In your own way

Do the Poor Benefit from Trade Liberalisation? Why?

Shadlee Rahman*

Abstract

Taking Bangladesh as a case, this article critically looks into trade liberalisation and discusses whether the poor can benefit from it. The Author argues that trade liberalisation can indeed benefit the poor, given the presence of complementary transmission mechanisms. However, in the absence of this, it becomes very difficult to find a causal relationship between the two. The challenge is to find the elements crucial for poverty alleviation both between and within countries to help the weak and marginalised.

 

Introduction and Thesis

‘Openness and trade Liberalisation have been a major component of economic policy advice for the last fifteen years’ (Winters: 2000). So wrote Alan Winters in a discussion paper in 2000.

The analysis of the effects of trade Liberalisation posits an extremely important question from the perspective of both economic theory and the developmental praxis. There are at least three lenses through which this theme could be addressed: firstly, the theoretical construct-what are the transmission mechanisms through which trade Liberalisation impacts on the economy? Secondly, what are the results of this transmission from the vantage point of poverty alleviation in developing countries? Thirdly, what external conditions affect trade Liberalisation policies?

The main argument, in this article, will be that trade Liberalisation can indeed benefit the poor, given the presence of complementary transmission mechanisms. However, in the absence of this, it becomes very difficult to find a causal relationship between the two.

Taking my cue from the above, I will discuss mainly three sets of issues – firstly, defining trade Liberalisation and looking at its connection to poverty through the workings of the various transmission mechanisms. Secondly, a review of how trade Liberalisation has impacted on poverty and income inequality in developing countries using Bangladesh as an example; and thirdly, why and which supportive facilitating policy measures are critically important to making trade Liberalisation-poverty relationship effective.

The choice of Bangladesh as a case study is informed by the high degree of openness of the economy and high levels of poverty which provide a good test case to examine the trade-poverty nexus.

 

Background/Framework

However, before we delve deeper into the aforementioned issues that I have mentioned would form the basis for my argument, it is important to understand a little more about the relationship between poverty and trade Liberalisation.

Indeed, the causal linkage between trade Liberalisation and the state of poverty, both in terms of the level of poverty (absolute poverty), as well as relative distribution of the gains (relative poverty as defined by Gini-coefficient)[1] is one of the most contested issues in contemporary economic literature. If one considers the degree of openness of an economy, one comes up with a rather contradictory and ambiguous finding – Singapore and Haiti are two of the most liberalised and open economies in the world; however, Singapore is one of the richest countries in the world whereas Haiti remains one of the poorest.[2] Evidently, then, the trade Liberalisation-poverty nexus is not a straightforward one.

Winters et al (2004) notes that there is also an issue of short and long run in the context of trade Liberalisation – poverty nexus, pointing out that according to some analysts in the shorter run trade Liberalisation could harm poorer actors in the economy, and that, even in the longer run, successful open regimes may leave some people behind in poverty. This then also brings a time dimension to this nexus.

Section I. Trade Liberalisation: Definition and Transmission Channels Impacting on Poverty

I will now come to defining and discussing the impact of trade Liberalisation on poverty.

Trade Liberalisation can be defined as the opening up of the economy to market forces of competitiveness and globalisation through deployment of a host of standard tools. The salient features of trade Liberalisation include reduction in import tariffs, reducing import duties, removal of tariff dispersion and exchange control deregulation, A common and oft-used indicator of the extent of trade Liberalisation is to measure the extent of global integration through the degree of openness of an economy (defined earlier) that takes into account its trade-dependence as a result of such trade liberalising measures.

Many developing countries traditionally started with pursuing import-substituting strategies. This strategy was informed by considerations such as the infant industry argument that advocated for the need to provide protection, incentives and support to nascent industries in developing economies. These policies, pursued in the 1960s and 1970s by many developing countries, subsequently came under criticism because of their inability to deliver a faster pace of economic growth and higher rates of poverty alleviation. This has been well-documented in the economic literature (Krugman:1993); (Srinivasan and Bhagwati:1999); Bhagwati (2007); Dollar and Kraay, (2002). However, the debate turned out to be a nuanced one.

