The Impact of International Trade on Poverty

Introduction

Over the past years, the mass and value of international trade is experiencing a higher growth rate and the world economy has experienced substantial changes between and within countries. The developing countries are now participating in the international market for trade and as a result the world economy has become highly integrated (Bhandari 2015). In this background, many researchers have sought to explain the effect of international trade on poverty. According to Gasiorek et al. (2016), a valuable framework for understanding the effect of trade liberalisation on poverty is to consider their directness and immediacy. The authors argue that the most direct effects of trade liberalisation works through changes in price. They argue that lower tariffs have a direct and immediate effect on the price of imported goods and therefore a direct and immediate effect on household welfare which in turn affects poverty. Lower prices, resulting from increased competition, enhanced transport system, and tariff reductions, increase the welfare of consumers and for producers that buy intermediate inputs. However, lower prices reduce the income for producers. In the developing countries, many households are likely to be both producers and consumers and therefore the net effect of trade liberalisation on poverty is complex to identify and explain.

The impact of tariff and non-tariff barriers on poverty also depends on production structures and the consumption habits of the poor (Ederington and Ruta 2016). For example, if barriers for agricultural products are lifted and if agricultural products are a significant part of the consumption bundle of poor households, then this will result in increased incomes for the poor thus reducing poverty. Nonetheless, the incomes of domestic producers of the agricultural products may fall; which implies that whether producers are concentrated among the poor population or not, producers will always be crucial in determining the aggregate poverty impact (Goldberg and Pavcnik 2016). On the other hand, Islam et al. (2017) note that trade liberalisation might provide increased export opportunities for producers and the ability to source cheaper and higher quality intermediary inputs thus increasing their competitiveness.

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Another effect of trade liberalisation works through the impact on tariff revenues. Martuscelli and Gasiorek (2019) note that in many developing countries, tariff revenues form an important part of total government revenue and therefore trade liberalisation reduces those revenues, which significantly affects the poor. Analogously, Zahonogo (2016) writes that if international trade affects public revenues, this may directly lower expenditure on social programmes and public services. Given that cheap access to education, health, and social security is essential for the poor, then reduction in the provision of these services significantly impacts on poverty.

In light of the above information, the relationship between international trade and poverty is complex to understand. This paper seeks to explore this relationship in greater depth. Based on theory and empirical evidence, this paper explains the link between international trade and poverty and discusses the circumstances under which international trade may or may not lead to poverty reductions. The paper will provide country examples in the explanations.

The relationship between international trade and poverty

Stopler-Samuelson (SS) theory is among the leading frameworks in explaining the impact of international trade on poverty. The theory suggests that growing trade openness increases real income of the abundant factor (Gnimassoun 2019). For example, many developing countries are abundant with unskilled labour and therefore the poor (unskilled labour) in these countries will acquire the highest gain from trade liberalisation. From this perspective, Martuscelli and Gasiorek (2019) write that in the low-income countries, trade liberalisation should benefit the poor as these economies have a comparative advantage in the production of unskilled or low-skilled goods that require unskilled labour. Closely related to the SS theory is HHeckscher-Ohlin (HO) theory, which suggests that if labour is not perfectly mobile, then the winner and losers from international trade can be identified depending on the level of skills regardless the sector (importing or exporting) they work (Shuaibu 2017).

The neo-classical growth model that also been used to explain the effect of international trade on poverty. From this perspective, developing countries have abundant of unskilled labour thus trade liberalisation will result in capital flow to developing countries and consequently increase per capita income in these countries (Kis-Katos and Sparrow 2015). However, if per capita incomes changes are influenced by productivity differences between countries, then trade liberalisation will not affect poverty because capital will flow from low-productive countries to high-productive countries (Le et al. 2015).

