Market Liberalism, Growth, and Economic Development in Latin America pptx

1 Economic Development in the Middle East Rodney Wilson 2 Monetary and Financial Policies in Developing Countries Growth and stabilization Akhtar Hossain and Anis Chowdhury 3 New D

1 Economic Development in the

Middle East

Rodney Wilson

2 Monetary and Financial Policies

in Developing Countries

Growth and stabilization

Akhtar Hossain and

Anis Chowdhury

3 New Directions in Development

Economics

Growth, environmental concerns

and government in the 1990s

Edited by Mats Lundahl and

Institutional and economic

changes in Latin America,

Africa and Asia

7 The South African Economy

Macroeconomic prospects for the medium term

Finn Tarp and Peter Brixen

8 Public Sector Pay and Adjustment

Lessons from five countries

Edited by Christopher Colclough

9 Europe and Economic Reform

in Africa

Structural adjustment and economic diplomacy

Obed O Mailafia

10 Post- apartheid Southern Africa

Economic challenges and policies for the future

Edited by Lennart Petersson

11 Financial Integration and Development

Liberalization and reform in sub- Saharan Africa

Ernest Aryeetey and Machiko Nissanke

12 Regionalization and

Globalization in the Modern

World Economy

Perspectives on the Third World

and transitional economies

Edited by

Alex E Fernández Jilberto and

André Mommen

13 The African Economy

Policy, institutions and the future

Steve Kayizzi- Mugerwa

14 Recovery from Armed Conflict

in Developing Countries

Edited by Geoff Harris

15 Small Enterprises and Economic

16 The World Bank

New agendas in a changing world

Michelle Miller- Adams

17 Development Policy in the

Twenty- First Century

Beyond the post- Washington

consensus

Edited by Ben Fine,

Costas Lapavitsas and

Jonathan Pincus

18 State- Owned Enterprises in the

Middle East and North Africa

Privatization, performance and

reform

Edited by Merih Celasun

19 Finance and Competitiveness in

Developing Countries

Edited by José María Fanelli and

Rohinton Medhora

20 Contemporary Issues in Development Economics

Edited by B.N Ghosh

21 Mexico Beyond NAFTA

Edited by Martín Puchet Anyul and Lionello F Punzo

22 Economies in Transition

A guide to China, Cuba, Mongolia, North Korea and Vietnam at the turn of the twenty­ first century

Ian Jeffries

23 Population, Economic Growth and Agriculture in Less Developed Countries

An analysis of the CFA franc zone

David Fielding

26 Endogenous Development

Networking, innovation, institutions and cities

Antonio Vasquez- Barquero

27 Labour Relations in Development

Edited by Alex E Fernández Jilberto and Marieke Riethof

28 Globalization, Marginalization and Development

Edited by S Mansoob Murshed

A manual for policy analysis

Edited by Ganeshan Wignaraja

31 The African Manufacturing

Firm

An analysis based on firm surveys

in sub- Saharan Africa

Dipak Mazumdar and

Ata Mazaheri

32 Trade Policy, Growth and

Poverty in Asian Developing

Countries

Edited by Kishor Sharma

33 International Competitiveness,

Investment and Finance

A case study of India

Edited by A Ganesh Kumar,

Kunal Sen and

Rajendra R Vaidya

34 The Pattern of Aid Giving

The impact of good governance on

development assistance

Eric Neumayer

35 New International Poverty

Reduction Strategies

Edited by Jean- Pierre Cling,

Mireille Razafindrakoto and

François Roubaud

36 Targeting Development

Critical perspectives on the

millennium development goals

Edited by Richard Black and

Howard White

Constrained Growth

Theory and evidence

Edited by J.S.L McCombie and A.P Thirlwall

38 The Private Sector after Communism

New entrepreneurial firms in transition economies

Jan Winiecki, Vladimir Benacek and Mihaly Laki

39 Information Technology and Development

A new paradigm for delivering the internet to rural areas in developing countries

Jeffrey James

40 The Economics of Palestine

Economic policy and institutional reform for a viable Palestine state

Edited by David Cobham and Nu’man Kanafani

41 Development Dilemmas

The methods and political ethics

of growth policy

Melvin Ayogu and Don Ross

42 Rural Livelihoods and Poverty Reduction Policies

Edited by Frank Ellis and

44 The Political Economy of

Issues and challenges for the

twenty­ first century

Edited by Ricardo Gottschalk and

Patricia Justino

46 Trade, Growth and Inequality

in the Era of Globalization

Edited by Kishor Sharma and

Oliver Morrissey

47 Microfinance

Perils and prospects

Edited by Jude L Fernando

48 The IMF, World Bank and

restructuring and social policy

Edited by Junji Nakagawa

50 Who Gains from Free Trade?

Export­ led growth, inequality and

poverty in Latin America

Edited by Rob Vos,

Enrique Ganuza, Samuel Morley

and Sherman Robinson

51 Evolution of Markets and

Institutions

A study of an emerging economy

Murali Patibandla

52 The New Famines

Why famines exist in an era of globalization

Edited by Stephen Devereux

53 Development Ethics at work

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56 Ideas, Policies and Economic Development in the Americas

