Trade and Poverty Is There a Connection

Unfortunately while the arguments of the previous
paragraph seem very plausible, they are very case-specific.
Gender and intergenerational issues must be taken
seriously, and the consumption and incomes of individual
household members may be important in assessing
poverty. But no robust and general approach to predicting
the effects or even to analyzing them has emerged to
date. Thus other than noting that, along with the points
in the previous subsection, the gender/intergenerational
issues call for attention and flexibility in the application of
the basic results, it is difficult to specify how to proceed.
Finally, of course, information on intra-household
distribution is difficult to obtain. Since it is almost
impossible to disaggregate consumption across
household members, it is likely that the best approach to
these issues will call on physical indicators e.g. health or
nutritional status, and time allocation data.
C.Price changes and the transmission of shocks
The direct effects of a price change: the distribution
sector
I start by considering a change in the tariff facing a
single good. Figure 2, adapted from Winters (2000b),
summarizes the way in which such shocks might work
through to the variables determining household welfare
in a target country. Schematically, for any household the
figure comprises five columns of information. The
elements concerning distribution lie in the middle of the
figure where I trace the transmission of price shocks from
world prices through to final consumers (in the
rectangles), and briefly describe the factors influencing
the extent to which shocks at one stage are passed
through to the next.
Consider the transmission of price shocks in pure
accounting terms. For an import, the world price of a
good, the tariff it faces and the exchange rate combine to
define the post-tariff border price. Once inside the
country, the good faces domestic taxes, distribution from
the port to major distribution centres, various regulations
which may add costs or control its price and the possibility
of compulsory procurement by the authorities. I refer
loosely to the resulting price as the wholesale price.
From the distribution centre the good is sent out to
more local distribution points, and potentially faces more
taxes and regulations. In addition at this point, co-ops or
other labour-managed enterprises may be involved. It is
useful to distinguish these because their behaviour in the
face of shocks could be significantly different from that of
commercial firms. I term the resulting price the retail price,
although of course market institutions may well not
resemble retail outlets in the industrial economy sense.
Finally, from the retail point, goods are distributed to
households and individuals. Again co-operatives may be
involved, plus, of course, inputs from the household itself.
More significantly, the translation of price signals into
economic welfare depends on the household's
characteristics—its endowments of time, skills, land,
etc—technology and random shocks such as weather. The
last two are important conceptually, because anything
that increases the household’s productive ability permits it
to generate greater welfare at any given price vector.
47
A corresponding taxonomy can be constructed for
export goods, starting at the bottom of the column. An
export good is produced, put into local marketing
channels, aggregated into national supply of the good
and finally sold abroad. At each stage the institutions
involved incur costs and add mark-ups, all of which enter
the final price. If the export price of the good is given by
the prevailing price on world markets, all such additions
come off the farm-gate price that determines household
welfare.
In determining the effects of world price or trade
policy shocks on poor households it is vital to have a clear
picture of these transmission channels and the behaviour
of the agents and institutions comprising them. For
example, sole buyers of export crops (i.e. those to whom
sellers have no alternative) will respond differently to price
shocks than will producers’ marketing cooperatives.
Regulations that fix market prices by fiat or by
compensatory stock-piling can completely block the
transmission of shocks to the household level.
5
Even more important, all these various links must
actually exist. If a trade liberalization itself—or, more likely,
the changes in domestic marketing arrangements that
accompany it—lead to the disappearance of market
institutions, households can become completely isolated
from the market and suffer substantial income losses. This
is most obvious in the case of markets on which to sell
cash crops, but can also afflict purchased inputs and
credit. If official marketing boards provided credit for
inputs and against future outputs, whereas post-
liberalization private agents do not, no increase in output
prices will benefit farmers unless alternative borrowing
arrangements can be made.
The importance of transmission mechanisms is well
illustrated by the contrasting experience of markets in
Zambia and Zimbabwe during the 1990s—Box 1
(Oxfam—IDS, 1999). In Zambia, the government
abolished the official purchasing monopsony for maize;
the activity became dominated by two private firms which
possibly colluded to keep prices low and which
abandoned purchasing altogether in remote areas. Even if
the latter was justified economically in the aggregate, it
still left remote farmers with a huge problem. This was
exacerbated by the difficulties of their re-entering
subsistence agriculture, given that the necessary seed
stocks and practical knowledge had declined strongly
during the (subsidized) cash-crop period. In Zimbabwe, by
contrast, three private buyers for cotton emerged after
privatization, including one owned by the farmers. Here
the abolition of the government monopsony resulted in
increased competition and prices and farm incomes rose
appreciably. In a less extreme example Glewwe and de
Tray (1989) show how transport and storage costs
attenuated price changes of potatoes following
liberalization in Peru.
The discussion above prompts three comments. First,
and blindingly obvious, is that the effects of liberalization
depends on where you set off from. If an import ban plus
government monopoly subsidizes remote farmers, the
first round effects of liberalization will be to hurt those
groups.
6
A second important example of this, based on
the analysis of section D below, comes from Hanson and
Harrison (1999). They suggest that Mexico’s trade
liberalization in the 1980s has not boosted the wages of
unskilled workers as many had expected precisely because
its initial pattern of protection was designed to protect
that group. In short, the analysis of the poverty impact of
trade liberalization can be no more general than is the
pattern of trade restrictions across countries.
