Trade, poverty and inequality

What key insights have emerged from development economics in the past decade, and how should they impact the work of the World Bank? A new working paper Toward Successful Development Policies: Insights from Research in Development Economics from the Bank’s research department captures 13 of the most significant insights in the world of development economics.

Here’s insight #13 – on what we have learned from recent research on the size of the welfare gains from trade.See all previous insights here: Thirteen insights for successful development policies

International integration accelerates growth and reduces poverty when it is supported with strong institutions, rule of law, and investment.^ref1 Historically, episodes of rapid growth are associated with increasing international integration and trade. Many East Asian economies, such as Japan, the Republic of Korea and China have managed to attain remarkable growth rates while integrating into the global economy. Conversely, many slow growing regions are left out of the globalization process. 

Despite the compelling associations between international integration and growth, empirical evidence as to whether there is a causal link between the two is more limited.  Separating the impact of trade from other developments that overlap with episodes of increasing globalization, such as technological progress, is challenging.^ref2 To accurately quantify the gains from trade it is also necessary to account for the structure of global value chains, input-output linkages, knowledge spillovers, pro-competitive effects, and other mechanisms that may amplify them. In addition, trade may create dynamic gains which can be sizable. A recent study of the impact of WTO accession on patenting, for example, finds that about 7 percent of the increase in knowledge creation during the 1990s can be attributed to trade policy reforms.^ref3 Notwithstanding these challenges, studies that exploit quasi-experimental variation in trade costs generated by shocks as varied as the closing of the Suez Canal,^ref4 the reunification of Germany,^ref5 oil price fluctuations,^ref6 and major infrastructure expansions^ref7 consistently show that reducing trade costs improves incomes on average. 

Although globalization has been a force for development for the last three decades, protectionism is now on the rise. One reason is the frustration of those whom trade may have left permanently behind. International trade is not a zero-sum game, as it increases the size of the pie. However, it also changes how the pie is divided, creating winners and losers. The losses often are highly visibly concentrated among specific people in specific areas. The gains, by contrast, are often widely spread and therefore less salient. This undermines political support for global integration. 

In the past 10 years, the increased availability of microdata and computing power have spawned a burgeoning literature measuring these distributional impacts of trade ,^ref8 yielding several novel insights:

• The negative distributional impacts of international trade are large, localized, and long-lived.  The emergence of China as a dominant economic power and its integration into the global trading system have caused regions in both developed and developing countries with a high concentration of import competing industries to fall behind other regions. Workers who are adversely affected by trade liberalization face high moving costs and are often not able to leave to find better jobs in other regions. The adverse effects of trade liberalization are consequently concentrated in particular regions, while the benefits are widespread throughout the whole economy.^ref9 These negative localized effects persist in the long run, and the affected regions take a long time to recover, if at all.^ref10 Since workers’ regions seem as important as their industries and occupations in determining the distributional impacts of globalization, it is crucial to switch from industry-based social protection policies to more flexible and possibly region-based policies.^ref11
• Trade liberalization can favor the poor because low-income households often consume traded goods more than services and non-traded goods .^ref12 The consumption gains resulting from lower prices tend to be widely distributed (as most people consume many different products), but job losses in import-competing sectors tend to be highly concentrated (as most people usually only have one job – which if lost to import competition is a major shock).^ref13 
• Lower prices due to trade liberalization are often not fully passed on to consumers. Evidence from Ethiopia and Nigeria suggests that intermediaries capture most of the surplus from lowering international trade barriers .^ref14 Similarly, firms in India increased their markups after trade was liberalized, thereby offsetting some of the gains for consumers.^ref15

Harnessing the potential of globalization to reduce poverty and boost growth requires complementary social protection and investment policies that address market imperfections and compensate losers . These include reducing intranational trade costs in developing countries by investing in infrastructure, connectivity and market access, and setting up flexible social protection systems. Better infrastructure allows domestic and export market access for poor households, thereby facilitating structural transformation from subsistence farming to cash crops. Improved connectivity and platforms allow small enterprises, which tend to employ more low-skill and informal workers than large firms, to compete in global markets. Flexible social protection and investment schemes can help protect workers and entrepreneurs in lagging regions, whereas industry-based protection systems are often unsuccessful, since they fail to target groups that are suffering localized knock-on effects arising because of adjustment costs and limits to their mobility.