International Trade and Poverty Alleviation
Clarke Ricks School of Business,
Liberty University
BUSI 690: Policy and Strategy in Global Competition
Dr. Hicks
April 9, 2022
International Trade and Poverty Alleviation
How does trade liberalization affect the poor, and how can they be protected against its
negative short-term effects?
Trade reform has long been part of the arsenal of policies used to promote economic
efficiency, the development of new markets, and growth. Perhaps surprisingly, even after more
than fifty years of trade negotiations, there is still significant protection in the world economy
and thus scope for further benefits once protection is removed. Protection persists because it is
a convenient and nontransparent way for governments to direct economic benefits to
particular groups. Although trade liberalization raises the average standard of living in the
medium term, groups that had been favored by protection will see their incomes decline, and
the resulting restructuring of the economy may create economic dislocations in the short term.
There is increasing awareness that some of those who lose from trade reform might be the
poorest members of society, who have fewer assets to draw on to protect themselves during
hard times, and are thus less able to absorb adjustment costs, than their fellow citizens. Even a
transitory loss of income can cause the poor to lose opportunities to acquire human capital
through education, health care, and better nutrition and thus can reduce their chances of
escaping poverty. The vulnerability of the poor justifies looking more carefully at the effects of
trade liberalization on the poor and asking whether trade liberalization can be designed to
minimize its negative effects.
Liberalization's effects
Trade liberalization can affect the welfare of the poor by
changing the prices of tradable goods and improving access to new products;
changing the relative wages of skilled and unskilled labor and the cost of capital, thereby
affecting the employment of the poor;
affecting government revenue from trade taxes and thus the government's ability to
finance programs for the poor;
changing incentives for investment and innovation and affecting economic growth; and
affecting the vulnerability of an economy to negative external shocks.
Prices and availability of products.
Trade liberalization helps the poor in the same way it helps most others, by lowering
prices of imports and keeping prices of substitutes for imported goods low, thus increasing
people's real incomes. Imported products that might be especially important for the poor
include basic foods, pharmaceuticals and other medical or basic health products, and used
clothing. The poor may also benefit significantly from removal of export taxes or prohibitions,
to the extent that the poor are net producers of exports (as is often true in agriculture). An
open trade regime also permits imports of technologies and processes that can help the poor—
for example, packaging for perishable foods that is light and does not require refrigeration,
chemicals for sterilizing water, and improved seeds and fertilizers. An example of trade
liberalization resulting in tangible and immediate benefits for the poor is the African Summit to
Roll Back Malaria, held in April 2000, at which the continent's heads of state pledged to reduce
or waive taxes and tariffs for mosquito nets, insecticides, antimalarial drugs, and other goods
and services needed for malaria control. There is also some evidence that liberalizing imports of
used clothing can improve the welfare of the poor.
Wages and employment.
Trade theory predicts how trade liberalization will affect wages and employment under
very specific conditions. In practice, these conditions do not often hold, and for a more general
analysis, we have to rely on empirical studies. These suggest at least two factors that will
directly affect the way trade liberalization can change the wages and employment of the poor.
First, how flexible labor markets are will determine whether the effects of trade reform
translate into changes in employment or wages. If firms are constrained by labor regulations
from reducing their workforces, most of the adjustment to changes in relative prices of outputs
will be reflected in changes in real wages. If minimum wage legislation prohibits downward
adjustments in wages but labor mobility is high, however, adjustment will take place through
changes in employment.
In the rural and informal urban sectors (the informal sector is the part of an economy
where businesses are not incorporated or otherwise registered with governments) of
developing countries where the poor live, labor markets usually are highly flexible (being
generally unregulated) and are characterized by a high elasticity of supply for labor. Wages will
generally be determined by the requirements of urban and rural subsistence or the next-best
employment opportunities that are available. Thus, we can expect that adjustment to trade
shocks will take place predominantly through changes in employment. In this case, the costs of
trade reform for the poor may be large, and government assistance may be required to
mitigate their impact.
Second, the initial pattern of protection will have an important bearing on who wins and
who loses when that protection is removed. If the pattern favors unskilled workers in
agriculture and light manufacturing, as was true for Mexico in the early 1980s, then the
removal of protection could be expected to lower the relative wages of these segments of the
labor force.
Government revenues and programs for the poor.
There is a general concern that trade reform may lead to lower government revenues as
trade taxes are reduced and that, in an effort to maintain macroeconomic stability,
governments may cut social expenditures or implement new taxes that could
disproportionately affect the poor. At the initial stages of trade liberalization, however,
replacing nontariff barriers with tariffs and eliminating tariff exemptions will generally increase
government revenues. Similarly, if initial tariffs are prohibitively high, reducing them can result
in higher trade flows, which will increase revenues. Lowering high tariffs also reduces incentives
for smuggling and corruption, which, in turn, can increase the volume of goods recorded at
customs and boost revenues. Finally, simplifying the tariff regime to create a more uniform
structure, with just a few tariff rates, could increase fiscal revenue by increasing transparency
and simplifying tax administration. In the latter stages of reform, however, lowering tariffs may
lead to lower government revenues. In this instance, domestic tax reform (particularly the
introduction of broader-based and less distortionary taxes) or expenditure restraint that may
be required to maintain macroeconomic stability should be designed to minimize their adverse
effects on the poor.
Investment, innovation, and growth.