Second, usually many goods are liberalized at once, so
that the effects on individual households will be the sums
of many individual shocks. When some of the goods
affected are inputs into the production of others, the net
effect is quite complex and it is important to consider the
balance of forces. For example, Zambian liberalization
raised the selling price of maize in the 1990s, but even
where purchasing arrangements continued, input prices
rose by more as subsidized deliveries were abolished; as a
result, maize farming generated lower returns and output
fell. (Oxfam—IDS, 1999).
Indirect effects and the domain of trade
Third, we need to know how the household will
accommodate the price changes. This will first condition
our view of how serious the shock is: an adverse shock
may entail large losses of welfare if no alternative goods
or activities exist, or relatively small losses if they do.
Similarly positive shocks may deliver great benefits if
households can switch their purchases or activities to take
advantage of them.
An additional aspect of accommodating a shock is
that the act of substituting one good or activity for
another necessarily transmits the shock to other markets
which may not have been directly affected by a trade
reform. Thus it sets off a whole series of second-round
effects. A critical consideration in assessing these effects
is the domain over which the 'second-round' goods or
services are traded, because this defines the range of
agents whose behaviour will be altered as these markets
come back into equilibrium. The trading domains are
summarized on the far right of Figure 2.
The border price of a good that is traded
internationally will be largely if not entirely determined by
the world price. Hence putting aside any changes in the
various margins identified above, the prices of such goods
will not change further as the market equilibrates to a
shock. That is, there will be no ‘second-round’ price
effects because, in effect, with a world market, all
producers and consumers in the world will adjust their
behaviour a tiny amount to absorb the changes in the
target country.
For goods that are traded on a national market, but
not internationally, the second-round quantity shocks will
be spread over the whole of the national economy; this
too will probably display sufficient elasticity to absorb
48
5
Lest blocking price transmission seems automatically a good thing, remember that many shocks are positive and that official bodies have
a tendency to take a cut out of the price in return for providing the 'service' of insulation.
6
Second round effects could, of course, be positive
—
see below.
49
Box 1: Markets
—
better, worse and missing
The over-riding conclusion of the field research described in Oxfam
—
IDS (1999) and Winters (2000a) is the critical role of
markets in determining the poverty impacts of trade and other liberalizations. Where conditions for the poor have improved
this has usually been associated with the better performance of and access to markets. Where they have worsened, faulty
markets are generally to blame and in the extreme cases, the problem is often missing markets.
We illustrate this with two cases deriving from trade and associated reforms over the early nineties in Zimbabwe and Zambia.
Cotton in Zimbabwe:
Despite the hesitant and partial nature of formal liberalization policiesin Zimbabwe, there appeared to be a substantial
improvement in market outcomesover the period 1991-97, including an increase in competition in the cotton market
(Table1). Before the reforms, the Cotton Marketing Board used its monopsony to impose low producer prices on farmers in
order inter aliato subsidize the textile industry. In absolute terms, the impact will have been greater for larger farmers, simply
because they produced more cotton. But ultimately it probably affected smaller farmers most severely because they lacked
the large farms' ability to diversify into other crops such as horticulture.
Following deregulation and privatization, there is now substantial competition between three buyers, one of which is owned
by farmers themselves. Again, in absolute terms this must have benefited larger farmers more than small ones, but there
have been particular gains for the smallholders. These have included the fact that the buyers have chosen to compete with
each other not only on price (which has increased significantly), but also by providing extension and input services to
smallholders. While the latter are obviously reflected in the prices that the farmers receive, their provision fills a gap that
would otherwise exist in small farmers' access to inputs (including, in this case, information). Hence, the changes have
assisted small farmers both through an increase in price and by enabling them to produce more.
Table 1: Changes to markets: cotton in Zimbabwe
Before:
l
monopsony buyer (CMB) used low producer prices to subsidize inputs into textile industry;
l
commercial farmers diversified into unregulated crops such as horticulture and tobacco; small farmers suffered;
Now:
l
deregulation and privatization;
l
competition between three buyers;
l
some buyers offering input supply;
l
prices have risen (in current terms).
Maize in Zambia:
Such changes are precisely what the reforms in Zambia were intended to achieve. But here the result was very different. In
the case of maize (Table 2), the better-favoured areas have seen no effective change in market conditions, while the less-
favoured regions have witnessed a deterioration. Given that the status quo ante was relatively favourable for smallholders,
especially in remote areas, it is easy to see why these changes failed to improve the conditions of poor maize farmers.
Under the old regime, remote farmers were subsidized by those close to the line of rail (through pan-territorial pricing) and
small farmers by larger ones with storage facilities (through pan-seasonal pricing). In addition, the agricultural sector as a
whole was subsidized by mining. All of these subsidies have now been removed. Remote farmers are unambiguously worse
off, whilst larger ones and those close to the line of rail are probably also less well off, since the subsidies from mining
probably exceeded the tax in favour of remote areas.
But the deterioration in the situation of remote farmers is substantially worse than would have arisen solely from the removal
of pan-territorial pricing. For them, functioning markets have largely disappeared. The status quo ante was one of a sole
parastatal buyer; the status quo is that often there is no buyer at all or, if there is, the terms of trade are so poor that
transactions occur on a barter basis.
