International Economic Cooperation: Course Material 3

How Trade Is Important for Development and Alleviating Poverty

(Chapter 3, Globalization for Development)

Professor Hiwhoa MoonGSIS, Korea University

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International Trade and Its Impact on Poverty

• International trade is potentially a powerful force for poverty reduction through:

expanding markets, creating jobs, promoting competition, raising productivity, and providing new ideas and new technologies

The link between trade and reduction of poverty is not automatic

Unless certain conditions are met, this link can be ineffective.

Trade liberalization alone cannot reduce poverty. A broader approach is needed, which includes meeting challenges in economic, social, health, and educational areas.

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• Improving market access for developing countries is a priority agenda in international trade.

• Right business climate, infrastructure, and other economic and social conditions are essential for maximizing the benefits of enlarged trade through trade liberalization.

• International trade is a means of expanding markets,

and market expansion can generate additional employment and incomes of people.• Increased exports of labor-intensive products

from low-wage developing countries can create more job opportunities, thus may lead to increased incomes and higher wages.

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• Export can best help alleviate poverty when it supports labor-intensive production, human capital accumulation, or technological learning, as witnessed in the successful development of EA.

• Most primary product-exporting countries failed to alleviate poverty because their exports could not support these. Prices of their exports were always weaker compared to manufactured goods exported in other countries.

• Increased competition in home market through trade can cut cost of production and lower living costs of people, which lead to improved competitiveness of manufactured exports and enhance peoples’ wellbeing, respectively.

• Increased competition at home generates more jobs due to expanded sales abroad and increased profits resulting from improved competitiveness of manufactured exports.

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• Small farmers, for example, can increase prices of their products through exports from the prices paid by monopsonistic or oligopolistic buyers at home.

• To increase export earnings over long-term, technological upgrading (with associated learning processes) is vital. This will increase productivities through, for example, by utilizing the advanced technology-embodied new machineries and equipments which were imported.

• As technology gets upgraded in export industries, more demand will be made for skilled workers and less demand for unskilled workers. Therefore, unless training and education can continue to upgrade the skills of workers, the income disparity between the skilled and unskilled workers will be widened.

• For positive effects of trade to be realized, market access is critical for developing countries.

• But developed countries often maintain protective measures against core products of poor countries: agricultural products, processed foods, and labor-intensive manufacturers.

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• Substantial evidence is that high-income countries applies “tariff escalation,” which means increasing the level of protection along with the degree of processing of a product. Moving up the value chains in production process is crucial for the development of poor countries.

• Seventy percent of world’s “dollar poor” reside in rural areas. • Therefore, poverty alleviation should focus on rural development and boosti

ng rural farm and non-farm incomes through trade. • Successful examples: Vietnam’s rice sector, Bangladesh’s clothing industry,

and Grameen Bank’s Village Phone Program in Bangladesh.• Vietnam’s Rice Sector: Trade-based market expansion helped turning Vietna

m from a rice importer to rice exporter. Two-thirds of Vietnam’s households are involved in rice production since rice production business is labor-intensive.

• Bangladesh’s Garment Industry: Garment exports from Bangladesh increased sharply thanks to the 2 million workers in 3,000 factories.

Although their wages were at about 2 dollars a day, this income earning opportunity provided twice as much as that of an agricultural laborer. They could remit back to rural areas, which enabled increase of family income and education of remaining children.

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• Bangladesh’s Grameen Bank’s Village Phone Program: competition supported by imported technology.

Grameen Bank (a village-based micro-credit organization) launched a program with micro-loan package, which enabled wide expansion of rural villagers’ access to communication.

This expansion enabled significant increases in sales price of farm produce through competition, timely deliveries of farm inputs at lower costs, and reduction of risk of fatal farm diseases as well as natural disasters.

Incomes of rural poor people improved sharply as a result. 1) Productivity increase Trade allows countries to import ideas and capital goods embodying new technologies that make productivity increases possible.

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• New technology requires learning process to reap the fruits.• Exports increase the access to foreign market where

abundant new information to increase productivity is available.

• Exports serve to promote specialization and sustain production tempos of goods in which learning effects for productivity upgrading are embodied.

• Evidence on learning and technological upgrading is more readily available for the manufacturing sector.

• Empirical evidence of successful learning is shown in Figure 3.1 (p.33): China, Mexico, Malaysia, Thailand, and Philippines showed high percentage shares of high-technology manufactured exports (HTME) in their total manufactured exports.

• Learning varies greatly by country: initial capabilities, efficacy of markets and institutions, and the policies undertaken to improve them determine the learning ability of a country.

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• Korea’s successful and steady export performance has relied heavily on continuous technology upgrading, which was backed by adequate institutional framework and policies.

• Examples were liberal technology import policy, incentives for R & D, incentives for exports, incentives for corporate in-house training, numerous governmental vocational training centers, effective industrial extension services, and large-scale governmental research projects producing elements which can be exploited by firms for deciding and specializing areas for the future.

• The Maquiladora Export Sector in Mexico (Figure 3.2, p.34) suggests the importance of sourcing domestic inputs and local value added in the manufacturing process.

• One way to maximize the benefits of FDI is inducing the foreign multinational enterprises (MNEs) to utilize home-produced parts and raw materials, which will produce maximum backward linkages.

