Stuff I Say at School – Part X: Direct Effects of Trade on Poverty

This is part of the Stuff I Say at School series.

The Assignment

A critical literature review of trade openness on poverty. This post consists of section on direct effects of trade on poverty as well as the conclusion.

The Stuff I Said

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The majority of studies on openness and poverty concentrate on trade’s effects on economic growth and, consequently, growth’s effects on poverty. As Panagariya (2019, pg. 136) notes, this means that “the literature directly linking trade openness and poverty is sparse.” Nonetheless, a few more recent studies have attempted to look at the direct linkage between trade liberalization and poverty.

Measuring trade openness by the trade-to-GDP ratio and average tariffs, Aisbett, Harrison, and Zwane (2008) confirm previous studies in a cross-country analysis showing a strong link between trade and increased aggregate income growth. However, when the direct link between trade and poverty is measured, the tie is weakened considerably. Nonetheless, the direct association between trade and poverty remains positive, if not always statistically significant. The authors recommend complementary domestic policies related to good governance and institutions in order to make trade optimal for the poor. However, a more recent study finds a stronger direct tie between trade and poverty. Updating Aisbett et al.’s (2008) data with more recent years and the World Bank’s new poverty headcount ratio, Devashish Mitra (2016, pg. 65) shows that in the period of 1981-2013, “a single percentage point increase in trade leads to a poverty decline of 0.149 percentage points.”

Petia Topalova (2007, pg. 293) explores the effect of trade liberalization—measured by the weighted tariff average—on various districts within India from the late 1980s throughout the 1990s and comes to more pessimistic conclusion: “trade liberalization led to an increase in poverty rate and poverty gap in the rural districts where industries more exposed to liberalization were concentrated.” However, a response article by Hasan, Mitra, and Ural (2007) actually reverses her results after more robust measurements are taken into consideration (i.e., the inclusion of non-tariff barriers, the avoidance of nontradable employment weights,1 better sampling data from state-level measures). They “find that states whose workers are on average more exposed to foreign competition tend to have lower rural, urban and overall poverty rates (and poverty gaps), and this beneficial effect of greater trade openness is more pronounced in states that have more flexible labor market institutions” (2007, pg. 75). A follow-up study by Cain, Hasan, and Mitra (2012) updates Hasan et al. (2007) with the latest available data and comes to the same conclusions, determining that 38% of the poverty reduction between 1987 and 2004 was due to international trade.

Maelan Le Goff and Raju Jan Singh (2014) examine a panel of African countries between 1981 and 2010 and find that trade openness increases poverty after controlling for GDP per capita, education, and institutional quality, indicating the need for complementary reforms. Andreas Bergh and Therese Nilsson (2014) analyze 114 countries from 1983 to 2007, breaking the poverty data down into four five-year periods. In order to test economic globalization’s causality, they control for (1) the number of years McDonalds has been in the country and (2) the preceding average level of economic globalization of the neighboring countries. They discover that while trade flows lead to reductions in poverty, the significance disappears once they control for income and growth. However, even after those controls, liberalized trade restrictions have a large poverty-reducing effect (along with information flows).2

Despite some mixed results, this handful of studies seems to support the conclusions of the previous section that international trade ultimately leads to reduced poverty. Even still, complementary domestic policies are necessary for countries to reap the full benefits of trade.

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In her recent book, Kimberly Clausing (2019, pg. 65-66) writes, “Openness to the world economy has played an important role in one of the most encouraging developments in human history: the dramatic increase in worldwide living standards in recent years…International trade is not solely responsible for these impressive achievements, but it has played a key role.” This literature review fully supports Clausing’s view. Trade has done an enormous amount of good for the poor worldwide and will continue to do so as long as policymakers and the public steer clear of populist-fueled protectionism.