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57 European Union Trade Politics and Development

Everything but arms unravelled

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58 Membership Based Organizations of the Poor

Edited by Martha Chen, Renana Jhabvala, Ravi Kanbur and Carol Richards

59 The Politics of Aid Selectivity

Good governance criteria in World Bank, U.S and Dutch

development assistance

Wil Hout

Education and Transnational

institutional reform and social

welfare in the Western Balkans

William Bartlett

65 Work, Female Empowerment

and Economic Development

Sara Horrell, Hazel Johnson and

Health Care in India

Lessons for developing countries

A Venkat Raman and

James Warner Björkman

Dynamics in Asia and Africa

Edited by Keijiro Otsuka, Jonna P Estudillo and Yasuyuki Sawada

69 Microfinance

A reader

David Hulme and Thankom Arun

70 Aid and International NGOs

Dirk- Jan Koch

71 Development Macroeconomics

Essays in memory of Anita Ghatak

Edited by Subrata Ghatak and Paul Levine

72 Taxation in a Low Income Economy

The case of Mozambique

Channing Arndt and Finn Tarp

73 Labour Markets and Economic Development

Edited by Ravi Kanbur and Jan Svejnar

74 Economic Transitions to Neoliberalism in Middle- Income Countries

Policy dilemmas, crises, mass resistance

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76 Trade Relations between the EU

and Africa

Development, challenges and

options beyond the Cotonou

Agreement

Edited by

Yenkong Ngangjoh- Hodu and

Francis A.S.T Matambalya

77 The Comparative Political

Economy of Development

Africa and South Asia

Edited by Barbara Harriss- White

and Judith Heyer

78 Credit Cooperatives in India

Past, present and future

Biswa Swarup Misra

Local versus global logic

Edited by Rick Molz, Cătălin Ratiu

and Ali Taleb

81 Monetary and Financial

Integration in West Africa

83 Towards New Developmentalism

Market as means rather than master

Edited by Shahrukh Rafi Khan and Jens Christiansen

84 Culture, Institutions, and Development

New insights into an old debate

Edited by Jean- Philippe Platteau and Robert Peccoud

85 Assessing Prospective Trade Policy

Methods applied to EU–ACP economic partnership agreements

Edited by Oliver Morrissey

86 Social Protection for Africa’s Children

Edited by Sudhanshu Handa, Stephen Devereux and Douglas Webb

87 Energy, Bio Fuels and Development

Comparing Brazil and the United States

Edited by Edmund Amann, Werner Baer and Don Coes

88 Value Chains, Social Inclusion and Economic Development

Contrasting theories and realities

Edited by A.H.J (Bert) Helmsing and Sietze Vellema

89 Market Liberalism, Growth, and Economic Development in Latin America

Edited by Gerardo Angeles- Castro, Ignacio Perrotini- Hernández, and Humberto Ríos-Bolívar

Market Liberalism, Growth, and Economic Development in Latin America

Edited by Gerardo Angeles- Castro,

Ignacio Perrotini- Hernández, and

Humberto Ríos-Bolívar

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Library of Congress Cataloging in Publication Data

Market liberalism, growth, and economic development in Latin America / edited by Gerardo Angeles­Castro, Ignacio Perrotini­Hernández and Humberto Ríos-Bolivar.

p cm.

Includes bibliographical references and index.

1 Latin America–Economic policy 2 Latin America–Commercial policy 3 Free trade–Latin America 4 Economic development­­Latin America I Angeles­Castro, Gerardo II Perrotini­Hernández, Ignacio III Ríos­Bolivar, Humberto

This edition published in the Taylor & Francis e-Library, 2011.