Trade liberalisation affects poverty through different channels including economic growth, technological change, changes in factor and good prices, and factor movement among others (Brambilla and Porto 2017). Of these channels, the trade-growth-poverty channel has received much attention and it emphasises that liberalisation of trade increases the earnings of the poor by raising long-run economic growth (Shuaibu 2017). These studies also assert that the growing trade and flows of capital increase capital accumulation and productivity, which in turn raises the average returns of the poor thus reducing poverty (Gnimassoun 2019).

Studies using the technology channel suggest that low-technology products lead to slower economic growth while highly technology-intensive products lead to rapid economic growth. According to Islam et al. (2017), export growth in high tech sector significantly contributes to output growth if countries have a large share of manufacturing exports than the world average. In the same vein, Martuscelli and Gasiorek (2019) write that the importation of new products leads to introduction of new technology which raises productivity while inward foreign direct investment results in transfer of technology. As such, the growing income from productivity gains from international trade should increase the gains of the poor.

Trade composition has also been established to influence other channels through which trace affects poverty. According to Zahonogo (2016), the composition of trade flows substantially affect the welfare gains from trade liberalisation and the low-income developing countries experience larger effects of trade barriers and higher welfare gains for international trade.

Structural change is another aspect that researchers have used to explain the relationship between international trade and poverty. Structural change is the contraction or expansion of different sectors and the possible effect on employment and wage (Shuaibu 2017). Trade liberalisation is likely to influence changes in production, employment, and wages in different sectors but this will affect poverty depending on what is being liberalised, the sectors in which domestic production is concentrated and sectors in which consumers and producers are spatially located (Kis-Katos and Sparrow 2015). On the other hand, Islam et al. (2017) writes that labour is a key asset of the poor and therefore a structural change that reduced demand for unskilled labour would increase poverty in developing countries and vice versa. In the same vein, Martuscelli and Gasiorek (2019) write that the poor people are often concentrated in rural areas and therefore structural changes that promote agricultural growth are more likely to reduce poverty in developing countries. Structural changes have medium-term effect on poverty.

The longer-term effects of international trade on poverty are concerned with how trade liberalisation affects economic growth. According to Le et al. (2019), economic growth is necessary for poverty alleviation but not sufficient. The ability of economic growth to reduce poverty depends on the extent to which growth creates employment opportunities (Gnimassoun 2019). International trade promotes economic growth, which in turn reduces poverty. Economic growth is caused by a number of factors including increases in labour and capital, specialisation across or within sectors and from producing in a more efficient way. Trade liberalisation is likely to affect each of these factors: increased access to the global market and regional markets encourages investment and economies of scale; increased movement of workers across boarders improves the efficiency of labour markets; a more competitive environment favours productivity growth; and greater knowledge of markets, alternative techniques and opportunities increases technology adoption and transfer (Shuaibu 2017).

Circumstances under which international trade may or may not lead to poverty reduction

The actual effect on poverty of any liberalisation process critically depends on the constraints that the poor in an economy face. Constraints in this case refer to the limitations and obstacles that limit the ability of individuals and households to respond to shocks and incentives (Brambilla and Porto 2017). These constraints may be influenced by the characteristics if the poor and those of the surrounding environment or both. Among the factors that can affect the ability of the poor in an economy are levels of education, the quality of infrastructures and institutions, the structure of governance, and the business environment. Constraints affect the ability of the poor to adjust to negative shocks, to benefit from the liberalisation, and to seize the opportunities that arise (Le et al. 2019). The WTO and World Bank (2015) identify four key characteristics that are likely to constraint the poor: being in conflict or fragile states, living in rural areas, belonging to female-headed households, and operation in the informal sector. The bigger the constraint, the harder it is for the poor to seize the opportunities arising from increased employment and higher wages, lower prices, and enhanced access to export markets (Shuaibu 2017). There are also constraints that hinder the poor from adjusting to the shock cause by liberalisation and these include poor infrastructure, low administrative capacities, lack of financial access, and government policies such as export taxes: these constraints hinder the poor from adjusting to increased import competition (Perera et al. 2014).