It is difficult to disentangle the relative importance of institutional and infrastructural factors in this market failure. There has
been such a sharp deterioration in transport infrastructure that it is difficult for traders to reach areas that are more than a
relatively short distance from a major route. It is an open question whether trading would be more active if infrastructure
were better, or whether there are also institutional impediments. But in other areas, there are clear institutional constraints
on top of the logistical ones.
It might reasonably have been supposed that farmers would react to the change in relative prices of maize inputs and outputs
to shift production into crops that are less dependent on imports. This has happened, but only to a limited degree. In some
them with rather small resulting price changes. While
small, however, the price changes will be widespread and
through this mechanism shocks could be spread from one
region of the target country to another. If things are
traded only locally—say, because of transportation
difficulties or because they are services rather than
goods—the trading domain is smaller still: the price
adjustment will be larger than in the previous cases, but
the impact more narrowly focused geographically.
Several authors—e.g. Timmer (1997), Delgado (1998)
and Mellor and Gavian (1999)—argue that it is second-
round effects that make agricultural liberalization and
productivity growth are so effective at alleviating poverty.
Their demand spill-overs are heavily concentrated on
employment-intensive and localized activities in which the
poor have a large stake—for example, construction,
personal servants and simple manufactures. These
authors’ work assumes that developing-country rural
economies have excess labour and can deliver extra
output by taking on more workers without price
increases.
7
This, in turn, means that the increase in
income has multiplier effects so that total income in the
locality rises by more than the initial impact on the
fortunate farmers. The basic insight, however, also
generalizes to our situation. As farmers spend their extra
income the prices of local goods and services are driven
up, increasing the incomes of those who produce them.
Whichever model applies—with fixed or flexible prices—
the policy conclusion remains that liberalizing world trade
in agricultural goods is likely to have strong pro-poor
effects.
Positive shocks to the urban economy are also
desirable, of course, but will usually result in more diffuse
spill-overs—to a wider set of goods and more directly to
imports. Imports still generate spill-over benefits—output
in the export sector has to grow, because the imports
have to be paid for. But if the factors used intensively in
the export sector or in domestic sectors on which urban
residents spend their income are not among the poorest,
the spill-over from urban shocks will be less pro-poor. Of
course, in the end the relative benefits of different
second-round effects is a matter for detailed empirical
investigation case by case.
Finally there are two sets of goods for which explicit
prices are not observed, but which nonetheless are
important for assessing poverty impacts. First, subsistence
activities and goods: of course, by definition these are not
subject to direct trade shocks, but they will still be
affected by spillovers from goods that are. It is easiest to
think of these spillovers in terms of the ways in which
inputs of labour and outputs of subsistence goods are
impacted by changes in tradable goods’ and services’
prices. Recall as an example, the spillovers to kitchen-
50
cases farmers say they have lost either the knowledge or the physical inputs required to shift production back to subsistence
varieties and crops.
Table 2: Changes to markets: maize in Zambia
Before:
l
subsidized inputs;
l
government/co-operative crop purchasing;
l
pan-territorial, pan-seasonal pricing;
l
growth of (imported) input-dependent production across the country.
Now:
l
input prices have risen;
l
markets for crops have shrunk (especially away from line of rail and major roads);
l
limited availability of sustainable seeds;
l
fall in area planted to maize and production;
l
only partly offset by growth in more sustainable coarse grains because of consumer preference for maize;
l
shift to cotton which is less profitable, but in which 'better' markets exist.
7
See below for a discussion of whether such changes actually alleviate poverty.
51
gardening discussed above under the gender dimension
of adjustment.
The second set of goods for which we do not observe
prices is those that are just not available. While
conceptually simple to deal with in our schema—the price
of a good is infinity when it is not available—changes in
the set create complex measurement problems.
8
They
may be important, however, even for the poor, as Booth
et al (1993) document in Tanzania. They may also be
critical from a policy perspective, as, for example, when
non-tariff measures or regulation exclude certain goods
from the market. An interesting case-study is Gisselquist
and Harun-ar-Rashid (1998) who discuss the restrictions
on inputs into Bangladeshi agriculture and show how
their relaxation greatly increased the availability of, for
example, small tractors and water pumps to small
farmers.
Not only are prices affected by spill-overs and the
trading domain, but the distribution chain may also be.
Agents’ and institutions’ willingness and ability to pass
price changes through will be partly determined by the
domain of the market they serve. In practice the
information required to predict second round effects is
very complex. In many cases, however, the shocks
induced by trade policy changes will be sufficiently
specific and/or small for us to ignore the second-round
effects, and we can focus just on the direct impacts
described in rectangles in Figure2.
D.Enterprises: profits, wages and employment
Three elements of the enterprise sector
The left hand side of Figure 2—the elipses—describes
a completely different and equally important link from
trade to poverty—that arising through its effects on
enterprises. ‘Enterprises’ includes any unit that produces
and sells output and employs labour from outside its own
immediate household. Thus as well as registered firms
proper, it includes some of the informal sector and larger
farms that employ workers part-time or full-time. The
important distinction is that outputs are sold and inputs
acquired through market transactions. Hence the link in
the figure to border, wholesale and retail prices.
The analysis of the enterprise sector requires three
elements—demand, firms and factor markets. Demand
for the output of home enterprises is determined by
income (of which more later), and export, import and
domestic prices. The trade prices are largely or wholly
exogenous to the average developing country, but
domestic prices are endogenous, even if market forces
mean that they are actually constrained always to equal
one of the others.