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Trade liberalization, development and regional integration 5

1 Has trade liberalisation in poor countries delivered the

P E N é L O P E P A C H E C O ­ L ó P E z A N D A P T H I R L W A L L

2 Beyond the Washington Consensus: the quest for an alternative

I G N A C I O P E R R O T I N I ­ H E R N á N D E z ,

J U A N A L B E R T O V á z q U E z ­ M U ñ O z A N D

B L A N C A L A V E N D A ñ O ­ V A R G A S

3 Foreign trade and per capita income: new evidence for

H U M B E R T O R í O S - B O L í V A R A N D O M A R N E M E - C A S T I L L O

4 Regional integration and its effects on inward FDI in

developing countries: a comparison between North–South

Economic liberalization, development and growth in Mexico 193

9 Economic liberalisation and income distribution: theory

G E R A R D O A N G E L E S - C A S T R O

10 How risk factors affect growth in Mexico: a free- market

F R A N C I S C O V E N E G A S ­ M A R T í N E z

12 Technological innovation and sectoral productivity in the

1.1 The trade- off between growth and the balance of payments 18

4.1 Foreign direct investment, net inflows, comparison with

Figures xv

4.2 Foreign direct investment, net inflows, comparison with other

4.12 Dow Jones Index composite average and FDI inflows in Brazil

5.3 Graphic evolution of gravity equation fixed effects for Mercosur

8.4 Compensating variation as per cent of income by income

8.5 Compensating variation as per cent of income by income

11.1 Growth, returns and interest rate: aggregate levels,

11.4 Composition of firms according to financial structure,

13.2 GDP, unemployment, output gap and employment rate,

4.3 Share of cross­ border M&A sales in total FDI inflows in

5.2 Gravity equation for the panels of Mercosur and CAN:

5.3 Gravity equation for the panels of Mercosur and CAN:

8.7a Poverty: before and after trade reform 184

8.11 Poverty and inequality effects of liberalisation in the beef

8.12 Change in the probability of being employed after a Free Trade

9.7 Average real monthly income, Gini, and composition of

11.4 Dependent variable: bit(t subscript directly beneath

12.4 Estimate for municipalities with high density of population

12.5 Estimate for municipalities with low density of population

Tables xix

13.a.2 Granger Causality Test, 1985.1–2006.4 for an unrestricted

Gerardo Angeles- Castro is Research Economist and Head of Research and

Graduate Studies at the School of Economics in the Instituto Politécnico Nacional, Mexico

Blanca L Avendaño-Vargas is Research Economist at the Faculty of

Eco-nomics in the Benemérita Universidad Autónoma de Puebla, Mexico

Fernando Borraz is Senior Researcher at the Central Bank of Uruguay and also

Head of the Department of Economics and full- time Professor at Montevideo University, Uruguay

Leobardo de Jesús is Research Economist at the Universidad Nacional

Autónoma de México (UNAM), Mexico

Alcino Ferreira Câmara-Neto is Dean of the Centre for Economic and Legal

Sciences (CCJE) and Chairman of the Development Council in the Federal

University of Rio de Janeiro (UFRJ); he is also Chief Editor of the Journal of Applied Social Science of the CCJE­ UFRJ, Brazil.

Daniel Ferrés is Assistant Professor at Montevideo University, Uruguay.

Thomas Goda is PhD student in Economics at the London Metropolitan

Uni-versity, UK

Matteo Grazzi is Economist at the Science and Technology Division of the

Inter­ American Development Bank Washington, DC, USA He is also an external researcher at the Centre for Research on Latin American Studies and Transition Economies Studies (ISLA) of the Bocconi University, Milan, Italy

Clemente Hernández-Rodríguez is Coordinator of Research and Consultancy

Centre in Administration and Management, and Associate Director of Research in the Asia Pacific Institute at Tecnológico de Monterrey, Campus Guadalajara, Mexico

Eduardo Loría is Research Economist at the Universidad Nacional Autónoma

de México (UNAM), Mexico

Omar Neme- Castillo is Research Economist at the School of Economics in the

Instituto Politécnico Nacional, Mexico

Contributors xxi

Penélope Pacheco- López is consultant for UNIDO­ Mexico’s Office in the area

of the competitiveness of the Mexican manufacturing sector

Ignacio Perrotini- Hernández is Research Economist and Head of the Graduate

Faculty of Economics at the Universidad Nacional Autónoma de México

(UNAM), Mexico; he is also the Editor of Investigación Económica

(Eco-nomic Research), a bilingual leading journal in Latin America

Humberto Ríos-Bolívar is Research Economist at the School of Economics in

the Instituto Politécnico Nacional, Mexico; he is also the Editor of the journal

Panorama Económico (Economic Panorama).