The Heckschor-Ohlin–Samuelson Theorem, by building on David Ricardo’s comparative advantage theory, points out that countries have diverse factor endowments, and benefit by trading goods that are intensive in the use of factors in which it has abundant supply. Raihan (2008), by referring to Berg and Krueger (2003), identified a number of transmission channels in this regard including- a higher real return to capital in unskilled labour-abundant countries that exploit their comparative advantage; the reduction in rent seeking activities inspired by trade restrictions and access to larger markets, and openness to ideas and innovations that may be generated by openness to trade. The resultant efficiency and productivity gains led to higher growth.

However, not many authors were able to convincingly address the linkages through which trade Liberalisation impacted poverty. Winters (2000) developed the most-quoted theoretical framework where the poverty impact of trade liberalisation is captured through three broad channels. The first is the price channel, whereby price of goods and services produced by the poor are affected as a result of trade Liberalisation. The second channel through which poverty is impacted is through responses by enterprises to trade Liberalisation, which looks at the scope and opportunity of enhancing production through trade Liberalisation. The third channel is through the government, particularly the opportunity of increased income and revenue that trade Liberalisation-induced scaling up creates for government.

The above ideas were further developed in McCulloch et al (2001), who noted that these transmission channels did not result in automatic poverty alleviation and that four further issues were fundamental to overall impact of trade Liberalisation on poverty. The first is economic growth and it is noted that ‘the weight of evidence is that openness to trade is good for growth and growth benefits the poor’. The second point is that support may also be needed for short and medium term costs of adjustments. The third is to address the changing nature of risks and uncertainties originating from the policy of trade Liberalisation. The last issue is the need for complimentary public policy to assist the poor to take advantage of trade Liberalisation policy.

The upshot of the above discussion is that, whilst in theory trade Liberalisation should benefit the poor through factor markets, if other complementary measures are not present, the results could be different from what the theory would suggest. The next section looks at the empirical evidence in view of this nuanced and non-so-straightforward nexus.

Section II. Trade-Poverty Nexus: The Evidence

A large number of empirical-evidence based studies have tried to capture the Trade Liberalisation – Poverty nexus. A reading of this literature shows a lack of consensus amongst researchers that trade Liberalisation has necessarily led to poverty alleviation, not in the least because of interpretative differences.

In terms of the poverty-trade Liberalisation relationship, Dollar and Kraay (2001) finds that the impact of openness in terms of income of the poor was insignificant.[3] Perry and Olarreaga (2006) tried to capture impact of trade Liberalisation on poverty in the context of Latin America and found that ‘observed effects on poverty varied widely across countries where wage and income inequality increased or essentially remained unchanged’. Ravillion (2001) finds that a 1 per cent increase in mean income results in a fall of 2.5 per cent in the proportion of people in absolute poverty. However, the study also showed pro-poor growth is more likely if initial conditions allow the poor the ability to take advantage of the opportunities it generates. Hence, enabling measures and enabling environment in support of the weak is very important.

Raihan (2008) presents an informed review of the literature involving trade Liberalisation – poverty nexus (that deals with panel data for long periods). The author concludes that these studies find ‘no significant links between trade openness and changes in the relative well-being of the poor’ and that ‘cross-country econometric models do not provide any conclusive evidence in favour of the proposition that countries with higher levels of trade Liberalisation are more successful in ameliorating poverty’.

Bandara (2009) made an attempt to find the trade-poverty nexus in the context of South Asia and concludes that ‘there is no unique answer to the question of whether trade Liberalisation reduces poverty or otherwise in the South Asian region.’ For 14 selected Asian countries Mathur (2003) found that trade openness promoted economic growth; however, no significant relationship could be found between trade openness, and poverty and inequality. An interesting study by Topalova (2007) tried to capture inter-district poverty differential as a result of trade Liberalisation and found that ‘trade Liberalisation led to an increase in poverty rate and poverty gap in the rural districts where industries that were more exposed to Liberalisation were concentrated.’

Rodrik (2001) observes that ‘rapid integration into global markets is a consequence, not of trade Liberalisation or adherence to WTO strictures per se, but of successful growth strategies with often highly idiosyncratic characteristics’.

I think that from the aforementioned discussion of the relevant literature in the above section, it is safe to say that, in terms of poverty implications of trade Liberalisation, there is no one single answer- no evidence of robust causal relationship between the two.