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• An enclave FDI produces little backward-linkage effects.• Traditionally, “the local content requirement” was utilized by governm

ents to avoid enclave FDI. As the WTO started, however, the requirement for local content (or inputs) became illegal.• Key to inducing maximum local inputs by MNEs is producing competi

tive local intermediate products and the successful PR on their availabilities.

• Relevant institutional efforts by local suppliers, government, business associations, NGOs, and scholars will produce successful results.

• A key focus of government policy should be placed on bridging the information gap among the key players.

• An outstanding example of the trade-supported productivity and income increases is Mauritius: its “openness ratio” is high and the “preferential market access” for sugar, textiles, and clothing granted by EU and the US significantly contributed to success.

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• 2) Market Access

• Products from developing countries face at least five hurdles in gaining to access to foreign markets.

Tariffs Subsidies Quotas Standards and regulations Security checks

• Tariffs have the effect of raising the price of imported goods and hence reducing imports.

• World Bank’s comparison of the effective tariffs faced by poor people and the non-poor reveals that poor people face effective tariffs that are twice as high as those faced by the non-poor (14% vs. 6%).

• This is the result of the regressive global tariff system. Poor people are mostly affected by the high cost of food and clothing, which is partly the result of high tariff and the regressive tax system.

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• Tariff escalation is a common practice among developed countries. Under tariff escalation policy, tariff rate increases as the production process moves up the value added chain.

• Example: tariff on cocoa is 1% whereas tariff on chocolate is 30%.

• This tariff escalation practice prevents developing countries from moving up the value-chain ladder in their trade specialization.

• Also, subsidy in developed countries (mostly on agricultural products) in effect reduce the competitiveness of products produced in developing countries.

• OECD spent more per year on agricultural subsidies than the entire GDP of Sub-Saharan Africa.

• OECD agricultural subsidies are about twice as large as total agricultural exports of developing countries.

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• OECD spends nearly five times more on agricultural subsidies than on ODA.

• Quotas were imposed on imports from developing countries by developed countries. In particular, agricultural, textile, and clothing products from developing world faced most serious quota applications until the end of Uruguay Round.

• The MFA (Multi-Fiber Agreement), the quota system on imports of clothing and textiles, was phased out in 2005 under the WTO system. Now, only tariffs can be applied on the imports of these products.

• Standards and Regulations, unlike tariff and quota, in trade system will not give harmful effect to the welfare of people in imposing countries.

• They are often imposed for the safety of health or national security reasons.

• However, there are some countries which still use them as protective measures against imports.

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• The new food safety regulations introduced in the EU in 2005 made it mandatory for all fruit and vegetable products arriving in the EU traceable at all stages of production, processing, and distribution.

• As a consequence, many developing-country farmers risk being closed out of this important market.

• Another problem is that these standards are applied in a discriminatory fashion and require special skills and equipments beyond the capability of most developing countries.

• Intensified security checks in developed countries after the 9.11 pose as a serious barrier to exports from developing countries such as Pakistan.

• A World Bank estimate shows that the package of tariff reduction and cuts in agricultural subsidies directed toward imports from developing countries, would result in a total benefit of $250 billion and pushing about 100 million people out of poverty.

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• Promotion of Trade-Related Capacity Building along with expanded market access is important for increasing incomes of people in developing countries through trade.

• This capacity building needs adequate physical infrastructure and software such as market information, skills, financing, education, anti-corruption, governance, and the knowledge in trading.

• All of these elements can be strengthened by the direct efforts of the government concerned and by assistances from foreign governments and international agencies.

• Outside assistance is key to improving the capacity since most developing countries lack the in-house expertise in these capacity building.

• “Aid for trade” implies the complementary relationship between foreign aid and trade.

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Areas Sought by Developing Countries for Outside Assistance in Their Trade-Related Capacity Building

• Better representation in international organizations related with trade such as WTO.

• Improving infrastructure for facilitating exports.• Upgrading trade ministries, including training in WTO legal

matters and accession processes.• Efforts to promote diversification of exports to escape the

problem of primary products exports.• Upgrading systems to meet the increasing standards and

regulations in developed-country markets.• Developing information systems regarding potential export

markets.

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Capacity Building of Developing Countries

• Some initiatives from advanced countries to promote developing countries’ capacity-building in trade.

Advisory Center on WTO Law Agency for International Trade Information and

Cooperation funded by Switzerland Center for Trade Policy and Law funded by Canada International Trade Center’s World Tr@de Net• Despite these initiatives, the developing countries’ need

s in this direction are still very high.

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• Greater emphasis should be placed on: genuine needs assessment beneficiary orientation sufficient funding escaping bureaucratic restrictions through arm’s-length delivery organizations reevaluation of the professional qualifications of capacity- building staff

• Trade in Arms: Arms can occupy 10 percent (in some areas 20 even 20%) of total imports of developing countries. Wars and civil conflicts tend to result in development in reverse. At least a half million people is lost a year in conflicts in developing world globally. Therefore, regulations on global arms trade deserve serious consideration.

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• Trade in Hazardous Waste: Imports of hazardous waste can cause serious environmental effects and can impose economic costs.

• Importing hazardous waste into poor countries is motivated by lower disposal costs in these countries, as well as growing opposition to disposal in rich countries where massive amounts of them are produced annually.

• The “Basel Convention on the Control of Trans-boundary Movements in Hazardous Wastes and Their Disposal” was signed in 1989 and went into effect in 1992. This is an important multilateral agreement controlling hazardous waste trade.