Trade and investment liberalisation has decreased absolute poverty

28Dec 2017
The Guardian
Trade and investment liberalisation has decreased absolute poverty

Industrialization is often essential for economic growth, and for long-run poverty reduction. The pattern of industrialisation, however, impacts remarkably on how the poor benefit from growth.

Pro-poor economic and industrial policies focus on increasing the economic returns to the productive factors that the poor possess.

For example, raising returns to unskilled labour, whereas policies promoting higher returns to capital and land tend to increase inequality, unless they also include changes in existing patterns of concentration of physical and human capital and of land ownership.

Use of capital-intensive methods instead of labour-intensive ones tends to increase income disparities, as does the employment of skill-biased technologies, especially where the level of education is low and human capital concentrated.

Also, the location of industrial facilities has an impact on overall poverty reduction and inequality, as enterprises are often concentrated in urban areas – because of ready access to skilled labour force, better infrastructure, larger markets and technological spillovers.

Industrialization may increase inequality between urban and rural areas. Promoting development of rural non-agricultural activities, like production in small and medium-sized enterprises (SMEs), may decrease this disparity.

The degree of economic openness of a country can have an important influence on its pattern of specialisation and industrialisation. If countries are open to trade they should specialise in the production of commodities in which they have a comparative advantage.

In labour-abundant countries, trade liberalisation would tend to shift production from capital-intensive import substitutes towards labourintensive exportable.

Due to this change, domestic inequality in those countries is expected to decline because of the increased demand for labour, whereas inequality would increase in countries with an abundant endowment of capital.

Liberalisation of foreign direct investment can also decrease inequality in capital-importing countries, but that depends in part on the degree of skill-bias of technologies employed by foreign invested firms.

In several countries, trade and investment liberalisation has, indeed, decreased absolute poverty and sometimes also inequality. Analyzing the determinants of inequality in 35 developing countries and concluded that the phased removal of trade protection in manufacturing reduces the income of “the richest 20 per cent of the population and increases the income of the poorest 60 per cent”.

Examining impacts of increased trade on growth and inequality, changes were found in growth rates to be highly correlated with changes in trade volumes.

No systematic relationship between changes in trade volumes and changes in household income inequality was found, and it wasconcluded that on average greater globalization is a force for poverty reduction.

Still, the impact of trade liberalization is likely to vary between countries, depending for instance on factor endowments, and liberalization creates both winners and losers.

Similarly to international trade, the impact of foreign direct investments on income inequality is likely to vary between countries. Any foreign direct investment (FDI)-inequality relation depends e.g. on the sectorial composition of FDI, its impact on demand for unskilled workers, the skill bias of technical change induced through FDI, and the regional distribution of FDI.

During the past 40 years, the Indian economy has undergone remarkable structural change. The share of agricultural value added in GDP has more than halved between “1965 and 2005, from 45 per cent to 19 per cent”.

Despite structural changes, agriculture still accounts for a veryhigh share of employment. At the same time, the expansion of services has been sizable, with its share of GDP increasing from “35 per cent in 1965 to 54 per cent in 2005”.

 In contrast to many rapidly growing developing countries (especially in East Asia), there have not been sizable changes in the share of manufacturing “(16 per cent in 2005 vs. 14 per cent in 1965)”.

The share of textiles and clothing in manufacturing value added decreased between “1965 and 2000 (from 25 per cent to 13 per cent)”.

The share of machinery and transport equipment was “19 per cent of manufacturing value added in 2000 (roughly the same as in 1965) and the share of chemicals was about the same (up from 10 per cent in 1965), with much of the increase in the 1990s.

In the 1980s and 1990s, GDP growth was moderately strong in India, the compound annual growth rate being ‘5.8 per cent in the 1980s and 5.4 per cent’ in 1990-2002.”

 Growth has been occurring mainly in manufacturing and services. Between “1980 and 2002, the growth rate of manufacturing value-added averaged 6.6 per cent and that of services 7.1 per cent, while agriculture grew at only 2.8 per cent per year.”

 In the 1990s, growth was remarkable in services. High growth has been accompanied by increasing trade flows. For example, during the period 1991/92-2001/02, India’s gross trade flows almost tripled, and the trade-GDP ratio increased from “21.3 per cent to 33.1 per cent.

Growth has been especially rapid in services exports, which grew by 275 per cent, whereas merchandise exports grew by 145 per cent”. The share of manufactures in merchandise exports has been increasing gradually but significantly.