Jaime Ros is currently Professor of Economics at the Universidad Nacional

Autónoma de México (UNAM) He also taught Economics at the University

of Notre Dame and is a Faculty Fellow at the Helen Kellogg Institute of national Studies

Inter-Máximo Rossi is Professor of Economics at De la República University,

Uru-guay

A.P Thirlwall is Professor of Applied Economics at the University of Kent,

UK

José Carlos Trejo- García is PhD student in Economics at the School of

Eco-nomics in the Instituto Politécnico Nacional, Mexico

Ana Lilia Valderrama- Santibáñez is Research Economist at the School of

Economics in the Instituto Politécnico Nacional, Mexico

Juan Alberto Vázquez-Muñoz is Research Economist at the Faculty of

Eco-nomics in the Benemérita Universidad Autónoma de Puebla, Mexico

Francisco Venegas- Martínez is Research Economist at the School of

Eco-nomics in the Instituto Politécnico Nacional, Mexico

Matías Vernengo is Associate Professor at the Department of Economics,

Uni-versity of Utah, USA

Jaime Ros

The impact of economic liberalization on growth and development in developing countries is by now the subject of a vast literature that includes a variety of per-spectives This book takes up this subject and makes a substantial contribution to this literature, concentrating largely, although not exclusively, on Latin America Have the processes of trade liberalization since the 1980s lived up to their prom-ises? What went wrong with the policy package known as the Washington Con-sensus? What is the case for a developmental industrial policy in order to address the shortcomings of economic liberalization? What are the links between inter-national trade and the level of economic development? What have been the effects of regional trade agreements on trade flows and foreign direct investment (FDI)? Do North–South trade agreements really attract more FDI than South–South agreements? What about the role in FDI of bilateral investment treaties? These are some of the key questions addressed by this book through an array of statistical and econometric methods applied to samples of developing and, in particular, Latin American countries, before and after and cross country compar-isons, as well as case studies of Argentina, Chile, Mexico and Uruguay

The first part of the book focuses on the effects of trade liberalization and the processes of regional integration in Latin America Trade liberalization has not lived up to expectations regarding growth performance, poverty reduction and income distribution as argued by Pacheco- López and Thirlwall in their review of the evidence for developing countries (a conclusion shared by country studies in the second and third parts of this volume) This, at least in part, is due to the fact that trade liberalization, especially in poor countries, has had deleterious effects

on the balance of payments constraint on growth and also because, contrary to the orthodox predictions of the Stolper–Samuelson theorem, income inequalities have tended to increase in many developing countries as unskilled labour has not benefited from the expansion of trade More generally, the policy package known as the Washington Consensus has not improved economic performance and closed the development gap in the large Latin American economies This is attributed by Perrotini­ Hernández, Vázquez­Muñoz, and Avendaño­Vargas to the fall in investment rates (with the exception of Chile among the large Latin American economies) and the increase in the income elasticity of imports which contrasts sharply with the Chinese experience The policy implications derived

Foreword xxiii

by the authors include an alternative development strategy centred on the mentation of an industrial policy for development (Perrotini­ Hernández, Vázquez­Muñoz, and Avendaño­Vargas) as well as a trade strategy for develop-ment centred on acquiring dynamic comparative advantages and a call for a new world trade order that works for development in poor countries (Pacheco­ López and Thirlwall)

imple-All this doesn’t mean that trade liberalization and regional trade agreements such as Mercosur and the Andean Community have not led to an increase in trade flows among trading partners (without reducing extra­ regional trade flows) The increase in trade flows is shown by Hernández­Rodríguez using a gravity model which relates trade to income, distance between trading partners and membership in a trading bloc Trade agreements have also been accompanied by increasing flows of FDI as shown by Goda in his interesting comparison of the experiences of Brazil under Mercosur and Mexico under NAFTA Also, these trends in trade and FDI have generally had positive static effects on per capita income according to Ríos-Bolívar and Neme- Castillo in a study of a set of 21 Latin American and Caribbean countries

The second part of the book deals with trade reforms and development ence presenting three case studies of Latin American countries (Argentina, Chile, and Uruguay) Taking a long view of Argentina’s development, Ferreira and Vernengo argue that the recent growth and equity performance (except for the period since 2003) under economic liberalization compare rather unfavoura-bly to that of the import substitution industrialization period Grazzi examines the links between trade and investment liberalization (following the establish-ment of bilateral investment treaties and free trade agreements) and the flows of FDI in Chile, the third largest recipient of foreign investment in Latin America (after Brazil and Mexico) in absolute terms and the second in per capita terms after Trinidad and Tobago Using an augmented gravity model, the author finds that bilateral investment treaties have a positive and significant impact on FDI inflows, while there is little or no evidence of a significant effect of double taxa-tion treaties and free trade agreements The experience of Uruguay under Merco-sur is the subject of the chapter by Borraz, Ferrés and Rossi They conclude that while specific groups of the population (those with higher and lower incomes) reaped more of the mild gains from trade than the middle income groups, they could not find any evidence about absolute losers resulting from Mercosur.The third part focuses on Mexico and contains a heterogeneous collection of chapterss dealing with different aspects of its economic performance A first trend that characterizes the recent past is the rise and fall of inequality during the economic liberalization period This is the subject of the chapter by Angeles- Castro who finds that income inequality worsens after liberalization, mainly due

