Both theory and empirical analysis have well documented the long-term benefits from improved resource allocation and efficiency that follow from trade reform. And, although causation remains an issue, research has also shown strong and consistent correlation between trade reform and growth.
In comparison, much less is written and known on the subject of the nature, magnitude, and duration of adjustment costs associated with trade reform. What is the expected impact of trade reform on employment, wages, industry or poverty? Would reform lead to a massive layoff of workers from industries that shut down? Would it lead to large re-adjustment in wages? Would it lead to disappearance of manufacturing in developing countries? The answers to these and other questions are subject to several recent research which are briefly summarized below.
Impact on Labor
In a recent paper, Steven Matusz and David Tarr (1999 see below) surveys more than 50 studies that address the issue of the adjustment costs of trade liberalization, comparing estimates of adjustment with gains from trade liberalization.
Adjustment costs are defined to encompass a wide variety of potentially disadvantageous short-run outcomes that might result from trade liberalization. These outcomes may include a reduction in employment and output, the loss of industry-specific and firm-specific human capital, and macroeconomic instability resulting from balance of payments difficulties or reductions in government revenue.
The authors also distinguish between social and private costs. This distinction is important for while the social costs of adjustment are relevant for considering the aggregate welfare effects of trade reform, it is the distribution of private costs within society that form the basis of political opposition to reform. Knowledge of the distribution of private costs is also useful because of genuine concerns for an equitable distribution of income.
Among the more that fifty studies that the authors survey, three, examine empirically the employment effects from thirty separate economy-wide episodes of trade liberalization in developing and transition countries; two studies of small and medium size enterprises in eight African economies; two economy-wide studies of adjustment cost in Australia, Uruguay and the US as well as studies by several authors of trade liberalization in 22 industries in the U.S. and the U.K.
In the last empirical section the authors also discuss the impact of trade reform on macro-economic stability drawing on two studies that examined the impact on the fiscal deficit in 15 and 9 countries, respectively.
What does this extensive survey indicate? On the whole, and albeit with some caveats, virtually all the studies find that adjustment costs are very small in relation to the benefits of trade liberalization. This is true both in terms of the impact of trade reform on employment and its impact on government revenues and macro stability And those studies that focused on manufacturing employment in developing countries found that it did not decline one year after the episode of trade liberalization.
The explanation for the low adjustment costs in relation to the benefits is as follows: (1) most importantly, adjustment costs are typically short term and terminate when workers find a job, while the benefits of trade reform can be expected to grow with the economy; (2) estimates of the duration of unemployment for most industries are not high, especially where workers were not earning substantial rents in the original job; (3) in many industries normal labor turnover exceeds dislocation from trade liberalization, so that downsizing where necessary could be accomplished without much forced unemployment; and (4) it has been observed that a great deal of inter-industry shifts occurred after trade liberalization, which minimized the dislocation of factors of production. In addition, developing countries would be expected to have comparative advantage in labor intensive industries, so trade liberalization should favor labor. This may explain why manufacturing employment has typically increased after trade liberalization.
The findings by Matuzs and Tarr are similar to those by Hanson and Harrison (1998), who analyze in detail the reasons for the small impact of trade reform on employment in three developing countries, namely Mexico, Morocco and Uruguay.
Impact on Industry
One of the main concerns related to import is that opening up to cheaper imports may lead to "deindustrialization." This fear is not unique to developing countries. In the past two decades advanced economies have witnessed a continuous decline in the share of manufacturing employment for which freer trade with the South has sometimes been blamed. This phenomenon of deindustrialization in the context of developed economies is not discussed here and the interested reader is referred to Rowthorn and Ramaswamy (1998) and Silimbergo (1998).
In the context of developing countries, deindustrialization refers to the fear that an open trade policy may lead to the contraction and eventual disappearance of the few manufacturing industries which had often grown behind protective barriers. Although highly protected, import-substituting sectors or at least some firms within the sector may indeed be forced to live up to foreign competition or shut down, which is precisely what trade reform is supposed to do, the experience of trade reformer as a group does not support such fears. On the contrary, countries that have engaged in reform reducing the anti-export bias of their trade regimes and have also provided a business-friendly macro and regulatory environment, have seen their industrial sector and exports expand. Several East Asian and Latin American countries and some African economies, foremost among them Mauritius, are good examples of this trend. Trade policy reforms influences the manufacturing sector and employment in many other ways, including its impact on productivity, efficiency, labor turnover and so on. These influences are carefully examined in a recent review article by Tybout (1999).
Impact on Poverty
Studies on the direct impact of trade reform on poverty are not many. To the extent that trade reform improves efficiency and leads to a higher level of income or growth, it is expected to be beneficial to poverty reduction. Also, to the extent that trade reform (broadly defined) reduces anti-export bias and to the extent that exports are intensive in the use of unskilled or rural labor, trade reform is expected to increase real wage reducing both poverty and inequality. An example of such trends is provided by Mauritius (see English, 1998), where trade and other reforms during 1980s led to increased income and a sharp reduction of unemployment, poverty and inequality.
Further Readings and links
- English, Philip (1998): Mauritius: Re-igniting the Engines of Growth, Economic Development Institute, World Bank, Washington DC. [English - PDF 40k] [French - PDF 45k] - Lecture notes on Mauritius and Economic Growth [English PDF - 24k][French PDF - 30k]
- Hanson, Gordon and Ann Harrison (1998): Who Gains from Trade Reform? Some Remaining Puzzles; National Bureau of Economic Research Working Paper 6915.
- Matusz, Steven J. and David Tarr: (1999) Adjusting to Trade Policy Reform, Policy Research Paper 2142, World Bank, Washington DC.
- Spilimbergo, Antonio (1998): "Deindustrialization and trade" Review of International Economics (U.K.); 6:450-60, August 1998
- Robert Rowthorn and Ramana Ramaswamy (1998): Growth, trade, and deindustrialization, IMF working paper, WP/98/60, International Monetary Fund, Research Dept. April 1998.
- Tybout, James (1998): Manufacturing Firms in Developing Countries: How Well Do They Do , and Why?
- For a more in depth analysis of poverty and its relation to trade reform, visit the Poverty Website of the World Bank at http://www.worldbank.org/poverty/