“In 1962, manufactures made up 43 per cent of merchandise exports, while in 2003 the share was already three-quarters. Food exports comprised 11 per cent of merchandise exports in 2003”.

 Within manufactures exports, light industries have significance, especially textiles and clothing. Gems are also important exports. Recently, India has developed significant exports of chemicals, mostly drugs and dyes, and automotive components (Economist Intelligence Unit, 2005a)”.

In addition to rapid GDP growth, a sharp reduction in growth volatility has been important for the Indian economy. In the 24 years after 1980, the standard deviation of GDP growth has fallen to “1.9 per cent”, one reason being the shift in the sectorial composition of output and the decrease in the importance of agriculture.

 According to government estimates, the proportion of poor people in the total population (using national poverty lines) declined from “45.7 per cent in 1983 to 27.1 per cent in 1999–2000” in rural areas, and from “40.8 per cent to 23.6 per cent in urban areas”.

 For the country as a whole, poverty declined from “44.5 per cent to 26.1 per cent”. The widening of regional disparities has, however, been significant. After reforms, per capita expenditure differences between states have increased.

Real wages for agricultural labourers have grown at around “2.5 per cent per year in the 1990s, whereas public sector salaries have grown at 5 per cent per year”, which is one of the reasons for increased inequality between rural and urban areas.

Changes in poverty (during the period 1951-1991) have responded more to rural than to urban economic growth. It is argued that primaryand (informal) tertiary sector growth has had greater impact on poverty than secondary sector growth. Over the long term, the secondary sector has not been a significant source of poverty reduction.

One reason for that is likely to be high inequality in human resource endowments, preventing the poor from participating in the non-farm formal sector, especially in the more skill demanding activities.

As absolute poverty in Tanzania is principally a rural problem, the greatest poverty reduction can be attained by emphasizing rural development, in particular, agricultural development.

In some regions, however, poverty reduction is not possible through investments in agriculture, and employment in manufacturing or services is the only possible way to reduce poverty. The reform process has had clearly beneficial effects on the Indian economy.

Growth rates have been high and growth more stable than earlier. The service sector has expanded particularly rapidly, in terms of both output and exports. Along with economic growth, poverty has significantly declined.

Tanzania’s economy, however, still confronts many obstacles hindering its growth. Limiting factors for development have included: an inefficient legal system and extensive regulations like those of the labour market.

A low savings rate which has limited capital formation; a minor role for FDI, especially when compared to other developing countries; lack of access to finance, especially for small businesses; high tariff levels which restrict competition in domestic markets and hinder the development of potential exporters.

It is important to notice, however, that technological change is not only relevant to manufacturing, but similarly has significant impacts in other sectors of the economy.

A good example of this is increased productivity in agriculture, which has been essential for accelerated economic growth in many developing countries.

According to some analysts, the distribution of income among all people in the world has become more equal over the last two decades.  It has also had negative impacts on income distribution.

During the 1970s, for instance, demand for skilled workers in heavy and chemical industries pushed up domestic wages and increased wage differentials between skilled and unskilled workers.

The validity of official inequality measures has been questioned, however.  These included reduction in tariff levels, tariff dispersion and elimination of major non-tariff restrictions.

Job creation has shifted towards the private services sector, in both highly remunerated activities (financial services, telecommunications, etc.) and activities with low barriers to entry, such as informal commerce and personal services.

However, governments still has a primary role in promoting sustainable economic growth and especially poverty-reducing growth.

In addition to ensuring stability, well-functioning institutions and appropriate legislation (e.g. labour laws), other essential government actions are related to skills formation, technology support, innovation financing, infrastructure development, and provision of a variety of public goods.

All these have an impact on the growth and trade performance of a country. Rapid economic growth as such tends to decrease poverty. Rapid growth may increase income inequality, but this is not inevitable.

Whether or not it does, depends not only on the skill bias of technical change in an economy but on human capital formation measures and on the nature of taxation and expenditure policies.

In addition to promotion of job creating industries and SMEs and supporting the creation of domestic linkages, inequality can be decreased e.g. by subsidized access to education, subsidized housing, progressive taxation or economic asset redistribution like land reforms.

After the early stages of economic development, growth in the industrial sector is, however, essential for sustained long-run growth and poverty reduction.

In the countries studied, the growth of the manufacturing sector has created employment opportunities outside agriculture and, as manufacturing in many of these countries has been – at least at the beginning – intensive in unskilled labour, the poor have benefited.  E N D S.

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