The Background Of Trade Liberalization Economics Essay

Introduction

Openness and trade liberalization is now regarded as the key component of a nation’s economic growth and aggregate economic well being. Moreover, they are considered to have been the central to remarkable growth of the industrial countries since the mid 20th century. Yet, the continued existence of the widespread and abject poverty in truth represent the greatest failure of the contemporary global economy and the greatest challenges it faces as we enter the 21st century. It also raises some question regarding the claim that trade liberalization promotes growth and poverty reduction because given the massive trade liberalization in the last twenty five years; the global economy should have been able to successfully outrun the poverty. Yet this is not happening, at least not equally for the all the countries and region, like- Asia where still, despite the remarkable economic growth, almost two thirds of the world’s poorest population lives.

Within the development community, one of the most contentious areas of debates is now this linkage between trade liberalization and poverty where the critics and advocates both have some valid points in support of their arguments. Well known classical economists, David Ricardo and Adam Smith believes that free trade leads to economic prosperity of civilization and they have cited the growth of Egypt, Greece and Roman Empire as some example of the positive impact of trade liberalization. Also Modern economists, in favor of the trade liberalization argues that free trade helps to create jobs and thus reduce unemployment, makes import of capital goods easier and provides wide variety of choices to consumer in the marketplace which helps to improve efficiency and the standard of living. It also helps in technological and knowledge spillover, thus reducing the R&D cost of the developing countries. Moreover access to wider market and more diverse exports reduces the risk of trade volatility and exclusion of particular country markets. According to the critics, however, trade liberalization leads to an increase in poverty and inequality because it creates the proliferation of low-wage jobs and higher food prices (International Forum on Globalization, 2001), increasing the dependence of the poor countries

Nevertheless as one o the leading trade economists Robert Feenstra has pointed out – “Few economists would doubt the beneficial effects of trade, despite the adverse impact on some groups. Yet the hard evidence supporting such gains from trade-either in a dynamic or static sense-is surprisingly thin. (Feenstra, 2001)”

Following this line of argument the goal of this research paper is to find cross country empirical evidence on how poverty alleviation is affected by trade liberalization in Asia and also prove that for some countries only trade liberalization might not be enough but they probably need a few complementary reforms in order to take advantage of international trade. Some of such complementary reforms can be – investment in health and education, infrastructure development, law & order situation and so on.

Background of Trade Liberalization

Although free trade among the countries of the world has long history but its liberalization on a formal note started slowly after the 1960s. Because of the history of colonial territory of Africa and Asia, for the LDC’s in these regions, promotion of primary and secondary exports has always been considered a major ingredient in any viable long-run development strategy. The export success of the Asian Tigers has also provided impetus to the claim of the benefit of free economy for the LDC’s growth. During 1950s and 1960s due to a decline in world markets for primary product the developing countries experienced a balance of payment deficit and started considering import substitution strategy as the basis for achieving the desired development. But many countries pursuing this policy ran into severe external difficulties. During this difficult period some international organizations like – IMF and World Bank offered a rescue package, more widely known as Structural Adjustment Program through which they became the messengers of a new visions that countries were pushed to adopt. Thus the late 1960s witnessed a decisive shift in the policy away from import substitution and in favor of outward orientation.

Before initiating the liberalization process the influential countries of the world wanted the presence of a formal institution to preside over the matter and lend a hand to iron out the potential difficulties that might arise. Thus, after the Second World War, with a goal to ensure stable trade and economic environment, under the Bretton woods System a third institution was created to handle the trade side of international economic cooperation and GATT came into existence in 1947. The main purpose of GATT was to reduce tariff internationally to facilitate free trade. GATT was, however, ill equipped to deal with the more complex trade world, so in 1994; through a series of negotiation under the Uruguay round World Trade Organization was founded with the goal to open trade for the benefit of all. In 1995, twenty-two countries from the Asian continent became a member of this organization with the goal to use trade liberalization as an engine for growth and development. Up until the year 2000, main focus of WTO was only on trade but during WTO’s Doha Development Agenda, the Millennium Development Goal was established with a target of reducing the poverty by 50% by the year 2015 and this goal has successfully linked the poverty to the trade reforms and successfully involved the WTO with World Bank in achieving this goal.

The above discussion clearly indicates that most of the country, either willingly or unwillingly, started the process of trade liberalization after 1960s. However, the impact of this liberalization has been very different for each country. As the following graph shows, during 1980s, poverty measuerd by poverty headcount ratio in East Asia was quiet high and even exceeded that of South Asia. In 1993, the ratios were very close to each other but the scenario in 2008 shows a drastic change. This obiviously raises the question that even after starting their (East Asia and South Asia) journey with WTO at the same time, what factors contributed these large differences in poverty reduction?

Source: World Development Indicators (World Bank)

Literature Review

According to the famous Stolper-Samuelson theorem the abundant factor should see an increase in its real income when a country opens up to trade. So this indirectly also implies that if the abundant factor in developing countries is unskilled labor, then the poor (unskilled) in developing countries have the most to gain from trade.

Following this theorem, Krueger (1983) examined the of trade on poverty more directly, found out that although the manufacturing sectors of the developing countries’ were labor-intensive, they benefited very little from the freer trade policies.

Hertel, Perckel, Cranfield and Ivanic (2001) used international cross section consumer analysis for 1996 of developing countries in Asia, Africa and Latin America and found that the impact of trade liberalization has been very different between these countries. For some, it has helped to reduce the poverty but for others it has increased the level of poverty. Also, Fane (2006) concluded from that the reduction to the barriers to trade has indeed accelerated the economic growth but it has benefited the non poor.

Winters and McKay (2004) suggested that trade liberalization almost certainly requires combination with other appropriate policies.

Akapaiboon (2010) examined the link between Thailand’s economic growths with trade liberalization and found that it helped the economy by expanding the manufacturing sector and reducing the agricultural output but only because of the labor mobility between the sectors was possible.

Bhasin and Obeng (2007), from their study on Ghana, found that trade liberalization only reduce poverty when it is accompanied by an increase in aid.

By examining a panel of 30 African countries, Goff and Singh (2013) finds that trade openness tends to reduce poverty in countries where financial sectors are deep, education level high and governance strong.

Methodology:

Since the objective is to examine the impact of trade liberalization on the poverty alleviation and find out the complementary measure needed to take advantage of the liberalization, so for this purpose a panel of 22 Asian countries has been selected. These countries has been chosen on the basis that all of them have joined the WTO in 1995 and thus the implicit assumption is that each and every one have embarked the journey of trade liberalization together, but the magnitude might be different.

Following the same approach and a similar model as Goff and Singh (2013), we take poverty as the dependent variable. As we know, absolute poverty means the number of people who are living below a specified minimum level of real income or international poverty line. One way of measuring this absolute poverty is to use the poverty headcount ratio, which measures those numbers of people whose income fall below the absolute poverty line. Although some other measures of poverty like- poverty gap, human poverty index and the foster-gree-thorbecke measure, etc. but the purpose of these paper will be well served with a use of poverty headcount ration at $1.25 a day (PPP).

Now to find out the complementary measures needed to take advantage of the trade, we are going to consider the following independent variables- trade openness, financial sector (inflation, private credit/ GDP, aid dependency or aid flow/ GDP), Education or Human Capital Development, Governance (Law & order situation), Infrastructure development. Here also the assumption is that if these sectors are developed then country will be able to reallocate the resource to the more productive sectors. For example- if people are educated then they would take less time to acquire a new skill and adjust to a new environment, similarly if the law & order situation is stable then investors would feel secure to invest and the economy would flourish which in turn will create more employment opportunities.