experi-to an increase in the skilled labour premium, a reduction of agricultural incomes relative to services and a negative impact of market openness on wages in the traded sector This worsening of inequality is followed after 1998 by a decrease

in inequality associated to the decrease in the returns to skilled labour and a weaker effect of trade on wages in the traded sector Venegas- Martínez focuses

on growth performance from 1930 to 2002 The author brings currency, market, debt and fiscal risk factors in an intertemporal optimizing model of endogenous growth showing that risk factors may lead to qualitative changes in the determi-nants of growth in contrast with the deterministic setting Perrotini­ Hernández, Avendaño­Vargas, and Vázquez­Muñoz use a Minskyan framework to evaluate Mexico’s inflation targeting monetary policy, concluding that the management

of the interest rate under this regime may encourage Ponzi financing Using a production function approach, Ríos­Bolívar and Valderrama­ Santibáñez study the relationship between the labour productivity growth and investment in research and development (R&D) for the manufacturing sector, trade and serv-ices, finding that investment in R&D has a positive effect on productivity growth

in the three sectors Finally, Loría and de Jesús focus on the relationship between unemployment and output growth, confirming for Mexico the validity of Okun’s law that relates the change in unemployment to the rate of GDP growth

Overall, this is a very valuable volume of essays that contributes significantly

to the literature on its subject It must be read by all those interested in the effects

of trade and investment liberalization in developing countries, who will find in it not only new evidence but also fresh, intelligent and generally heterodox per-spectives on the subject matter

ACP African, Caribbean and Pacific Countries

Association of Integration)

BADECEL Banco de Datos Estadísticos de Comercio Exterior (Statical Data

Bank for Foreing Trade)

BADEINSO Social Statistics and Indicators

Bank of Credit)

(Centre for Prospective Studies and International Information)

Administración (Centre for Social Research on the State and Administration)

Survey of Households’ Expenditures an Incomes)

Acronyms xxvii

(National Institute for Statistics, Geography and Informatics)

SIMBAD Municipal Information System Database

aspects of Probit analysis)

There are 13 chapters in this collection linked in varying ways to the series of economic reforms introduced in the region in the last decades In this introduc-tion we do not intend to provide a comprehensive résumé of the chapters of the present book or to exhaust the great richness of the analyses and debates con-tained therein We just want to give a general appraisal of the editorial structure

of the volume There are many authors in this volume, and undoubtedly they disagree with each other on many important economic issues and policy ques-tions Yet, we have chosen to bring these chapters together because they indis-putably share a common concern, namely the search for an alternative economic policy model that best suits Latin America’s future economic development The book is organised in three parts

Part I

The first part comprises five chapters with the theme of trade liberalisation, development and regional integration It is very appropriate to begin the book

with a contribution written by Pacheco- López and Thirlwall, who examine the impact of trade liberalisation on the trade- off between development and the balance of payments The authors conclude that a new world trade order is needed where poor countries are allowed the acquisition of dynamic compara-tive advantage Perrotini- Hernández, Vázquez-Muñoz and Avendaño-Vargas take up the issue of the impressive development gap that separates the world’s most advanced economy, the United States, and Latin America They discuss the relative merits of the Washington Consensus strategy within a context where

‘classic conditions for market failure’ are ubiquitous They make the case for a developmental industrial policy which calls for a fiscal policy regime aimed at stabilising investment, growth and employment Ríos-Bolívar and Neme- Castillo study the relationship between international trade and per capita income in 21 countries of Latin America and the Caribbean in the period 1977–2007 They estimate the relationship between imports of capital goods, physical capital, per capita income and human capital Among other things, they find the existence of

a ‛literacy trap’ Thomas Goda wrestles with the relationship between regional integration and FDI in the Mercosur and the NAFTA areas He compares the impacts of FDI in North–South and South–South integration environments and finds empirical results which may be seen as conflicting with received theory Therefore, he states, regional integration as an effective means of attracting FDI should not be taken for granted Hernández-Rodríguez, in turn, builds a gravity model to explore the factors that influence trade flows within trade blocs and outside such blocs He concludes that geographic factors are most important, fol-lowed by income size

