correct price deflator, i.e.
estimating the price changes appropriate to each household
The transmission of border price shocks
- Extent of transmission may be limited by number of factors: transport costs and other costs
of distribution, extent of competition between traders, functioning of markets,
infrastructure, domestic taxes and regulations
Represent the local price of an importable good (Pml) as:
Pml = Pwr (l+tm) + ym
Pw = world price
r = exchange rate
tm = tariff or tax
ym = transaction costs on importables
For an exportable good (Pxl):
Pxl = Pwr (l – tx) – yx
NOTE: minus and not plus!
These equations illustrate four points:
1. Proportional changes in Pml are smaller than those in tax-inclusive border prices (P wr (l+tm))
a. Proportional changes in Pxl are bigger than those in Pwr (l – tx)
2. Changes in trade taxes t could be (partially) offset by changes in world prices if the country or
countries under consideration are large
3. Correcting exchange rate distortions can have major effects on the prices faced by the poor
4. Changes in border taxes t can be offset or exacerbated by changes in y
The degree of market integration is typically assessed in terms of co-movements in spatial price
spreads – the extent to which prices in different regions (including the border) move in parallel.
Are markets created or destroyed?
- Greater openness can result in a wider variety of commodities being available, or create new
opportunities for production
- The most substantial welfare costs of trade restrictions come from the goods and services
that they exclude from the market and the loss of productive activities that results from that
exclusion
How do households respond?
- To what extend are agents, and the poor in particular, able to protect themselves against
adverse impacts and take advantage of potentially favorable effects?
- Poor households with some subsistence activities, wage employment, self employment and
consumption are potentially jointly determined, so that shocks to one affect the other
- Complementary policy needed to ensure that poorer as well as richer households respond
appropriately (e.g. enhancing access to key inputs, markets or infrastructure)
3
, Do the spillovers benefit the poor?
- One of the main advantages of stimulating agriculture is that it strongly increases demand for
goods and services produced by the poor
- Growth linkages are divided in two forms:
o Production (or inter-sectoral) linkages
Upstream: sector’s demand for factors or intermediate inputs
Downstream: expansion of sector induced investments in processing and
distribution in sectors using its output
o Expenditure linkages: increased incomes in one sector (typically farming) increase
the demand for the outputs, and hence factor inputs, of another sector
o Standard Keynesian multiplier effect
Does trade liberalization increase vulnerability?
- TL typically affect both the means and variances of a household’s sources of income, and
could affect household vulnerability in four ways:
o Changes in mean income
o Changes in the portfolio of activities undertaken by households
o Changes in variability of existing income sources
o Poverty traps
- Poverty traps: actual realizations of bad outcomes may of themselves change the inter-
temporal distribution of income
- Poverty traps: situations in which, once a household falls below the poverty line, it is
impossible for them to escape
Does trade liberalization raise wages or employment?
- In a two factor world, the Stolper-Samuelson Theorem predicts that an increase in the price
of the good that is labor-intensive in production will increase its production and thus
increase the real wage
- Note: even if increases in the prices of unskilled-labor-intensive goods raise unskilled wages,
poverty will be alleviated only if poor households rely largely on unskilled wage earners
Alternative view of labor markets in developing countries: perfectly elastic supply of labor.
In this case the wage will be fixed exogenously by what labor can earn elsewhere and the adjustment
will take place in terms of employment.
Wage inequality
- Skills gap: relative wages between skilled and unskilled labor
- One potentially important dimension of the skills gap is whether openness stimulated
developing countries’ demand for education and acquisition of human capital. Simple
Stolper-Samuelson theory suggests that the returns to skill will decline and with them the
incentives for education
WG1: Winters & Martuscelli (2014)
Trade liberalization and poverty: what have we learned in a decade?
4
Literature
L1: Winters, McCulloch & McKay (2004)
Trade liberalization and poverty: the evidence so far
Introduction
- Relatively open economies contribute significantly to development
- But there are fears that trade liberalization harms people in the short run (leave the poor
behind)
- This paper examines the evidence about whether developing countries’ own trade
liberalizations have reduced or increased poverty (decompose the link between them)
- Evidence divided into four sections:
o Macro-economic aspects (growth and fluctuations)
o Households and markets
o Wages and employment
o Government revenue and spending
- Concern of this paper is mainly with poverty, not inequality
Economic growth and stability
- Sustained growth requires increases in productivity, and most of the evidence suggests that
TL operates through this route
- But: this link also provides short-run risks for factor owners if productivity increases faster
than output
- The researchers stress out the importance from the existence of markets: trade reforms can
both create and destroy markets
- If the poor are mostly in completely unskilled labor families, while it is semi-skilled labor that
receives the boost, poverty will be unaffected
- Even if favorable in the long run, static gains from trade rely largely on adjusting a country’s
output bundle
- Effects of liberalization on productivity growth is generally strong, and its consequences for
macroeconomic stability are mixed
Does trade liberalization enhance growth and hence alleviate poverty?
- Long run: economic growth is key to alleviation of absolute poverty
- Governments will have scope for stronger redistributive measures
- Liberal trade is usually only one of several indicators of openness used, and one that often
seems to weigh rather lightly in the overall results
- Difficult to establish link between liberal trade regime and income or growth
o Measuring trade is difficult (tariffs, quantitative restrictions, levels of credibility)
o Causation difficult to establish
Actual openness, usually measured by imports plus exports relative to GDP,
is likely to be endogenous
o If you want long-term or permanent effect on growth, TL requires to be combined
with other appropriate policies as well
1
, Encourage investment, allow effective conflict resolution, promote human
capital accumulation
From growth to poverty
- Growth does not have identifiable systematic effects on income distribution
- Openness is associated with significantly higher income growth everywhere except in the top
quintile, and that the greatest effects proportionally are for lower quintiles; that is, openness
appears to be progressive
- Relationship between inequality and growth can be different because you can use data based
on income or based on consumption
- There is an increasing body of evidence that income distribution (and by association,
poverty) determines growth rates (and hence mean incomes)
Simple Hechscher-Ohlin trade theory suggests that in relatively unskilled-labor-abundant countries TL
will relieve poverty. In practice, other factors may need to be considered.