Trade Liberalisation-Poverty Nexus: The Bangladesh Case

In view of the absence of any evidence of a robust causal linkage between trade Liberalisation and poverty, and the diversity of experience that the aforesaid literature survey exposes, Bangladesh could be a very good case to test the hypothesis as to whether there is a positive nexus between the two.

Table 1: Custom-Made Table about Trade Liberalisation and Poverty Correlates of Bangladesh

Indicator

1991-92 1995-96 2000 2005 2010
Poverty (National Poverty Line, %) 58.8 51.0 48.9 40.0 31.5

(23.0)

Consumption GINI 0.26 0.31 0.33 0.33 0.32
Income GINI 0.39 0.43 0.45 0.47 0.46
Trade openness (%) 16.8 23.3 26.5 31.3 34.6

(40.0)*

MFN tariff un-weighted import average (%) 47.4 22.3 21.4 16.5 15.0

Estimated 2015 Figures *Source: HIES, BBS (1991-92, 1995-96, 2000, 2005, 2010); Economic review, Ministry of Finance (2002-03, 2007-08, 2015).

Bangladesh began with a highly import-substituting strategy in the 1970s, but begun to pursue a policy of accelerated trade Liberalisation in the 1980s. The trade reforms were mainly pursued under the Structural Adjustment Policy (SAF) and Enhanced Structural Adjustment Facility (ESAF) underwritten by the World Bank in the mid-1980s [(CPD, 1995); Rahman et al (2006); Raihan (2008); Mujeri (2002)]. Quantitative restrictions were done away with and average tariff rates came down significantly (shown in Table 1). In the 1990s, Bangladesh’s trade Liberalisation deepened further. Export-oriented industries, particularly the readymade garments sector, took advantage of zero-tariff import facility for inputs and flourished. At present, Bangladesh, with annual export of USD 30 billion, is the world’s second largest exporter of apparels, employing about 4 million workers, 70 per cent of who are women. As evidenced from Table-1, the degree of openness of Bangladesh economy rose from 16.8 per cent to 34. 6 per cent in 2010, indicating an increasing global integration of the Bangladesh economy through pursuing trade Liberalisation.

The table also shows that Bangladesh experienced a fast pace of poverty reduction –decreasing from 58.8 per cent in 1999 to 31.5 per cent in 2010 (2015:23%). However, there is a significant degree of variation in poverty rates across administrative divisions in Bangladesh – ranging between 24 per cent and 40 per cent of population below the national poverty line (2010). What is also evident from the table that income inequality (GINI) rose between 1991 and 2010 from 0.39 to 0.46. Therefore, in agreement with my main argument, it will be wrong to infer a one to one causation between the degree of openness and movement of aforesaid variables. However, it can be safely said that in the era of trade Liberalisation, Bangladesh had experienced a significant pace of poverty alleviation, but inter-regional disparity remains significantly high.

Mujeri (2002) had tried to establish the nexus between trade Liberalisation and poverty in Bangladesh. In terms of growth, the urban economy appears to have gained from trade Liberalisation through higher growth in manufacturing sector. There is also the issue of short and long run impacts of trade Liberalisation. For example, Raihan (2010), finds that, in the short run there are possibilities of reduced welfare and increased poverty; however, in the long run, resources are relocated towards the more efficient and expanding sector, generating positive outcomes on both accounts.

One will also need to keep in mind that, ‘trade Liberalisation’ is not a uniform concept. There are many elements in trade Liberalisation and the pacing, phasing and sequencing are critical to its success in the context of developing countries such as Bangladesh and particularly, the possible impacts and implications for poverty alleviation. For example, Rahman et al (2006) observes states that ‘partial, rational and gradual approaches to the Liberalisation of trade are not only preferable options for Bangladesh, but are also consistent with many of the arguments put forward by the new trade theories.’

Even in case of export-oriented RMG sector of Bangladesh, which has gained most from trade Liberalisation as part of the restructuring of the global garments industry or as Naila Kabeer (2002) puts it, the ‘new international division of labor’, the wage rates and working conditions have continued to remain poor. To put into context, the minimum wage in the RMG, about USD 65 per month, is below the national poverty line. Indeed, following the Rana Plaza tragedy that killed 1134 people, issues of working conditions under a liberalised trading regime, has come under serious questioning (CPD, 2015). This brings another dimension to the trade Liberalisation – poverty nexus. It is just not the wages or the income distribution which is crucial. The distributive justice and safety and security of workers in export-oriented industries also merit is just as important.