Part II

In the second part of the volume a set of three case studies is presented Neto and Vernengo offer a critical assessment of the process of economic devel-opment of Argentina from the mid- 1940s to the present time Their historical approach leads them to identify three stages of economic growth (the state- led growth model from 1946 to 1976, the liberal stage from 1976 to 2001 and the commodity boom period from 2002 to 2008) which have been unsustainable altogether In addition, Grazzi examines in some detail the determinants of FDI inflows into Chile through the estimation of a gravity model from 1990 to 2005 His econometric results lead him to conclude that investments in Chile are mostly of the resource- seeking type; that FDI is negatively affected by distance and positively affected by the source country’s GDP and GDP per capita This second part ends with an analysis of the impact of trade liberalisation on income distribution in Uruguay Borraz, Ferrés and Rossi study the long- term effects on poverty and inequality resulting from Uruguay integrating into Mercosur Their empirical results show that even if gains from trade liberalisation can be observed, those benefits are unevenly distributed Therefore, trade liberalisation

Câmara-is not necessarily and always a pro- poor growth strategy The ultimate effect of economic liberalisation and market integration depends on the impact of price

theoreti-1990 to 2004, and conduct a microeconomic analysis of financial instability in Mexico They conclude that financial fragility can occur when the central bank targets low inflation and appreciates the exchange rate due to the presence of high pass- through effects from currency volatility on to the price level Trejo- García, Ríos-Bolívar and Valderrama- Santibáñez examine in some detail the relationship between human capital productivity and economic growth under market openness conditions and, focusing on the behaviour of three economic sectors – manufactur-ing, commerce and services – they show that investment on research and develop-ment has a positive effect and in most cases the coefficients are statistically significant Lastly, Loría and de Jesús assess the validity of Okun’s Law in Mexico They estimate Okun’s Law for the Mexican economy from 1985 to 2006 and found robust evidence in favour of bidirectional causality between output and unemployment.

Finally, the analyses comprising this volume provide rich diagnoses and empirical analysis which, we hope, may contribute to the debate for the enhance-ment of economic development of Latin America May this book inspire further research on the topics dealt with

Part I

Trade liberalization,

development and regional integration

1 Has trade liberalisation in poor

countries delivered the promises

expected?

Penélope Pacheco- López and A.P Thirlwall

Trade liberalisation has not lived up to its promises But the basic logic of trade – its potential to make most, if not all, better off – remains Trade is not a zero- sum game in which those who win do so at the cost of others; it is, or at least can be, a positive- sum game, in which everybody is a winner If that potential is to be real- ised, first we must reject two of the long- standing premises of trade liberalisation: that trade liberalisation automatically leads to more trade and growth, and that growth will automatically ‘trickle down’ to benefit all Neither is consistent with economic theory or historical experience.

(Stiglitz, 2006)

1.1 Introduction

The last decades have witnessed tremendous pressure on poor developing tries to liberalise their trade The free trade mantra preached by developed coun-tries and major international development organisations has become like a religion, holding out the promise that if poor countries adopt the faith, they will somehow be ‘saved’ The broad purpose of this chapter is to challenge this sim-plistic view The chapter is based on a review of the vast literature of theory and case studies (including research of our own) on the relation between trade liber-alisation and economic performance across the world (see Thirlwall and Pacheco- López, 2008), which leads us to four general, but important, conclu-sions The first is that while there can be static gains from trade (if certain crucial assumptions are met) there is nothing in the theory of trade per se which demon-strates conclusively that trade liberalisation will launch a country on a higher sustainable growth path Even Jagdish Bhagwati (2001), the high priest of free trade, is honest about that (see below) Second, the impact of trade liberalisation

coun-on reducing world poverty has been minimal, and may have increased it Third, trade liberalisation has almost certainly worsened the distribution of income between rich and poor countries, and between unskilled wage- earners and other workers within countries, contrary to the predictions of orthodox theory Finally, the evidence is fragile that the economic growth performance of countries that have liberalised extensively is in any way superior to countries that have not The timing, sequencing and context of liberalisation are of prime importance in

determining the impact of liberalisation What really matters for growth formance is domestic economic policy and growth- supportive institutions This will lead us at the end of the chapter to a brief discussion of trade strategy for development.

per-1.2 What is wrong with orthodox trade theory?

