Trade, Growth and Inequality in the Era of Globalization
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Trade, Growth and Inequality in the Era of Globalization

Kishor Sharma, Oliver Morrissey, Kishor Sharma, Oliver Morrissey

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Trade, Growth and Inequality in the Era of Globalization

Kishor Sharma, Oliver Morrissey, Kishor Sharma, Oliver Morrissey

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About This Book

In recent years, globalization has been the subject of considerable research and comment. A major phenomenon, it is open to a variety of interpretations. In particular, the debate over trade liberalization, growth and inequality has come under close scrutiny as demonstrations against globalization have gathered pace.

This volume provides a much needed comparative study of the link between globalization, growth and inequality. It assesses how globalization affects growth, inequality and poverty in developing and transition countries. Paying particular attention to eleven low and middle income countries, the authors argue that globalization can actually help reduce poverty and inequity when institutions and physical infrastructures are efficient. Divided into four parts, the book documents the lessons drawn from case studies on Africa, Latin America and Central Asia.

A fascinating book which sheds light on many globalization issues, Trade, Growth and Inequality in the Era of Globalization will be of interest to students and researchers of development economics, globalization and international trade.

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Publisher
Routledge
Year
2006
ISBN
9781134261833
Edition
1

Part I
Introduction

1 Trade, growth and inequality in the era of globalization

Kishor Sharma and Oliver Morrissey

The second half of the twentieth century witnessed major developments in international politics and economics. The creation of international institutions (such as the United Nations (UN) system, World Bank and more recently World Trade Organizations (WTO)), the fall of the Berlin wall and collapse of the former Soviet Union (FSU), and widespread removal of barriers to trade and investment by the majority of countries are diverse examples. These developments have promoted greater integration of the global economy, reflected in increased mobility of goods, people and capital between countries. Together with developments in transport and especially communications, this has significantly increased economic interdependence among countries, leading to an unprecedented growth in world output and international trade. For example, from 1947–97, world output grew sixfold whilst international trade increased 16-fold. In common parlance the term ‘globalization’ encompasses all of these developments, and the beneficial and adverse effects associated with them. Globalization is a major phenomenon, open to a variety of interpretations and the subject of considerable research and comment. This volume concentrates on one element of globalization, trade between nations, and uses case studies to attempt to assess how increased trade affects growth, inequality and poverty in developing countries (although some of the countries included may be called transition countries, we adopt the more general term developing).
Something of a consensus has emerged that to address deep poverty in developing countries, achieving sustained higher economic growth is essential (but perhaps not sufficient). A key question is then how to accelerate and sustain higher economic growth. The experience of many countries suggests that achieving higher economic growth through an inward-oriented development strategy is unsuccessful, either because the country has a small domestic market or because inward-orientation promotes inefficiency, or both. It has been argued that creating an incentive for efficient utilization of resources is a key to sustainable growth and an outward-oriented development strategy is conducive for creating such an environment (Easterly, 2001; Srinivasan, 2001). When there is an incentive for efficient utilization of resources, resources are deployed in line with a nation’s comparative advantage, leading to efficiency gains. This can help to sustain higher economic growth and lift millions of people out of poverty, as suggested by comparing the experience of growth and poverty reduction in East Asia to the stagnation and increasing poverty in Africa since 1970 (Sala-i-Martin, 2002).
Trade liberalization can contribute to this process, increasing efficiency both by reducing price distortions and by increasing incentives for competitive producers. The economic benefits may be limited in the short run, as domestic producers face increased competition from imports and exporters need time to respond to new market opportunities. The econometric evidence linking trade liberalization to growth must be interpreted with caution (Rodrik, 1999), although the evidence linking exports and growth is strong (Greenaway et al., 1998). Furthermore, there is very little evidence that trade reduces growth, although liberalization can create balance of payments problems in poor developing countries (Thirlwall, 2003). Trade liberalization is generally a desirable economic policy reform, but it does not guarantee growth and any impact on an economy is conditional on the initial economic structure and the prevailing policy and institutional environment.
