Trade and Poverty in the poor countries

Jagdish Bagwati is a professor of economics at Columbia University and a senior fellow of council of foreign relations. He has had a lot of contributions over the past few decades in the fields of trade and economics. In the article of “Trade and Poverty in the poor countries” Bhagwati explores the effects of trade on the poor, i.e. developing countries. Even though the idea of free trade and its benefits to the developing countries has been around for quite some time, the polarization of the people into sides for and against globalization has only recently come into focus. Critics of the globalization and free trade concept argue that free trade increases the poverty levels and both rich and poor countries.

Economists in support of trade liberalization argue that opening up trade and markets for competition only leads to a win-win situation. They argue that trade allows competition to creep in the market, which leads to the local industries improving the production methods and goods quality. This is good for the consumer. They point out that when aiming goods for export, the large costs of production comes down and therefore makes the prices within a large part of the population’s affordability range. This in turn raises the living standards of the population. To reinforce of their case, the success stories of China and India are pointed out. In the past two decades, there has been rapid growth in both trade and poverty reduction in China and India. In essence, the economists in support of free trade link the free trade to poverty reduction as follows.

  • Trade leads to growth of markets and industries of a country
  • Poverty reduction is to follow with the increased growth
  • Hence trade leads to decrease in the poverty levels of the country.

Critics of the free trade argue that the World Bank, IMF and other developing countries preach free trade in order to get larger share in the developing countries markets. They point to the fact that developed countries retained influence and protected their own industries in their infancy and now are forcing the developing countries to open up their markets before their industries are mature enough to compete with the multinationals.

Free trade invites poor countries to specialize in low tech industry and work their way up. This is because the industry to process low tech products is usually already in place. Critics of the free trade argue that free trade policies ensure that developing countries only specialize in areas low growth potential.

Import substitution and export promotion

Poor countries in order to enhance their growth turn to import substitution or export promotion as their strategy for industrialization. Import substitution means that developing countries rather than importing the basic goods they require start setting up industries to manufacture them locally. This requires that the government provide protectionism to the local industries. As far as the theory goes, the import substitution provides some leeway for the infant industries to develop and be able to compete with the international industries in the future. In reality, according to Bagwati the results are opposite to the expected. The lack of competition decreases the quality of good’s production and also provides no incentive for growth.

The other developmental strategy is the export promoting strategy. This strategy involves poor countries crafting their industry development in such a way as to the foreign country’s needs i.e. for export purposes. The countries try to build on to and enhance the industry infrastructure which is already setup in place and in sync with the export demand requirements. This strategy revolves around the promotion of free trade. Bagwati highlights Stolper-Samuelson’s argument in support of this export promotion strategy in saying that “free trade should help in the reduction of poverty in poor countries which use their comparative advantage to export labor-intensive goods” (Bhagwati, 2002). Export promotion is directed towards development of those industries which can potentially compete in the international markets. Therefore as far as the theory goes, if a there is excess of human capital, and the country develops that human capital, according to Bagwati (2002), it can eventually lead to decrease in poverty by reducing unemployment. He points to India and China as the prime example of the success of such a strategy.

Marco-economic stability

Macro economic stability means balanced and controlled macro economic frame works including debt ratios, balanced pricing, and a beneficial fiscal policy in a well functioning economy. Bhagwati (2002) supports macro economic stability and maintains that “If a country wishes to maintain an export promoting, as distinct from import-substituting, strategy, so that it is generally speaking opting for freer trade then it will have maintain macro economic stability. Thus, such macro economic stability must be regarded as endogenous, the policy choice in favor of freer trade.” In an export promoting free trade oriented economy, macro economic stability is the basic requirement for enhancement of trade which leads to growth. Bhagwati (2002) quotes Sir Dennis Robertson as stating “trade as the engine of growth”. Macro economic stability includes low levels of inflation and the presence of a positive trend in the per capita GDP. According to Bagwati 2002, “empirical evidence suggests that inflation hurts poor in the countries” and therefore, by providing macro economic stability, the inflation can be kept at a low level therefore poverty levels can be controlled or even reduced. “Therefore, commitment to an outward oriented trade policy indirectly assists the poor since they are vulnerable to inflation” (Bhagwati, J., 2002)

Immiserizing growth

This term was first introduced by Bagwati in 1958. Immiserizing growth is the phenomenon which leads a country to become worse off than it initially was in terms of economic growth even though it is following export promotion and free trade policy. Opponents of free trade point to this as a case of how poor countries get misled into imbalanced trade agreements which favor the developed countries. If poor and developing economies have an export promoting strategy, and are heavily reliant on their exports for economic growth, then the terms of the trade will deteriorate. Developing countries are exposed to the risk of Immiserizing growth when the international business community places unfavorable demands on the exporting country in the terms of the trade. Bagwati argues through the Arthur Lewis models that if thee is plentiful labor, where growth is focused, then the laborers will achieve beneficial employment. If growth is only occurring in one segment of the population, “then the growth will pass poor by and growth may even immiserize the poor further as when the poor are working tiny plots of land to produce farm products whose prices fall because of the larger farms”. (Bhagwati, J., 2002)

Harrod-Domar growth model

Primarily made use of in the development related economics, this model tries to explain growth in the terms of capital and savings. Harrod -Domar growth model is always compared with Solow-swan model. Trade can affect industry efficiency as well as labor growth. Bagwati implies that according to Harrod-Domar model, if trade only affects the efficiency in the utilization of the available resources and not the labor, even then, “growth rate will permanently be enhanced because of lasting decline in marginal capital output ratio.” (Bhagwati, J., 2002)

To sum up the arguments Bagwati by example of India and China demonstrates the link with trade and growth, and further growth and poverty reduction. He argues that for the past two decades since these countries have opened up their markets fro free trade, high growth rates have been recorded and considerable poverty reduction has been noted.

Reference:

Bhagwati, J. and Srinivasan T.N (2002). Trade and Poverty in the Poor Countries. The American Economic Review, Papers and Proceedings of the One Hundred Fourteenth Annual Meeting of the American Economic Association, 92,180-183.