An important consideration in sustained poverty reduction is whether the country is
experiencing robust economic growth in which the poor can participate. One of the main
channels through which trade reform affects growth is by reducing the anti-export bias of trade
policy and leading to a more efficient allocation of resources. However, this is a onetime gain in
allocative efficiency and need not affect the economy's long-term growth rate. In the long term,
trade liberalization can affect the economy's rate of growth by creating incentives for
investment. In addition, trade reform usually encourages foreign direct investment, with
attendant spillovers of advanced technologies and new business practices that increase overall
productivity and growth in domestic firms.
Recent empirical research (for example, Rodriguez and Rodrik, 1999) suggests that the
relationship between trade liberalization and growth is not straightforward. In particular, the
effects of trade reform on growth depend upon the existence of other, complementary
macroeconomic and structural policies and the creation of appropriate institutions. For
example, in cross-country research, one variable that is consistently related to the rate of
growth is the parallel-market premium on the exchange rate, indicating that exchange rate
overvaluation may be an important inhibitor of growth. The implication is that undertaking
trade reform without implementing appropriate macroeconomic and exchange rate policies (to
improve competitiveness) will be less effective in promoting growth. Thus, a consistent overall
economic package is essential if trade reform and other structural measures are to succeed in
fostering adjustment and growth.
Even when liberalization leads to growth, one concern often raised is that open trade
policies may lead to a pattern of growth that disproportionately benefits the rich, thus
worsening the country's distribution of income. Recent evidence (see, for example, Dollar and
Kraay, 2001), however, casts doubt on this assessment.
Vulnerability to negative external shocks.
Trade liberalization will make an economy more open and deepen its economic integration
with the rest of the world. In many cases, this will help an economy to diversify its exports in
line with its comparative advantages and to become less dependent on single export markets or
products. In addition, integration with foreign markets helps an economy become less
dependent on the domestic market, so that domestic economic downturns are offset by growth
in the international economy. Openness may, however, also make an economy more vulnerable
to external shocks, such as abrupt changes in the terms of trade, that can significantly reduce
growth. If the shocks directly affect certain sectors, such as agriculture or informal production,
they can have significant effects on the poor.
Findings of empirical studies
Because of the complexity of the linkages between trade reform and poverty, the empirical
evidence on trade liberalization and poverty is limited largely to case studies. Some studies use
computable-general-equilibrium (CGE) models to trace the effects of trade reform on the poor.
Winters (2000) reports on a joint Oxfam-Institute of Development Studies study of
liberalization of the cotton market in Zimbabwe during the late 1980s and 1990s that illustrates
the potential effects of liberalization on the poor. Before liberalization, the government was a
monopsony buyer (a sole buyer facing many sellers) of cotton from farmers and used low
producer prices to subsidize inputs into the textile industry, thereby reducing the incomes of
small, poor farmers. Liberalization included elimination of price controls and privatization of the
marketing board. The results were higher prices and greater competition among three principal
buyers, not only on price but also in providing extension and input services to small
landholders.
In Zambia, liberalization of the maize market had the opposite result. Before liberalization,
maize producers enjoyed cross-subsidies, financed by the mining sector, that considerably
lowered the cost of inputs. In addition, small producers in remote areas were implicitly
subsidized by prices, set by a parastatal firm (one funded by the government without formally
being a part of it) serving as monopsony buyer, that were uniform for all seasons and
throughout the country. When the subsidies were removed and the parastatal was privatized,
larger farmers close to national markets saw no effective change in market conditions while
small farmers, and especially those in remote areas, were severely affected by price
fluctuations. In addition, owing to a sharp deterioration in transportation infrastructure, remote
rural markets for corn completely disappeared, leaving poor farmers without formal incomes.
These episodes provide examples of the effects of different types of liberalization. In
Zimbabwe, initial restrictions were analogous to a tax on exports that kept producer prices low
and inhibited competition. The removal of these "taxes" resulted in benefits to net suppliers of
exports. In Zambia, however, the restrictions were analogous to a tariff on imports that results
in a subsidy being provided to domestic producers (and a tax on consumers) of import-
competing products. The removal of the tariff/subsidy resulted in a decline in revenue for
producers of the import-competing products and, at the extreme, the disappearance of
uncompetitive domestic production. A more important distinction between these two cases, as
Winters points out, is that in Zimbabwe liberalization resulted in the creation of markets in
which the poor could participate and an improvement in market performance, while in Zambia
it resulted in the disappearance of functioning markets for the poor's produce.
In general, this study and others have found that, in most cases, trade reform increases the
income of the poor as a group and that the transition costs are generally small relative to the
overall benefits. Nevertheless, there are cases where the short-run effects of liberalization on
the poor and others are negative and significant. Although these negative results cannot be
discounted, it is important to realize that in many cases they have been affected by the initial
patterns of protection.
It is also important to note that most studies assume a short-term perspective in which no
changes in investment or the growth path of the economy can occur. But the more important
gains from liberalization come from dynamic gains, such as more efficient patterns of
investment and technological diffusion. Further, they do not include the effects of
complementary policies that facilitate adjustment to the new free-trade equilibrium. For all
these reasons, the studies are likely to significantly overstate liberalization's costs and
understate its benefits, even for the poor. Over the medium term, changes in investment and
economic growth can significantly exceed the negative distributional effects of changes in
prices that result from trade liberalization.