Orthodox trade theory is based on Ricardo’s (1817) law of comparative age, and the Heckscher–Ohlin theorem which argues that countries will gain by specialising in the production of goods which use their most abundant factor of production (Heckscher, 1919; Ohlin, 1933) Paul Samuelson (1962) cites Ricar-do’s theory of comparative advantage as one of the few laws in economics ‘that

advant-is both true and non- trivial’ There are, indeed, static welfare gains to be had by countries specialising in goods in which they have the greatest comparative advantage (or lowest opportunity cost), but two crucial, often- forgotten, assump-tions need to be met The first is that in the process of resources reallocation, full employment is preserved, but this is not guaranteed If unemployment arises, the welfare gains from greater specialisation may be offset by the welfare losses of unemployment As Keynes (1930) rightly says ‘free trade assumes that if you throw men out of work in one direction you re- employ them in another As soon

as this link in the chain is broken the whole of the free trade argument breaks down.’ The second crucial assumption is that in the process of freeing trade, balance of payments equilibrium is preserved, which is also not guaranteed In orthodox theory, the balance of payments is assumed to look after itself without affecting output and employment This was the implicit assumption of the gold standard adjustment mechanism, and is also implicit in the theory of flexible exchange rates But if trade liberalisation leads to a faster growth of imports than exports and the nominal exchange rate is not an efficient balance of payments adjustment weapon, then output will need to contract to reduce imports, leading

to welfare losses As we shall see later, this has been the experience of many developing countries forced to liberalise prematurely

In fact, the existence of unemployment provides one of the major economic arguments for protection, as outlined in Johnson’s (1964) classic paper on tariffs and economic development Unemployment means that the social cost of labour

is less than the private cost so that a welfare gain is possible by encouraging more domestic employment until the social cost of production is equal to the world price of goods A subsidy to labour, however, is the first best policy because an equivalent tariff would reduce consumer surplus Johnson also out-lines some of the other classic economic arguments for protection such as the infant industry argument, the externalities argument and the optimal tariff argu-ment But Rodrik (1988) is correct that despite the body of trade theory which legitimises protection, the arguments have still not penetrated the vast literature

on trade policy in developing countries even though the market imperfections that the arguments reflect are more serious in developing countries than in developed countries

Trade liberalisation in poor countries 9

As well as potential static gains from trade (although not guaranteed, and in any case small (see Dowrick, 1997)) there are also possible dynamic gains which arise through the greater flow of ideas, new knowledge, investment and econo-mies of scale if the domestic market for output is small The dynamic effects of trade, however, depend primarily on what countries specialise in; whether natural resource activities or manufacturing John Stuart Mill (1848) pointed this out in the nineteenth century, and Stiglitz (2006) today makes the same enduring point:

Without protection, a country whose static comparative advantage lies in, say agriculture, risks stagnation; its comparative advantage will remain in agri-culture, with limited growth prospects Broad- based industrial protection can lead to an increase in the size of the industrial sector which is, almost every-where, the source of innovation; many of these advances spill over into the rest of the economy as do the benefits from the development of institutions, like financial markets, that accompany the growth of an industrial sector Moreover, a large and growing industrial sector (and the tariffs on manufac-tured goods) provides revenues with which the government can fund educa-tion, infrastructure, and other ingredients for broad- based growth

In other words, if trade is to be an engine of growth, poor countries need to acquire new comparative advantage in goods that have favourable production and demand characteristics Structure matters for economic growth This is rec-ognised in ‘new’ trade theory pioneered by Krugman (1984, 1986) in the 1980s, who shows there is a case for protecting industries with spillovers and externali-ties, and for using import substitution for export promotion In most standard growth models, however, the effect of trade on growth is ambiguous For example, in the canonical neoclassical Solow model (1956), trade cannot affect the steady- state growth rate, because it is treated as an exogenous constant Only

in the ‘new’ growth theories of, for example, Grossman and Helpman (1991a, 1991b) does trade have the potential to raise the growth rate permanently through learning and spillover effects, but they have to be continuous Bhagwati (2001), the most ardent advocate of free trade, even for poor developing coun-tries, frankly admits:

Those who assert that free trade will lead necessarily to greater growth

either are ignorant of the fine nuances of the theory and the vast quantity of literature to the contrary on the subject at hand or are nonetheless basing

their argument on a different premise; that is, that the preponderant evidence

on the issue (in the post- war period) suggests that free trade tends to lead to greater growth after all In fact, where theory includes several models that can lead in different directions, the policy economist is challenged to choose the model that is most appropriate to the reality she confronts And I would argue that, in the present instance, we must choose the approach that gener-ates favourable outcomes for growth when trade is liberalised

The issue is empirical, but certainly history is not on the side of the free- traders None of the now- developed countries transformed their economies on the basis

of laissez- faire, laissez- passer Great Britain started to protect and foster tries as early as the late fifteenth century under Henry VII, and did not start dis-mantling the structure of protection until the repeal of the Corn Laws in 1848 From then on Great Britain preached free trade, but it had already attained technological superiority in the world economy, and such preaching, as List (1885) remarked, was like ‘kicking away the ladder’ The United States followed Great Britain’s protectionist route at the end of the eighteenth century under the influence of the Treasury Secretary, Alexander Hamilton, who, in 1791, first coined the term ‘infant industry’ Adam Smith’s advice to the United States in

indus-his Wealth of Nations (1776) was to pursue free trade:

Were the Americans, either by combination or by any other sort of violence,

to stop the importation to European manufactures, and, by thus giving a monopoly to such of their own countrymen as could manufacture the like goods, divert any considerable part of their capital into this employment, they would retard instead of accelerating the further increase in the value of their annual produce, and would obstruct instead of promoting the progress

of their country towards real wealth and greatness

If the United States had followed Smith’s advice, it would have remained an economic backwater instead of becoming the richest country in the world based

on high productivity in industry The same can be said of modern- day economic giants, such as Japan and South Korea, whose comparative advantage once lay

in rice, but who, through selective protection, import substitution, export tion and directed credit, transformed themselves into industrial power- houses (see Chang, 2005) The newly industrialising countries of South- East Asia, and particularly China, are pursuing the same route to development – transforming their industrial structure through deliberate policy intervention – and are growing fast as a consequence Stiglitz (2006) is right when he says that ‘economists who promise that trade liberalisation will make everybody better off are being disin-genuous Economic theory (and historical experience) suggests the contrary.’ All

promo-we know is that as countries get richer they dismantle trade restrictions, not that they get richer because they liberalise trade The issue for poor developing coun-tries today is not whether to protect, but how to protect in order to ensure the dynamic efficiency of their nascent industrial activities

1.3 Poverty and income inequality within countries

At this moment in time, nearly one billion of the world’s population live on less than $1 a day, and 2.7 billion live on less than $2 a day (Chen and Ravallion, 2004) In other words, over one- third of the world’s population lives in absolute poverty Advocates of trade liberalisation promise that the freeing of trade will lift people out of poverty The former European Trade Commissioner, Peter

Trade liberalisation in poor countries 11 Mandelson, wrote in the Guardian newspaper (3 October 2008) that globalisa-

tion is the greatest engine of poverty reduction the world has ever seen If he had looked at the facts, however, he would see that since 1980 the absolute number

of people in poverty has not decreased The number on less than $2 a day has

increased from 2.4 billion to 2.7 billion, and the number on less than $1 a day (excluding China) has increased from 848 million to 870 million The reduction

in the total number living on less than $1 a day is because of a fall in China in the early 1980s, but this was due to agricultural reforms not to trade liberalisa-

tion Winters et al (2004), in their survey of trade liberalisation and poverty,

claim that ‘theory provides a strong presumption that trade liberalisation will be poverty alleviating in the long run and on average’ This is simply not true, because, as we have seen, the theory of trade liberalisation says nothing definite about economic growth The impact of trade liberalisation on poverty depends

on its effects on employment and prices Trade liberalisation can easily cause poverty by throwing people out of work For example, since the NAFTA agree-ment was signed between the US, Canada and Mexico in 1994, two million Mexican maize farmers have lost their jobs because they cannot compete with subsidised maize from the US Trade liberalisation can provide new opportun-ities in the export sector, but only if the sector is prepared

The statistical research on the relation between trade liberalisation and poverty is very inconclusive The most comprehensive study is by Ravallion (2006) who takes 75 countries where there have been at least two household surveys on poverty, and runs a simple regression of the percentage change in the poverty rate on the percentage change in the ratio of trade to GDP (as a proxy for liberalisation) There is a statistically significant negative coefficient of 0.84, but the correlation is very fragile For example, controlling for initial conditions makes the relation insignificant, and adding other control variables makes no dif-ference Ravallion concludes ‘it remains clear that there is considerable variation

in the rates of poverty reduction at a given rate of expansion of trade volume’ Equally, however, ‘based on the data available from cross- country comparisons,

it is hard to maintain the view that expanding trade, in general, is a powerful force for poverty reduction in developing countries’

At the same time as the absolute numbers in poverty have been increasing, the distribution of income within poor countries has also been widening, con-trary to the orthodox predictions of the Hecksher–Ohlin (and Stolper–Samuel-son, 1941) theorems Goldberg and Pavcnik (2007), in their survey of the distributional effects of globalisation in developing countries, say: ‘while ine-quality has many different dimensions, all existing measures for inequality in developing countries seem to point to an increase in inequality which in some cases is severe’ The major cause of income inequality is wage inequality between skilled and unskilled workers Orthodox trade theory predicts a narrow-ing of wage inequality in poor countries because their comparative advantage should lie in the production and export of goods using abundant unskilled labour This narrowing has not happened for four main reasons: first, trade- related, skill- biased technical change; second, competition between poor countries; third,