Mainstream economists argue that developing countries have a comparative advantage in unskilled labour-intensive products and an outward- oriented development strategy creates an environment for increasing the production of such products, leading to an increase in demand for unskilled labour. This in turn will alleviate poverty by increasing the real income of the poor and increasing the growth rate (Sharma, 2003). More rapid growth means more revenue, which will enable the government to spend more on social welfare programmes, increasing the access of the poor to basic services. However, the ability of second generation (post- 1980s) liberalizers to increase their exports of labour-intensive products is limited, mainly due to low supply-side elasticities and restricted access to the rich countries’ markets, particularly for textile, clothing and agricultural products in which they have a comparative advantage. The supply- side elasticity is low due to fragmentation of the local product and factor markets, as well as low levels of physical infrastructure and human capital. To address the lower levels of human and physical capital, poor countries need investment in these areas but they lack financial resources to do so. Ironically, international assistance is on the decline. In real per capita terms, net official development assistance (aid) disbursements to poor countries fell by 46 per cent between 1990 and 2000 (UNCTAD, 2002). This drop in aid may have reduced gross domestic investment in poor developing countries (see Table 1.3 below), making poverty alleviation a more challenging task.
Even if developed countries continue to maintain protection, it does not mean that developing countries should follow the same path. Development experience has shown that barriers to trade and investment retard growth through inefficiency and rent-seeking behaviour and result in a large welfare loss (it may be that rich countries are better able to absorb this cost of protection). Developing countries should not postpone liberalization reforms just because they lack efficient institutions or infrastructure or because developed countries continue to maintain protection in sensitive sectors. Globalization, however defined, is an actual phenomenon–it is happening and individual countries must react to this changing environment (Basu, 2003).
Few countries engage in trade reform in isolation, and typically they undertake a variety of macroeconomic, trade, exchange rate, price and fiscal reforms together (see Greenaway and Morrissey, 1993). Consequently, it is very difficult to disentangle the effects of a particular policy on growth or poverty, or on other performance measures. For example, devaluation and removal of subsidies could worsen welfare and increase poverty in the short run, by increasing the prices of goods and services that the poor consume, even if associated trade reforms aim to increase returns to productive activity. In principle, a coordinated structural adjustment programme (SAP) can mitigate these adverse effects, although the success of SAPs is debatable to say the least (e.g. McGillivray and Morris- sey, 1999). The idea is that domestic economic adjustment, following the policies that rich countries have long had (Bhagwati, 2004: 223), facilitates the efficient response of the economy to the improved incentives associated with trade reform. Aid donors like the World Bank provide resources to support adjustment, but SAPs have paid insufficient attention to mitigating the social problems arising in the process (Stiglitz, 2002; Nayyar, 2002). ‘Regrettably, the World Bank, which is crippled now by overreach into everything under its so called comprehensive development strategy, appears to suffer from a lack of appropriate prioritization’ (Bhagwati, 2004: 236).
The experience of the East and South Asian countries over the past few decades suggests that countries that engage with global integration grow fast and thereby reduce poverty. For example, in the last four decades Asia as a whole has doubled its share in world income–from 12.1 per cent in 1960 to 25.9 per cent by 2000–mainly through a superior growth performance in East Asia initially and China and India more recently (Table 1.1). As income grew, at least in part owing to economic liberalization, poverty fell. In Africa and Latin America, however, poverty rose because growth rates were not fast enough to increase savings and investment. As a result, their shares in the world income either fell, in the case of Sub-Saharan Africa (the one region of the world where living standards are probably lower now than they were 30 years ago), or rose marginally in the case of Latin America (Table 1.1).
The East and South Asian experience also suggests that efficient institutions, infrastructure and good governance are crucial to benefit from global integration. The high performing East Asian countries have been committed to develop these essential ingredients of the market economy. Effective institutions provide support services to the losers to move from one economic activity to another by way of training and market information, and facilitate increases in economic efficiency (World Bank, 2003). Good governance is associated with sound macroeconomic policies and a sound legal system. These are essential ingredients for the operation of a market economy, but market failure is widespread in poor countries. For example, market failure can occur when people do not have the basic skills that are acquired through education and training, or where there are inefficient infrastructure and institutions (Stiglitz, 2002; Nayyar, 2002). Weak institutions are not only a cause of market failure, they also undermine the ability of government to address such failures. Consequently, weak institutions undermine the ability of governments to implement reform and to support sectors of the economy in responding to reform. Institutions also mediate how the effects of reforms on the economy are distributed, and especially whether any benefits accrue to the poor.