On the other hand, the success of Bangladesh’s apparels sector also owes significantly to the preferential market access it enjoys in major markets as a least developed country (LDC). This brings back the issue I raised in the introduction. It is just not trade Liberalisation policy pursued within the country. Just as important are the policies pursued in the WTO and by developed countries e.g. trade restrictive measures and domestic subsidies. Thus, in accordance with my main argument, the Bangladesh test case would show that there is a need for other supportive measures if developing countries are to have the benefits of a stronger trade liberalisation – poverty nexus.

 

Section III. The Answer to “Why”: Facilitating Factors

The analysis presented in the above two sections clearly show somewhat contradictory results. Now we come to the ‘why.’

From a theoretical construct, it is evident that trade Liberalisation, through the transmission mechanisms of scale and efficiency, should have a positive impact on poverty. On the other hand, cross country studies based on empirical evidence and exercises , fails to unambiguously show that trade Liberalisation benefits the poor, both in the absolute sense (poverty alleviation) and relative sense (reducing income inequality). The results vary across countries – for example, in Latin America, poverty has worsened whilst in others (e.g. South Asia), poverty has come down. Even within countries, across regions, benefits have been uneven.

The message that comes out is inherent in the transmission channels themselves. Trade Liberalisation – poverty nexus is not automatic and is mediated by intermediate variables. Winter et al (2004) articulates this most succinctly. There are risks emanating from trade Liberalisation policies for the weaker sections which need to be addressed. There are both winners and losers from trade reforms. Losers may need to be supported through safety-net  programmes in the short turn and capacity building support in the long-term.

McCulloch et al (2004) draws attention to a number of areas including agriculture, market access conditions and services market where significant initiatives will be called for in the context of the current global trading regime. It should be pointed out that there will be a need for weaker economies to be offered differential treatment and financial and technical support to help their strengthened participation in the global trade sphere.

What emerges from the literature is that, trade Liberalisation per se is not necessarily poverty alleviating and inequality reducing, but with supportive policies and interventions, trade policy could be a powerful ally of pro-poor growth. These supportive measures ought to be both domestic and global. In the domestic arena this relates to investment in economy-wide activities such as infrastructure and education. These are critical to translating comparative advantages potentially created by trade Liberalisation into competitive advantages. In the global arena, this relates to creating conducive environment for strengthened global integration of weaker economies so that they are able to reap the benefits of trade Liberalisation. Support in the form of market access and technology transfer will be critically important.

Conclusion

The preceding discussion proves that trade Liberalisation could potentially be a powerful tool for poverty alleviation and inequality reduction if other complementary and supportive policies, both in the domestic and global arena, are put in place at the same time. In my opinion, therefore, trade Liberalisation is a necessary, but not sufficient precondition, an opportunity rather than a guarantee, for benefiting the poor through employment creation, income augmentation and poverty alleviation. I would agree with the concluding observations made in Winters et al (2004) when they state that trade reform may be one of the most cost-effective anti-poverty policies available to governments. Certainly, evidence suggests that trade Liberalisation can be an important component of a “pro-poor” development strategy. The challenge, then, it seems, is to find the elements crucial for poverty alleviation both between and within countries to help the weak and marginalised.

_________________________

*Shadlee Rahman is studying MA Development Studies at the Institute of Development Studies (IDS) in the UK. He has interned at BRAC Bangladesh and UNDP Bangladesh. 

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Notes

[1] Gini-coefficient is a measure of inequality in income distribution with the range varying from 0 (perfect distribution and 1 (absolute concentration of income).

[2] Singapore’s degree of openness was 368.2 percent and the percentage of people below poverty line was near-zero, whereas for Haiti the corresponding figures were degree of openness of 70.1 per cent with 53.9 percent of population below the poverty line (WDI 2015)

[3] Dollar and Kray (2001) study used data for a large panel of 137 countries, between 1950 and 1999.

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