9
As noted above, domestic prices will
be determined by interactions at several levels, but here
we subsume this all into one term, and some goods will
be non-traded internationally and so have only domestic
prices.
The demand for the domestic good must be matched
by supply, which stems from the second element—firms.
These divide their output between home and export
markets according to relative prices, and determine total
output according to those prices relative to costs. Costs,
in turn, depend on factor prices (wages, returns etc) and
factor input-output coefficients (i.e. the inputs necessary
per unit of output), the latter of which depend on
technology and again on relative factor prices. If there are
increasing returns to scale, input-output coefficients also
depend on total output. In accordance with the analysis
of households above, factors and their returns need to be
disaggregated by type, including caste, gender and skill.
Given total output and the input-output coefficients,
total factor demand is given, and this is confronted with
total factor supply in the factor markets—the third
element. These are equilibrated by movements in factor
prices, with the result that employment and wages—the
two variables of most relevance to poverty—are
determined. Implicit in this view is that the distribution of
assets and skills across households is given and that
household welfare depends only on factor rewards and
employment opportunities. Increasing asset stocks is an
issue of economic growth, and perhaps public
expenditure (for education and health), both of which we
treat below. Redistributing them between households is a
separate issue quite independent of international trade
policy. The distribution of the employment of factors
across sectors, however, is not given. The movement of
factors between sectors plays a crucial role in the poverty
impact of trade shocks.
The remainder of this section considers two different
approaches to enterprise effects—one assuming fixed
economy-wide levels of employment for each factor of
production so that shocks are reflected only in factor
prices (a 'trade theory' approach), and one assuming
infinitely variable levels of total labour employment at a
given fixed wage (a 'development theory' approach). It
observes that neither polar view is wholly correct and that
a critical variable for enterprises in the real world is the
degree of substitutability in demand between their output
and that available via imports.
‘Trade theory’—inelastic factor supplies
Of course, all the processes described in the
introduction to this section happen simultaneously, but
the figure helps to explain some of the critical links. I start
with traditional trade theory, in which total factor supplies
are exogenously fixed, wages and returns are perfectly
flexible and the domestic and foreign varieties of each
good are identical.
Price changes, including those emanating from trade
policy changes, affect the incentives for enterprises to
produce particular goods and the technologies they use.
The simplest and most elegant analysis of these
incentives—the Stolper-Samuelson Theorem (among the
most powerful and elegant pieces of economic analysis
8
Feenstra (1994) has pioneered methods of approaching this problem, particularly in the context of the availability of inputs into
production.
9
If the domestic and imported varieties of a good are identical and there are no constraints on sales, domestic prices will equal import
prices.
52
Box 2: Why the Stolper-Samuelson theorem is not sufficient to analyze poverty
The Stolper-Samuelson (SS) theorem, that an increase in the price of the labour-intensive good raises real labour incomes and
reduces real returns to capital, is a hugely powerful result of direct and immediate relevance to the link between international
trade and poverty. Like all theory, however, it is built on restrictive assumptions, and once these are violated its power and
definitiveness are eroded. This erosion does not mean that the theorem has nothing to say
—
indeed, it is still a vital part of
economists' tool-kits
—
but it does mean that it needs to be supplemented with further, usually case-specific, analysis to draw
concrete conclusions.
The basic SS mechanism
—
derived from a formal model with two goods, two factors and two countries
—
is that as the price
of the labour-intensive good rises, production of it increases, drawing factors of production away from the other, capital-
intensive, sector. Since the labour intensive sector wishes to employ more labour per unit of capital than the capital intensive
sector releases (by virtue of their factor intensities), this reallocation increases the demand for and the relative price of labour
to capital. This change causes both industries to switch to less labour intensive production methods
—
i.e. to employ less
labour per unit of capital
—
which, in turn, raises the marginal product of labour in both industries. If factors are paid their
marginal products, labour receives a higher wage in terms of each good and so, a fortiori, has a higher real wage regardless
of its consumption patterns. Similar reasoning shows why capital's real return falls.
The main assumptions in this chain of reasoning are described below, along with a brief indication of what happens when
they are violated.
l
The functional distribution of income is not the same as the personal distribution of income:the income of a given
household is only indirectly linked to the returns to various factors of production. It depends on their ownership of
the various factors, which is usually very difficult to ascertain empirically. Recently Lloyd (1998) has shown how to
generalize SS to the personal distribution of income conditional on both households' endowments and their
consumption patterns.
l
Dimensionality: The very powerful SS result holds only in a '2 x 2'model, with 2 factors and 2 goods. Once we move
beyond this the results are much weaker. In an n x n model each factor has an 'enemy'
—
a good whose price increases
definitely hurt the factor
—
but not necessarily a 'friend'. In non-square models, with different numbers of factors and
goods, unambiguous results are even scarcer.
l
Mobility of labour:independently of the number of different classes of labour distinguished, each is required to be
perfectly mobile between all sectors and regions of the economy
—
i.e. there are perfect labour markets at the national
level. If this is violated
—
i.e. labour markets are segmented
—
similar labourers in different markets must be treated as
being different factors, and will fare differently from each other.
l
Diversified equilibrium:to be sure of SS effects, the country must be producing all goods, both before and after the
price change in question. If we distinguish many different goods at different levels of sophistication, this is unlikely. If
countries do not produce all goods, the basic mechanism can break down and perverse results are possible
—
e.g.