The case of Indonesia

Indonesia started to liberalise its trade regime in the mid-1980s when it reduced tariff lines and slowed tariffication of non-tariff barriers (Kis-Katos and Sparrow 2015). These were followed by financial deregulation, tax reforms, and reforms of fiscal policy. Indonesia then experienced an economic crisis between 1997 and 1998 and in response it further lowered the tariff rates. The period before the economic crisis was characterised by high flexibility of labour and high elasticity of unskilled labour (Kis-Katos and Sparrow 2015). After the economic crisis, Indonesia experienced a shift from agricultural productivity towards urban employment, which expanded the service sector and led to the growth of the export-oriented economy (Kis-Katos and Sparrow 2015). These structural changes resulted in steady decrease of poverty rates: the growth in urban services was a powerful force that drove the poverty reduction rates. Although these changes increased inequality, Kis-Katos and Sparrow (2015) write that the beneficial effects of the reforms were not concentrated on the very poor, which promoted poverty reduction. It is at the same time that labour regulation started to tighten resulting in rising minimum wages and extensions of social security coverage, factors that are associated with poverty reduction in Indonesia.

A study conducted by Warr (2014), investigated the effects of trade liberalisation in Indonesia from 1993 to 2002 on poverty levels and considered the role of labour market as a channel for these effects. The findings reveal that during this period, Indonesia lowered its tariff barriers across all tradable sectors, with the average import tariffs been lowered from 17.2% in 1993 to 6.6% in 2002. The results also show that trade liberalisation has contributed to poverty reduction in Indonesia, which has been attained through increasing incomes for the poor population. However, the findings show that tariff liberalisation and increased competition in the regional output markets increase poverty while tariff reductions for inputs lower poverty levels. This implies that input markets affect the relationship between trade liberalisation and poverty in a short-run analysis. Nonetheless, the study maintains that the driving mechanisms behind poverty reduction in Indonesia is increasing the competitiveness of firms which is attained through reduction in import tariffs on intermediate goods; this is also seen to induce work participation for low and medium skilled labour and wage increases for the medium-skilled labour. From this study, we can conclude that reductions in tariffs on intermediate goods lead to decreases in poverty while employment and wages changes are vital in poverty reduction.

The case of Vietnam

Vietnam is increasingly integrated in the Asia-Pacific and world economies. The trade ratio drastically increased from 10% in the early 1980s to over 100% in the 2000s. In the year 2000, the annual growth in real GDP per capita averaged around 5.6%%. The country has also experienced substantial poverty reduction at aggregate and provincial levels; the poverty ratio reduced from 58.1& in the early 90s to 14.5% by 2008 (Le et al. 2019). With this achievement, Vietnam was classified as a lower-middle income country by the World Bank in 2010 while previously it was regarded a low-income country.

Extensive research has shown that trade liberalisation significantly contributed to economic growth and poverty reduction in Vietnam. According to Le et al. (2019), trade liberalisation exposed Vietnam to the world price volatility and in response; Vietnam set price controls on rice production, which reduced expenditure amongst farm household thus reducing poverty. On the other hand, Kozel (2014) writes that trade liberalisation not only benefits the rural population in Vietnam but also the urban population. Le et al. (2015) adopts a model of micro-determinants of growth to explore the effects of price and employment on household welfare in Vietnam and the results reveal that trade liberalisation contributes to poverty reduction through creation of employment opportunities. This is in line with Hoang et al. (2014) who assert that improved employment in the Vietnam export sector has positively impacted on poverty. From a different perspective, Le (2014) writes that in Vietnam, the increase in government revenue from trade taxes has partially been channelled into poverty-reduction activities. Therefore, we can argue that trade liberalisation in Vietnam has contributed to poverty reduction in four channels namely growth, market distribution, government revenue, and employment.

