Sunday, September 12, 2010

Trade, poverty and lagging regions

Krishna, Mitra and Sundaram have an interesting NEBR working paper 16322 where they show that states with lesser openness to international trade generally have weaker transmission of international prices to domestic prices. It means that poverty is high in lagging regions due to a lack of exposure to international markets. They also show that countries with lesser proportion of the population in lagging regions experience greater reduction in poverty rates following trade liberalization. They suggest that in order to make gains from trade equitable, there has to be adequate provision of infrastructure, including equipped ports, better and more extensive roads and communication links.

Generally, increase in trade (read exports) boosts economic growth rate. The growth, in most of the cases, translates into reduction in poverty (on an average) as there is rise in national income. However, the distribution of gains from trade is not always uniform, meaning that some gain, others won’t, or even some might lose. Lagging regions might not benefit from trade because transportation and transaction costs might be very high. Furthermore, some regions might have market rigidities such as immobility of labor and lack of capital, which also suppresses gains from trade. Also, trade liberalization might itself lead to clustering of industries in one place, primarily due to economies of scale. This also makes distribution of the fruits of trade uneven. For instance, three coastal areas in China (the Bohai Basin, the Pearl River Delta, and Yangtze River Delta) accounted for more than half of the country’s GDP in 2005, but constitutes less than a fifth of the total geographical area.

The paper is about estimation of differential impact of trade liberalization in lagging and leading regions within a country, factors inhibiting market integration, and factors preventing trade from positively affecting development in lagging regions. The authors find that a percentage point reduction in tariff rate decreases poverty by 0.22 percent in the leading states, while the effect is insignificant in the lagging states. Within leading states, the effects of trade liberalization are also larger in urban areas: A percentage point decrease in tariff rate decreases poverty by 0.19 percent in rural sector and by 0.26 percent in urban sector in the leading states.

Price transmission from international prices to domestic prices is less perfect in lagging states than in leading ones, especially in the rural sector. The authors estimate that, in urban India, a one percent reduction in international prices implies a 0.61 percent reduction in the unit price in the leading states but a 0.53 percent reduction in the unit price in the lagging states. Meanwhile, in rural India, a one percent reduction in international prices implies a 0.60 percent reduction the unit price in leading states but a 0.34 percent reduction in the unit price in the lagging states.

They also look at the impact of trade liberalization on productivity. They find that trade liberalization has increased the productivity of Indian industry, though the impact in lagging states is “weekly smaller”. Specifically, a one percentage point reduction in tariff rate increases productivity by 0.41 percent across all leading states but only by 0.38 percent in lagging states.

In an extension to their study in India, they find that in other South Asia countries (Bangladesh, Pakistan, Nepal, and Sri Lanka), the impact of trade liberalization on poverty depends on the proportion of national population living in lagging regions. Countries with a smaller proportion of population in lagging regions benefit more from trade liberalization. A point increase in the proportion of population in lagging regions depresses the annual growth in per capita GDP after trade liberalization further by 0.01 percentage points. This might be the reason why, in Nepal, after more than two decades of trade liberalization, its fruits is hardly seen in the economy, which has seen population growth rate almost equal to GDP growth rate quite some time. At one point the country had negative per capita growth due to high population growth rate. Furthermore, the authors find (statistically “weaker”) that a point increase in the proportion of population in lagging regions decreases the annual rate of decline in poverty following trade liberalization by an additional 0.01 percentage point.

For Nepal, the authors assume that central and western development regions to be leading regions and eastern, far-western, and mid-western development regions to be lagging regions. According to the author’s classification, around 46% of the population in Nepal resides in lagging regions. The mean national average distance to capital city is calculated to be 236 Kms. Nepal liberalized trade in 1991, India 1994, Pakistan 2001, Sri Lanka 1977-83 and 1981, and Bangladesh 1996 (see Table 4 in the paper).

“Bangladesh, India and Nepal show higher regional inequality as measured by above average poor in the most lagging region as a percentage of the total poor in the economy. For these countries, a priority would be to ensure integration of backward regions and government redistribution programs to lessen inequality so that the poor may also benefit from trade reforms.”

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