Davis (1996).
l
Differentiated goods:SS is based on a model in which goods are homogeneous across foreign and domestic suppliers.
Many argue that goods are better thought of as differentiated, in which case the critical issue is how closely domestic
varieties are substitutable for the foreign varieties whose prices have changed. If the answer is 'rather little', the prices
of domestic varieties will be only slightly affected by trade shocks but there will be little quantity response to the price
increase for the imported variety, so the terms of trade losses from the price increase will be correspondingly
unmitigated.
l
Constant returns to scale and smooth substitution between factors:If industries are subject to economies of scale,
their responses to price shocks will tend to be larger than a CRS approach suggests. Also, under such circumstances
it is possible for all factors to gain or lose together, which weakens the inter-factor rivalry aspect of SS. Similarly, if
technology is endogenous or if labour can be substituted for other factors only in discreet steps, there may be
discontinuities in the way factor prices respond to shocks.
l
Perfectly competitive goods and factor markets:these are required for the direct and simple transmission of goods
price shocks into factor price effects. Once there are economic rents in the system, transmission becomes more
complex and difficult to predict.
l
Non-traded goods:if some goods are non-traded, their prices are no longer determined by world prices plus tariffs,
but by the need to clear the domestic market. They will accommodate shocks through both price and quantity
responses, rather than just the latter as for traded goods in a small country. This will tend to attenuate the rate at
which tradable goods price shocks are translated into changes in the relative demands for different factors.
53
on any subject)—generates very powerful results indeed.
It proves that, under particular conditions, an increase in
the price of the good that is labour-intensive in
production will increase the real wage and decrease the
real returns to capital.
10
Unfortunately, for all its elegance, Stolper-Samuelson
is not sufficient to answer questions of trade and poverty
in the real world, and it must be supplemented by more
heuristic but less specialized approaches—see Box 2 on
‘Why the Stolper-Samuelson Theorem can’t analyze
poverty’. Its basic insight, however, applies under a very
broad set of circumstances. An increase in the price of a
good—exportable, importable or non-traded—will
increase the incentive to produce it. This will raise the
returns to factors of production specific to that good—
e.g. labour with a specific skill, specialist capital
equipment, brand image—and, assuming that some
increase in output is feasible, will also generally affect the
returns to non-specific, or mobile, factors. Typically, the
returns to at least one such factor will increase and those
to at least one other fall. Presuming that the poor have
only their labour to sell, the focus for poverty studies is on
wage rates—usually on unskilled labour and wages.
Broadly speaking, if the prices of unskilled-labour-
intensive goods increase we would expect unskilled
wages to increase. As these industries expand in response
to their higher profitability, they absorb factors of
production from other sectors. By definition, an unskilled-
labour-intensive sector requires more unskilled labour per
unit of other factors than do other sectors, and so this
shift in the balance of production increases the net
demand for unskilled labour and reduces it for other
factors. If poor households depend largely on unskilled
wage earners, poverty will be alleviated by the resulting
wage increase (although, of course, head-count indices
will vary only if the wage increase moves families from
one side of the boundary to the other).
It is important to note that in the previous paragraph,
the first-order effect is the total production effect, not any
shift in factor proportions. It arises because the industry
using relatively more unskilled labour increases its
demand for allfactors while other industries release all
factors. It is the different compositions of these different
sectors' preferred bundles of factors that matters, not any
shifts within them.
11
A parallel analysis concerns technical
progress. Increases in the general level of efficiency in an
industry will reduce its price and/or increase its
profitability. This will increase its level of output and thus
generally increase demand for the factors that produce
it.
12
Factors specific to that sector will benefit, as will
mobile factors that are used intensively in the sector. This
effect could be offset if technical progress is heavily biased
against one factor or another (the factor saved loses out),
but if progress is concentrated on only a few sectors it is
generally more important to know which sectors and to
know their factor intensities, than to know the factor-bias
of the technical progress. If, on the other hand, technical
progress is uniform across sectors, the composition effects
largely cancel out and factor bias is the key to predicting
the factor demand effects of technical progress.
In world terms developing countries are clearly labour-
abundant, so that freer trade (whether generated by their
own or by industrial countries' trade liberalization)
gravitates towards raising their wages in general.
However, within developing countries it is not clear that
the least-skilled workers, and thus the most likely to be
poor, are the most intensively used factor in the
production of tradable goods. Thus while, for example,
the wages of workers with completed primary education
may increase with trade liberalization, those of illiterate
workers may be left behind or even fall. One of the
reasons that agricultural liberalization is such an
important goal for future trade policy is that for this sector
we can be reasonably confident that low-skilled workers
in rural areas—the majority group among the poor—will
benefit through the production responses.
