International Trade and Poverty Alleviation

• Author: Geoffrey J. Bannister and Kamau Thugge
• Position: Senior Economist in the Trade Policy Division of the IMF's Policy Development and Review Department/Senior Economist in the Southern African III Division of the IMF's African Department

How does trade liberalization affect the poor, and how can they be protected against its negative short-term effects?

Trade reform has long been part of the arsenal of policies used to promote economic efficiency, the development of new markets, and growth. Perhaps surprisingly, even after more than fifty years of trade negotiations, there is still significant protection in the world economy and thus scope for further benefits once protection is removed. Protection persists because it is a convenient and nontransparent way for governments to direct economic benefits to particular groups. Although trade liberalization raises the average standard of living in the medium term, groups that had been favored by protection will see their incomes decline, and the resulting restructuring of the economy may create economic dislocations in the short term.

There is increasing awareness that some of those who lose from trade reform might be the poorest members of society, who have fewer assets to draw on to protect themselves during hard times, and are thus less able to absorb adjustment costs, than their fellow citizens. Even a transitory loss of income can cause the poor to lose opportunities to acquire human capital through education, health care, and better nutrition and thus can reduce their chances of escaping poverty. The vulnerability of the poor justifies looking more carefully at the effects of trade liberalization on the poor and asking whether trade liberalization can be designed to minimize its negative effects.

Liberalization's effects

Trade liberalization can affect the welfare of the poor by

* changing the prices of tradable goods and improving access to new products;

* changing the relative wages of skilled and unskilled labor and the cost of capital, thereby affecting the employment of the poor;

* affecting government revenue from trade taxes and thus the government's ability to finance programs for the poor;

* changing incentives for investment and innovation and affecting economic growth; and

* affecting the vulnerability of an economy to negative external shocks.

Prices and availability of products. Trade liberalization helps the poor in the same way it helps most others, by lowering prices of imports and keeping prices of substitutes for imported goods low, thus increasing people's real incomes. Imported products that might be especially important for the poor include basic foods, pharmaceuticals and other medical or basic health products, and used clothing. The poor may also benefit significantly from removal of export taxes or prohibitions, to the extent that the poor are net producers of exports (as is often true in agriculture). An open trade regime also permits imports of technologies and processes that can help the poor-for example, packaging for perishable foods that is light and does not require refrigeration, chemicals for sterilizing water, and improved seeds and fertilizers. An example of trade liberalization resulting in tangible and immediate benefits for the poor is the African Summit to Roll Back Malaria, held in April 2000, at which the continent's heads of state pledged to reduce or waive taxes and tariffs for mosquito nets, insecticides, antimalarial drugs, and other goods and services needed for malaria control. There is also some evidence that liberalizing imports of used clothing can improve the welfare of the poor.

Wages and employment. Trade theory predicts how trade liberalization will affect wages and employment under very specific conditions. In practice, these conditions do not often hold, and for a more general analysis, we have to rely on empirical studies. These suggest at least two factors that will directly affect the way trade liberalization can change the wages and employment of the poor. First, how flexible labor markets are will determine whether the effects of trade reform translate into changes in employment or wages. If firms are constrained by labor regulations from reducing their workforces, most of the adjustment to changes in relative prices of outputs will be reflected in changes in real wages. If minimum wage legislation prohibits downward adjustments in wages but labor mobility is high, however, adjustment will take place through changes in employment.

In the rural and informal urban sectors (the...