Table 1.1 Regions’ shares of world income and population (per cent).
The possible linkages between trade liberalization, growth and poverty are many and complex. International trade provides access and exposure to a global market that is very competitive, so success in exporting or competing with imports requires increased efficiency in producing high quality, niche or price competitive goods. The major share of the benefits from trade for any economy will accrue to those households owning the factors that are most in demand, and these are not necessarily the factors in which the economy is best endowed. In principle, increased global trade should benefit unskilled labour in developing countries as that is the factor they have most of. In practice, however, the need to be competitive often means that it is relatively skilled labour that is most in demand. In general, poor households do not own factors that are in demand (and that is one reason why they are poor), their labour is the most unskilled and they rarely own land or capital. This does not mean that trade cannot benefit the poor, but suggests that benefits will tend to be indirect (perhaps via growth) and that the poor will derive the least direct benefit from trade. Insofar as trade expansion fuels economic growth, aggregate demand in the economy increases and this benefits all.
In the short run, and in general, there will be winners and losers from trade liberalization. Producers and those earning their incomes in expanding sectors (typically exporting) will gain, whereas those earning incomes in contracting sectors (typically import-competing) will lose. From the perspective of households as consumers, however, trade is generally beneficial as it should mean that a greater variety of products are available at lower prices and/or higher quality. Trade therefore has interacting effects on households, some good and some bad, depending on their consumption pattern and the sector in which they are employed.
It is not therefore so surprising that evidence on the effects of trade on incomes and the poor is quite mixed (see Cornia, 2004; Shorrocks and van der Hoeven, 2004; van der Hoeven and Shorrocks, 2003).
Trade liberalization should not be confused with trade performance. Trade performance is an outcome; policy is only one factor affecting the outcome, and it is the outcomes that in turn affect growth and poverty. Trade liberalization is a policy input that influences the outcome by altering relative incentives. The performance outcome depends on the ability of agents and sectors to respond to these altered incentives, and this in turn depends on characteristics of the economy. Although countries’ characteristics and conditions are varied, it seems obvious that globalization works better in countries with efficient institutions, infrastructure and good governance. In determining the speed of reform these country- specific characteristics have to be recognized. ‘While globalization can bring economic and social benefits once the transition to it is made, this leaves open the question of how rapidly the transition to globalization should be made. Indeed, some of the hostility to globalization stems not from globalization per se but from the speed with which it is pushed as policy makers liberalize trade, capital flows, and so on, and to the occasional lack of institutional mechanisms to make such a transition smooth’ (Bhagwati, 2004: 898).
In this context, this volume aims to improve our understanding about the links between trade, growth, inequality and poverty in developing countries using a case study framework. An increasing number of studies have examined the links between growth, inequality and poverty–some cross-country, some country specific, some including trade and some not–although the findings are often contradictory or weak (see Cornia, 2004; Shorrocks and van der Hoeven, 2004; van der Hoeven and Shorrocks, 2003). To the extent that trade liberalization is an indicator of economic policy reform in which distortions are reduced and market incentives increased, it should be growth promoting. In general, one expects poverty to be higher if growth is lower. However, there is only very weak crosscountry evidence that trade liberalization is associated with poverty reduction (Mbabazi et al., 2003).
Even if the findings of cross-country studies about the links between trade, growth and poverty are not contradictory, they have limited use for policy formulation in individual countries. This is because such studies ignore the country-specific features and assume that structural parameters are constant across the countries in the sample (Srinivasan and Bhagwati, 1999). Cross-country studies provide only a partial picture of the effects of market-oriented policy on the poor because the same reform may have different effects in different countries, hence ‘average’ results can provide only a rough guide to the impact of reform on the poor. Although the East Asia experience suggests that trade liberalization is conducive to growth and poverty alleviation (Sharma, 2003), the findings can’t be generalized to other regions. Case studies of a large number of countries from different backgrounds may provide a better insight into the complex links between trade, growth and poverty, taking into account each country’s structural and institutional features. This volume does so by bringing together case studies from Africa, Latin America and formerly central planned Asian countries. We limit our case studies to 11 countries, all of which have gone through market-oriented reforms to different degrees and at different points in time, but these can be seen as complementing the 11 Asian countries covered in Sharma (2003).