It is sometimes suggested—at least implicitly—that
the factor intensity approach to the distributional effects
of trade policy is refuted by the failure of Latin American
liberalization in the 1980s to alleviate poverty. Without
denying the need for refinement in the argument, I
believe that the alleged surprise arose more from faulty
premises than from theoretical failure. Thus, as Wood
(1997) argues, by the 1980s Latin America was not
obviously the unskilled-labour abundant region of the
world economy: both China's 'arrival' in world markets
and Latin America's abundant natural resources suggest
otherwise. Similarly the growth of outsourcing, for which
Northern firms do not find it most efficient to seek the
lowest-grade labour, suggests that Mexican exports are
now intensive in labour that is relatively skilled by local
standards—Feenstra and Hanson (1995). Finally, of
course, it may take time for markets to clear. Thus while
Chile's liberalizations (trade and otherwise) were
associated with worsening inequality over the 1980s
inequality measures have now returned to pre-reform
levels—and at vastly higher average income levels and
lower poverty levels—World Bank (1997) and Ferierra and
Litchfield (1999).
‘Development theory’—infinitely elastic factor supplies
One exception to the rule that an increase in the
demand for a factor increases its wage (real return) is if
the factor is available in perfectly elastic supply, i.e. if
effectively any amount of the factor can be obtained at
the prevailing wage. Then the wage (return) will be fixed
exogenously—e.g. by what the factor can earn
elsewhere, which is assumed to be unaffected by the
trade policy shock that we are considering—and the
adjustment will take place in terms of employment.
First, suppose that labour is the elastically supplied
factor. Most generally this will be because the formal
sector can draw effectively infinite amounts of labour out
of the informal sector or subsistence agriculture at the
subsistence wage. This is the famous ‘reserve army of
labour’ model propounded by Nobel Laureate W Arthur
10
The Stolper-Samuelson Theorem is described in all international economics textbooks—see, for example, Winters (1991) or, in more detail,
Bowen, Hollander and Viaenne (1998). A full account appears in Deardorff and Stern (1994).
11
In fact, if the wage for unskilled labour increases, all sectors will switch to slightly less unskilled-labour intensive techniques of production
.
12
Only if demand is inelastic will the increase in demand fail to outweigh the savings in factors implicit in the greater efficiency.
Lewis (1954). Of course, if the formal wage is no more
than the subsistence wage (as the model strictly implies),
this transfer will have very little effect on poverty. Poverty
will only be alleviated if the loss of labour in subsistence
agriculture allows the workers remaining in that sector to
increase their ‘wage’, either because the sector begins to
run out of labour (the case of successful development) or
because the workers had negative social product in that
sector (e.g. overcrowding).
Another case where the supply of labour is effectively
infinite is where the formal sector has an enforced
minimum wage, at which lots of people are willing to
work. In this case we can presume that as labour transfers
to the formal sector it earns a higher wage and that, as a
result, some poverty is alleviated. If trade liberalization
raises the value of the marginal product of labour in the
formal sector, e.g. by raising the price of an exportable
output, it reduces the employment cost imposed by the
minimum wage and alleviates poverty. If, on the other
hand, trade reform reduces the value of the marginal
product and thus reduces employment, it has adverse
consequences. Box 3 summarizes the alternative analytics
of the labour market.
One possibility that bears some thought is that trade
reform could increase measured or perceived poverty
even though it raises unskilled wages in the formal sector.
Suppose, following Harris and Todaro (1970), that
workers migrate from rural areas to urban areas until the
subsistence wage and the expected wage in the city are
brought into equality.
13
Then, if the subsistence wage is
unaffected by a trade reform, any rise in the actual city
wage that it induces must be balanced by a higher
probability of unemployment in the city. Thus in expected
value terms the trade reform would be beneficial (actually
54
Box 3: Trade, poverty and the labour market
—
the simple analytic
The classic link between international trade and poverty in developing countries is via the labour market. If opening up to
international trade allows a country to export more labour-intensive goods and replace local production of capital and skill-
intensive goods by imports, it increases the demand for labour
—
typically in the formal sector. (Of course, if the country is
not a labour-abundant one, or trade policy previously favoured labour very strongly, liberalization may not boost labour
demand). If poverty is concentrated among people who are actually or potentially part of the labour market, increasing
demand will help to alleviate poverty. But how, and whether, it does so depends significantly on how the labour market
operates.
Consider two extreme assumptions. In Figure 1, I assume that the supply of labour to the formal sector is completely fixed.
When the demand for labour shifts out from DD to D'D', employment can not increase and the market must be brought
back to equilibrium by an increase in wages from w0 to w1. If some of the workers in this market were poor-or were part
of poor families
—
the increase in wages has a direct and beneficial impact on poverty. This is the classic "Stolper-Samuelson"
result that appeared to work so strongly in East Asia over the 1970s and 80s.
The second extreme is illustrated in Figure 2, where the supply of labour is perfectly elastic at the prevailing wage. Now an
increase in labour demand is accommodated by increasing employment to L1, with no change in wages. The effect on
poverty depends heavily on what the additional workers were doing before accepting these new jobs. If they were engaged
in subsistence activities
—
agriculture, scavenging
—
and earning the equivalent of w0 initially, there is no change in their
situation. Only if the switch into this labour market were so great as to significantly reduce labour supply to the subsistence
sector and hence raise its "wage" for everyone would be a poverty impact. This is no less than the case of successful
development, through which whole economies are transformed over a period of decades. Trade liberalization is an important
part of the process, but it is not the only one.
