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To Maximize the Gains from Trade - Focus on Firms and Cities

Megha Mukim's picture

Trade and growth go hand-in-hand. When the 2008 global financial crisis hit, both collapsed.

Since then both have steadied somewhat. But recovery has been jobless in many countries. The biggest challenge that developing countries will face: sustaining economic growth, while maintaining their focus on reducing poverty and inequality. Trade can be an important weapon in the policy-maker’s arsenal to help tackle these dual objectives.

Broadly, economists agree that declining levels of poverty have been accompanied by sustained periods of rapid growth and openness in all countries. In India, there has been a wealth of econometric work that demonstrates the links through which openness to trade has contributed directly to poverty alleviation – via growth and employment. More recently, Arvind Panagariya and I measured the impact of trade on poverty across different social groups – castes and religions – in India. We found that trade openness lifts all boats, for schedules castes and tribes, and for marginalized communities. Interestingly, the impact was especially strong in urban regions.   Other research finds that states whose workers are on average more exposed to foreign competition tend to have lower rural, urban and overall poverty rates.

It is firms that trade, not countries.  Firms are one of the main channels through which trade impacts welfare. Caroline Freund and Martha Denisse Pierola show that a small number of large firms have a significant impact on most countries’ export growth and pattern of diversification, while most job creation happens within rapidly-growing small and medium-sized firms which are often downstream suppliers to these large firms.
If trade helps lift people out of poverty, creating wealth at the bottom of the pyramid, so what? As Atul Gawande says, what about the how? How do we come up with implementable solutions based on this knowledge? What might be some of the policies that maximize the impact of trade on poverty and shared prosperity?
First: Let’s focus on gazelles – firms that grow and create value rapidly and consistently. These firms often look to international markets for growth. They are important because they are often engines of employment, technological innovation and growth. Even more, they could be indicators of a country’s emerging competitive advantage. I’ve blogged about gazelles in the past, and won't repeat myself here. But suffices to say, we need to complement our focus on entrepreneurs, with a focus on productive survivors - or gazelles.
Second: We need a focus on clusters. Economic clustering helps create upstream and downstream linkages across firms, usually large firms with small and medium-sized firms, thereby creating a network. These linkages are important channels for the transfer of technology and offer an opportunity for SMEs to grow from sub-contracts and economies of scale. SMEs contribute only 28 percent of US gross exports - but they account for 41 percent of value-added exports, reflecting their role as intermediate suppliers. Clustering of firms helps to trickle-down the benefits of trading in international markets – for instance, through technological linkages with upstream intermediary suppliers. This has been the case with Volvo’s bus and truck plants in Brazil, Mexico, India and China. As a case in point, domestic SMEs in Bangladesh that supplied to large exporters are more likely to be productive and grow faster, creating wealth at the bottom of the pyramid.
Third: Cities and trade are inextricably linked. Trade liberalization is associated with growth in urban agglomerations. In turn, cities provide the space for specialization and market access that facilitate trade. Cities attract and galvanize entrepreneurs and productive capital, and much of job creation – both in modern sector activities and in the informal sector – is overwhelmingly urban. 80 percent of global economic activity is generated in cities, activities that benefit from density and proximity – of goods, people and ideas. In a world of mobile capital and labor, cities remain critical nodes for trade because exporters and importers can benefit from economies of scale and access to large local markets. In turn, these exports help inject income from the rest of the world to the local economy, generating employment and income spillovers for city residents.
Trade is fiercely competitive. By focusing on firms, clusters and cities, policymakers can maximize its returns to people and places.


Submitted by Andrey Klopotovsky on

Many of us would be prepared to agree with the statements given in this article. The concern, however, how much additional debt could those gazelles, clusters and cities afford and who should be prepared to take additional market risks of their expansion - public or private investors? The issue also is how to keep at reasonable level inflation rate in the country and profit margins under respective projects.

Submitted by Megha on

Hi Andrey - thank you for your comment. How indeed to find the money to focus on firms, clusters and cities? In resource-poor environments, public-private partnerships could certainly bolster the public purse for infrastructure investments. Often, changes in policy might require institutional commitment to regulatory reforms, without big financial commitments. If you're interested, the World Bank's study on 'Planning, Connecting and Financing Cities' documents innovative ways of paying for city-level investments.

Submitted by john treleaven on

i could not agree more with your conclusions. Companies do business as a consequence of which statistics demonstrate that countries trade, but they do not and cannot.
All businesses are located in a city, town or municipality and it is this level of govt which has the most immediate impact on the success of any business. as a rule tbese very govts least understand their impact on business and the economy. "Business friendly" communities are essential to the health of any country.

Submitted by Megha on

Thank you John! Local and city governments often have a number of policy levers available to them (the 'Mayor's Wedge') to influence economic outcomes, such as jobs, entrepreneurship, growth and trade. Like you, I believe, that these can be very potent tools and should be utilized effectively.

Submitted by John Treleaven on

And I guess my main worry is less a failure to encourage and strengthen the local economy than the too amply opportunity to stymie economic development by accident. Local govts in most places are underfunded to a significant degree (even if property taxes are the most secure revenue stream there is). Placing significantly higher taxes on commercial/industrial land, for example, puts an entire local economy at risk, particularly during stressful times. Fee revenue is a silent, if destructive way to avoid property tax increases.
Let us also keep in mind that companies do not ever pay taxes, their customers do so. The political optic however seldom recognizes this as high rates and more fees are placed on "wealthy" businesses who can well afford the burden, until their customers can no longer afford the products. Local governments must be part of the solution to the economic development challenges we all face, not a source of the problem.
Think of a horse pull competition as a metaphor for society. The horses are the private sector, the only source of economic power. The sled is society, and societal costs, which the horses pull willingly. But is it the role of governments to add weight to the sled, encourage the horses to multiply, or to apply technology by adding wheels to the sled?? Too often local governments look for more rocks ro place on the sled...

Submitted by Megha on

Hi John - agreed, that is a worry. Academics, development banks, NGOs and public practioners, are spending more time and resources to understand better how to ensure (as you put it eloquently) that local governments be part of the solution, and not a source of the problem. Thank you for your comments.

Submitted by John Treleaven on

My worry is that local governments are far more often part of the problem than they are part of the solution.

Submitted by John Treleaven on

Think of a horse pull in which the horses are the private sector providing all of the energy to accomplish the task. The sled represents society and societal needs and expectations. What is the role of local (indeed, all levels) of government, place more rocks in the sled, encourage the horses to multiply, or facilitate the adoption of technology by adding wheels to the sled?? Too often, stuck between voters wants and financial constraints local governments find it easy to place more rocks on the sled...

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