Characteristics of the sample countries

For the world overall, indicators of living standards have improved significantly over the past few decades. For instance, using world averages, life expectancy improved from 58 years during 1970–75 to about 67 years during 2000–05, infant mortality per 1,000 live births fell from 96 in 1970 to 56 in 2002 and adult illiteracy rates halved, from 45 per cent in 1970 to 22 per cent by 2002 (Table 1.2). While these overall achievements are pleasing, they are not evenly distributed across countries and achievements in the area of poverty reduction is far from satisfactory, particularly in developing countries. For example, almost one third of the people in developing countries live in poverty and cannot meet their basic needs. About 840 million people suffer from malnutrition and about 230 million children have no access to schooling.
Table 1.2 gives an overview of the diverse experiences of the countries included in our sample. Some such as South Africa and the Latin American countries are near or above the world average on most indicators in the 2000s. Others, such as Ethiopia, Myanmar and Uganda are below the world average on most indicators. Most have shown significant improvements in all indicators since the 1970s, the exception being life expectancy, which deteriorated in Kenya and South Africa. Most countries experienced a large fall in gross domestic investment as a percentage of GDP during 1990 to 2000, except for Ethiopia and Myanmar (Table 1.3). When investment is falling it is difficult to develop and maintain the institutions and infrastructure crucial for growth. This is a matter for concern as trade liberalization typically required efficient institutions and infrastructure to accelerate growth. Growth performance has generally been poor, especially in the 1990s (Table 1.4). The Central Asian countries experienced negative growth in the 1990s, and for Kenya per capita income declined. However, others such as Uganda and Myanmar appear to have done quite well in the 1990s.
There are considerable inter-regional and inter-country differences in the incidence of poverty among our sample (Table 1.5). Poverty is extremely high in Africa, with the exception of South Africa, but relatively low in Sri Lanka, Central Asia and Latin America (excluding Bolivia). This confirms the pattern for non-monetary indicators in Table 1.2. Levels of per capita income and its distribution vary significantly between the countries (Table 1.6). Income inequality (as shown by the Gini coefficient) tends to be highest in Latin America (a well-known phenomenon), and a feature of our sample for other regions is that countries with lower per capita income have lower income inequality. The association between the high per capita income and high inequality suggests that growth may only benefit a minority of the population. However, empirical evidence suggests no systematic relationship between economic growth and inequality within countries (e.g. Ravallian, 2004), although inequality may help to explain growth across countries (higher inequality being associated with lower growth). Insofar as trade and trade reform alter the relative returns to owners of factors of production, such as skilled versus unskilled workers, it may affect inequality (at least wage inequality). This is one way in which trade may affect poverty, by increasing the incomes and income- earning opportunities of the poor (...

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