The alternative
—
and more common
—
case is that the wage in the formal sector exceeds the subsistence wage
—
possibly
because it grants access to social services. In this case the workers who transfer to that sector experience a direct wage
increase which almost certainly alleviates poverty. This is the situation in the Zambian Copperbelt where each mining job is
reported to support 14 dependants (Oxfam
—
IDS, 1999) and in India, where the formal sector manufacturing wages are
substantially above the poverty line (CUTS, 1999)
13
The expected wage is the actual wage multiplied by the probability of finding a job at that wage.
55
benefiting existing urban workers, who would receive a
wage increase, and imposing no expected cost on
migrants from the subsistence areas). However, if the
urban poor are more readily measured or observed than
the poor on rural subsistence farms, this could lead to the
appearance of greater poverty.
In fact, neither of the polar extremes—of wholly fixed
or wholly flexible labour supplies—is likely to be precisely
true. Hence in practical assessments of the effects of trade
shocks on poverty, determining the elasticity of labour
supply and knowing why it is non-zero, is an important
task.
A possible indicator of the relative importance of the
sorts of effects just described comes from CUTS, (1999).
Using the years 1987/8 to 1990/1 to reflect pre-
liberalization performance and 1991/2 to 1994/5 post-
liberalization performance, CUTS finds formal
manufacturing sector employment in India growing faster
after liberalization, and wages more slowly: employment
at 3.8% and 9.4% and wages at 8.1% and 7.0%
respectively. Similar results apply at the sectoral level.
However, as Winters (2000a) observes, the success of the
reserve army model in explaining the evolution of formal
manufacturing in India is not really surprising: the sector
accounts for only about 1.3% of the Indian workforce!
A much more perplexing aspect of the Indian reform
of 1991 is that it appears to have been associated with a
significant decline in employment in informal
manufacturing, especially in labour intensive sectors. This
decline outweighs the increase in formal employment and
seems to have been concentrated in the rural areas. In
Winters (2000a), I speculate that the most likely
explanation—if, indeed, the data are to be believed—is
that the real depreciation that accompanied liberalization
(which will have raised the prices of traded relative to
non-traded goods) switched output from non-tradables
to tradables and that the former are disproportionate
users of the informal sector. If true, this reminds us that
poverty impacts must consider the fate of the non-
tradables sector as well as that of tradables.
From a poverty perspective, of course, the important
question is what happened to those who lost their
informal jobs. If they could move back into subsistence or
other agriculture at approximately the same wage, not
much happened to them in poverty terms, and the
observed increase in formal jobs seems to offer a net gain.
If, on the other hand, the loss of an informal job signals a
descent (deeper) into poverty, the net effects of these
changes is negative for poverty alleviation. Unfortunately,
we just do not know the answers to these questions,
although other data in CUTS (1999) shows that wages in
the informal sector are quite often below poverty levels.
Formal sector wages, on the other hand, seem to be
uniformly substantially above poverty levels.
Capital might also be available in infinite supply—e.g.
say, from multinationals at the world rate of return. In this
case the inflow of capital into the liberalized sector is
likely to boost wages and/or employment, which will
increase the welfare benefits and, if they exist, the poverty
alleviation benefits, of a trade liberalization. It is important
to remember, however, that if capital inflows make for
larger effects when sectors gain from liberalization, they
are equally likely to increase them in sectors that lose.
The latter is not to say, however, that capital mobility
causes otherwise avoidable losses from trade
liberalization. When capital has been attracted into a
country by distortionary policies—e.g. tariff protection
and tax holidays—the inflow could have been
immiserizing. Then, while the outflow resulting from the
reform of these policies will impinge directly on workers
in the affected sector, the overall welfare effects taking
account of spill-overs to other sectors will be positive—
and larger than if there had been no immizerising
investment to undo. If the distorted sector was
particularly crucial in addressing poverty, however, it
might be that such liberalization worsens poverty, at least
in the short-run until the affected workers have found
alternative jobs and/or the government has diverted some
of the gains elsewhere in the economy into poverty
alleviation policies in the stricken sectors.
Of course, if our target country does not face
exogenously given prices for every good, developments in
the enterprise sector will affect the prices faced by
consumers and hence feed back into column 2 of
Figure2. For tradable goods this is probably not a major
consideration because few developing countries have
significant market power over the medium and long
terms, but for non-tradables it will be important. Given
weak infrastructure and trading institutions, many goods
and services are effectively non-traded in the developing
world; their prices will be determined by the need to
equate local supply and demand and by the influence on
supply of endogenous changes in factor prices.
Differentiated products
An important distinction in the analysis of the
enterprise sector is whether or not goods are
homogeneous across foreign and domestic suppliers.
Homogeneous goods must have the same prices, and so
international trade defines the prices of both traded and
domestic varieties. Trade prices essentially determine
internal producer and consumer prices and analysis is
straightforward. The alternative view is that goods are
differentiated, so that each variety faces its own separate
downward-sloping demand curve, with links between
goods depending on the degree of substitutability
between varieties. In this case the transmission of trade
policy shocks to domestic prices is less direct, usually
affecting more goods but by less than in the
homogeneous goods case. This typically also attenuates
the shock to factor prices, because, as more goods are
affected, the net shifts in the relative demands for
different factors are less extreme. (The more goods
involved, the more likely are changes in factor demand to
be off-setting.) The degree of substitutability between
domestic varieties and those traded varieties that are
affected by the trade reform becomes a critical parameter
in this view of the world—see Falvey (1999): the higher it
is, the more the shock is focused on the related domestic
varieties.