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The case of Africa

The African continent faces the challenge of poverty reduction and inclusive growth thus per capital income in the continent remains among the lowest in the world (Gnimassoun 2019). To overcome this state, African leaders have facilitation the integration of African economies as well as other economies outside Africa with an aim of promoting inclusive growth and reducing poverty levels.

A study conducted by Gnimassoun (2019) sought to explore why poverty levels remain high in Africa despite the continent adopting regional integration and liberalising its exports. The results show that most of the African countries are highly specialised in production and export of commodities but most of the exported goods are not processed in Africa. The study therefore argues that diversifying the production and exports of African countries could promote intra-African trade thus promoting the standard of living in Africa. In the same vein, Zahonogo (2016) writes that if African countries are able to diversify their economies, they would be able to reduce their exposure to exogenous shock in commodity prices thus promoting the investment of major long-term projects.

Another study conducted by Brambilla and Porto (2017), sought to explore the relationship between trade and poverty in Africa. The study establishes that Africa lacks quality infrastructure, which could have been essential in strengthening regional integration and integration of Africa in the world economy. The study also establishes that transport infrastructures in Africa are insufficient and of poor quality, which exacerbates the cost of trade between countries thus hindering integration of Africa in international trade as well as inhibiting regional trade. For example, the World Bank estimates that the cost of intra-African trade is about 50% higher than in East Asia, and is the highest intra-regional costs in all developing regions. Therefore, we can conclude that poor infrastructure and inability to process goods are constraints to Africa’s ability to enjoy the benefits of trade liberalisation resulting in higher poverty levels.

Conclusion

The aim of this paper was to explore the relationship between international trade and poverty. The paper has established that the link between trade liberalisation and poverty is complex to understand given that there are constraints that limits the ability of the poor to enjoy the benefits of international trade thus continuing to remain poor. The paper also establishes that reduction of tariffs and creation of employment mediates a positive relationship between international trade and poverty. These two factors have been seen to play a crucial role in promoting poverty reduction in Indonesia and Vietnam. In addition, the report shows that the levels of education, the quality of infrastructures and institutions, the structure of governance, and the business environment can affect the ability of the poor and the evidence of Africa has been provided to demonstrate the role of poor infrastructure in regional and global integration: Africa has insufficient and poor quality infrastructure, which increases the cost of regional trade. Therefore, we conclude that international trade impacts on poverty but the effect is either positive or negative depending on the structure of a country and the liberalising activities.

References

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Brambilla, I. and Porto, G., 2017. Trade and Poverty Reduction. Win–Win: How International Trade Can Help Meet the Sustainable Development Goals, pp.61-87.

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Kis-Katos, K. and Sparrow, R., 2015. Poverty, labor markets and trade liberalization in Indonesia. Journal of development Economics, 117, pp.94-106.

Kozel, V. ed., 2014. Well begun but not yet done: Progress and emerging challenges for poverty reduction in Vietnam. The World Bank.

Le, M.S., 2014. Trade openness and household welfare within a country: A microeconomic analysis of Vietnamese households. Journal of Asian Economics, 33, pp.56-70.

Le, M.S., Singh, T. and Nguyen, D.T., 2015. Trade liberalisation and poverty: Vietnam now and beyond. Routledge.

Le, M.S., Su, J.J. and Nguyen, J., 2019. Trade liberalisation, poverty, and inequality in Vietnam: a quantile regression approach. Applied Economics, 51(36), pp.3971-3981.

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Perera, S., Siriwardana, M. and Mounter, S., 2014. Reducing poverty and income inequality in Sri Lanka: does trade liberalisation help?. Journal of the Asia Pacific Economy, 19(4), pp.629-655.

Shuaibu, M., 2017. The Effect of Trade Liberalisation on Poverty in Nigeria: A Micro–Macro Framework. International Economic Journal, 31(1), pp.68-93.

Warr, P., 2014. Agricultural liberalization, poverty and inequality: Indonesia and Thailand. Journal of asian Economics, 35, pp.92-106.

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