If the unskilled are primarily employed in non-traded sectors, while exports draw mainly on the semi-
skilled, a liberalization accompanied by a real-exchange-rate depreciation could have adverse effects.
Trade liberalization and productivity
- Improved productivity is necessary for sustained economic growth and development
- Thus, for example, if higher productivity reflected declining inputs rather than increasing
outputs, its short-term effect could be to reduce employment and hence exacerbate poverty
- Many studies show that reductions in trade barriers were followed by significant increases in
productivity, generally because of increased import competition
- There are problems with causation: efficiency and exporting are highly correlated because
efficient firms export
The immediate effect of an increase in productivity could be to reduce inputs as well as to raise
output. The net effect on employment will then depend on the relative sized of the output and
productivity shocks and will be influenced by factors such as the flexibility of labor and credit
markets.
Are open economies less stable?
- Macroeconomic volatility is one of the most important sources of risk for all households,
both poor and non-poor
- The presumption is usually that open economies are less stable
- Open capital markets should be associated with smoother consumption but more volatile
investments
- Open goods markets should be associated with greater output volatility
Households and markets
- Treat households are the basic unit over which poverty is defined
o Investigate price changes because of reforms, their effects on consumption and
production of households
2
, - Greatest challenge in poverty assessments: constructing the correct price deflator, i.e.
estimating the price changes appropriate to each household
The transmission of border price shocks
- Extent of transmission may be limited by number of factors: transport costs and other costs
of distribution, extent of competition between traders, functioning of markets,
infrastructure, domestic taxes and regulations
Represent the local price of an importable good (Pml) as:
Pml = Pwr (l+tm) + ym
Pw = world price
r = exchange rate
tm = tariff or tax
ym = transaction costs on importables
For an exportable good (Pxl):
Pxl = Pwr (l – tx) – yx
NOTE: minus and not plus!
These equations illustrate four points:
1. Proportional changes in Pml are smaller than those in tax-inclusive border prices (P wr (l+tm))
a. Proportional changes in Pxl are bigger than those in Pwr (l – tx)
2. Changes in trade taxes t could be (partially) offset by changes in world prices if the country or
countries under consideration are large
3. Correcting exchange rate distortions can have major effects on the prices faced by the poor
4. Changes in border taxes t can be offset or exacerbated by changes in y
The degree of market integration is typically assessed in terms of co-movements in spatial price
spreads – the extent to which prices in different regions (including the border) move in parallel.
Are markets created or destroyed?
- Greater openness can result in a wider variety of commodities being available, or create new
opportunities for production
- The most substantial welfare costs of trade restrictions come from the goods and services
that they exclude from the market and the loss of productive activities that results from that
exclusion
How do households respond?
- To what extend are agents, and the poor in particular, able to protect themselves against
adverse impacts and take advantage of potentially favorable effects?
- Poor households with some subsistence activities, wage employment, self employment and
consumption are potentially jointly determined, so that shocks to one affect the other
- Complementary policy needed to ensure that poorer as well as richer households respond
appropriately (e.g. enhancing access to key inputs, markets or infrastructure)
3
, Do the spillovers benefit the poor?
- One of the main advantages of stimulating agriculture is that it strongly increases demand for
goods and services produced by the poor
- Growth linkages are divided in two forms:
o Production (or inter-sectoral) linkages
Upstream: sector’s demand for factors or intermediate inputs
Downstream: expansion of sector induced investments in processing and
distribution in sectors using its output
o Expenditure linkages: increased incomes in one sector (typically farming) increase
the demand for the outputs, and hence factor inputs, of another sector
o Standard Keynesian multiplier effect
Does trade liberalization increase vulnerability?
- TL typically affect both the means and variances of a household’s sources of income, and
could affect household vulnerability in four ways:
o Changes in mean income
o Changes in the portfolio of activities undertaken by households
o Changes in variability of existing income sources
o Poverty traps
- Poverty traps: actual realizations of bad outcomes may of themselves change the inter-
temporal distribution of income
- Poverty traps: situations in which, once a household falls below the poverty line, it is
impossible for them to escape
Does trade liberalization raise wages or employment?
- In a two factor world, the Stolper-Samuelson Theorem predicts that an increase in the price
of the good that is labor-intensive in production will increase its production and thus
increase the real wage
- Note: even if increases in the prices of unskilled-labor-intensive goods raise unskilled wages,
poverty will be alleviated only if poor households rely largely on unskilled wage earners
Alternative view of labor markets in developing countries: perfectly elastic supply of labor.
In this case the wage will be fixed exogenously by what labor can earn elsewhere and the adjustment
will take place in terms of employment.
Wage inequality
- Skills gap: relative wages between skilled and unskilled labor
- One potentially important dimension of the skills gap is whether openness stimulated
developing countries’ demand for education and acquisition of human capital. Simple
Stolper-Samuelson theory suggests that the returns to skill will decline and with them the
incentives for education
WG1: Winters & Martuscelli (2014)
Trade liberalization and poverty: what have we learned in a decade?
4