As I noted at the end of the preceding section, a trade
reform will sometimes be sufficiently straightforward that
it will not be necessary to trace all the connections
mentioned here, but rather focus on just a very few of
them. This can only be determined case-by-case, however.
E.Taxes and spending
The right hand set of boxes in Figure 2—the
trapezoids—illustrates the third of the major static links
between trade and poverty: via taxes and government
spending. The common presumption is that falling
revenues can squeeze social expenditures and hurt the
poor, but, in fact, this is far from inevitable.
For most countries, the early stages of trade
liberalizations in the 1980-90s entailed converting
quantitative restrictions and regulations into tariffs and
reducing high tariff rates. Particularly when the latter was
accompanied by a reduction in the scope of tariff
exceptions and exemptions it was as likely to increase
tariff revenue, as to reduce it—Pritchett and Sethi (1991)
and Hood (1998). Thus in this first stage, concerns over
revenues can be over-stated, although, of course, the
effective increase in taxation implied by reducing
exemptions could raise prices. If these increases in prices
impinge heavily on the poor, they could worsen poverty
even if they increase economic welfare overall—
particularly if the government is not efficient in spending
the revenue it collects. On the whole, however, given that
exemptions are mainly granted to the rich and influential,
it is unlikely that their loss is anti-poor.
Eventually, however, trade liberalization will reduce
tariff rates so far that government revenue falls. This
triggers the more common worry that the government,
finding its revenue constrained, will curtail expenditure on
social and other poverty alleviating policies and/or levy
new taxes on staple and other goods consumed heavily
by the poor. Given the association between structural
adjustment, stabilization, liberalization and poverty over
the 1980s, these worries have some historical basis, but it
would be mistaken to assume that the association is
immutable. It is clear, however, that governments must
display care and maintain a clear focus if they are to
ensure that this indirect route does not have adverse
effects on poverty. Experience in East Asia over the late
1990s suggests that pro-poor expenditure can be at least
partially protected even in the face of far larger shocks
than a trade reform.
A further question under this heading is whether trade
liberalization restricts a government's ability to manage
spending and taxation in a way that impacts poverty. To
start again at the less obvious end of the question, a trade
liberalization bound at the WTO makes the price-reducing
effects of tariff cuts less reversible: it constrains the
government's (and its successors’) ability to manipulate
policy in arbitrary ways. Given that such manipulation very
often redistributes real income from the poor to the rich,
and that uncertainty reduces the incentives to invest, the
constraints are likely to be beneficial. Put more positively,
WTO may allow governments to tie their own, or their
successors', hands in ways that would otherwise be
politically impossible.
Much more common is the fear that bindings and/or
commitments at the WTO prevent governments from
pursuing pro-poor interventions. For example, if price
variability is a problem it has been argued that the ban on
variable levies, which stabilize the domestic prices of
internationally traded goods, could hurt the poor by
subjecting them to greater uncertainty. It is sometimes
argued that the Uruguay Round Agreement on Subsidies
precludes production subsidies that could stimulate
output and development—see, for example, the positions
of India and Korea during the negotiations—Croome
(1995, p201).
14
Moreover, consumption subsidies—a
more promising anti-poverty tool—were not affected by
the Round. There is a slight danger that the Agreement
on Agriculture could undermine food subsidy schemes.
This occurs if countries' nominal subsidy requirements
have increased above low base year levels of support, and
if direct consumption subsidies can not be substituted for
the production-based subsidies that the Agreement
constrains. But again, few developing countries face such
problems.
All these arguments are essentially specific examples
of the analysis above: they are trade interventions whose
direct effects can be traced via the distribution and
enterprise sectors. In addition, however, they have
systemic effects because they affect whole classes of
policies. For example, even if some particular subsidies
would be advantageous, given the difficulty of identifying
these cases and preventing their capture by interest
groups, a blanket ban may be advantageous. Alternatively
if governments have established good reputations for
using trade policy contingently to stabilize the real
incomes of the poor, blanket bans may raise perceived
uncertainty in sectors that have not, to date, been subject
to intervention. Clearly making such determinations in
practice is going to be very complex, and all one can do is
plead that they be made on the basis of the evidence on,
rather than the theoretical potential of, government
performance.
Finally, some have argued—e.g. Rodrik (1997)—that
increased openness reduces governments' abilities to raise
revenue because mobile factors can no longer be taxed so
readily. If so, social and redistributive expenditure could be
under threat. In its direct form this argument applies only
to factors that can move locations in response to taxation
(or other) incentives, so international trade policy is only
indirectly relevant. For example, the general reduction in
trade barriers since the mid-1980s has made it easier to
'cut up the value chain', which presumably fosters capital
mobility.
On the trade side, increasing world competition
makes it more costly for an individual country to tax
exports in terms of both eroding the tax base and
distorting production patterns. However, it is not clear
that individual countries have ever had much scope for
such taxes in manufactures, which is where trade barriers
have come down most strongly in recent decades. An
example where a country’s own policy rather than world
conditions (others’ policies) matter would be if reducing
56
14
The Agreement does restrict production subsidies in principle but for developing countries the disciplines are relatively weak. A trading
partner would have to demonstrate actual harm before acting against them, which seems very unlikely for the sort of subsidies that might
help to alleviate poverty.

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