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2003 by Asian Development BankJuly 2003ISSN 1655-5260

The views expressed in this paper are those of the author(s) and do notnecessarily reflect the views or policies of the Asian Development Bank.

The ERD Policy Brief Series is based on papers or notes preparedby ADB staff and their resource persons. The series is designed toprovide concise nontechnical accounts of policy issues of topicalinterest to ADB management, Board of Directors, and staff. Thoughprepared primarily for internal readership within the ADB, the seriesmay be accessed by interested external readers. Feedback iswelcome via e-mail (policybriefs@adb.org).

ERD POLICY BRIEF NO. 21

Trade and Poverty:What are the Connections?

Douglas H. Brooks

July 2003

Douglas Brooks is Principal Economist in the Macroeconomics andFinance Research Division of the Economics and ResearchDepartment, Asian Development Bank. The author acknowledgesIfzal Ali and Jean-Pierre Verbiest for helpful insights.

International trade and its liberalization can expand the range ofgoods and services available to the poor and reduce prices of thosegoods and services, increasing real income and reducing poverty. Inpractice, trade expansion creates both winners and losers. In theprocess, trade can reduce relative poverty, absolute poverty, both, orneither, but is usually found to benefit the poor. Cross-countryregressions suggest that, on average, economic growth resulting fromtrade liberalization and openness benefits the poor proportionatelywith the rest of the population.1 However, the effects of trade opennesson the poor, beyond the effect on overall growth, are not systematicand there is considerable variation across countries and time periods(Berg and Krueger 2002).

Developing economies on average impose much higher tradebarriers than developed countries and would increase their welfaresubstantially by liberalizing their own trade regimes (Dollar and Collier2002). Empirical analysis indicates that trade expansion followingreform has had positive net effects on income and employment for thepoor (Bannister and Thugge 2001, McKay et al. 2000). Policies aimedat increasing the access of the poor to the gains from trade bytargeting sectors of greatest importance for the poor, institutionalstructures, and investment responses, can mitigate negative impactsand increase the beneficial effects of trade expansion. Rather thanattempting to restrict trade, policy responses that use trade expansionto increase opportunities for the poor to participate in productiveactivities, increase productivity in tradable goods sectors, and increasegrowth will yield the greatest benefits for the poor.

Benefits of Trade for the Poor

Trade-induced price changes may result directly from changesin supply or demand, or indirectly through changes in the exchangerate resulting from alterations in the terms of trade. Trade can raisereal incomes and reduce absolute poverty by lowering prices ofimports and import substitutes consumed by the poor or by raising

1 While empirical studies crediting trade with contributions to growth have beencriticized on methodological grounds, even the critics agree that it strains credulityto believe that trade liberalization in recent decades has not played a significantrole in economic growth and poverty reduction (e.g., Rodriguez and Rodrik 1999,Cooper 2002).

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prices of exports or import complements produced by the poor.Relative poverty can also be reduced to the extent that lower pricedimports or higher priced exports disproportionately involve the poor.

However, the greatest impact of trade on the poor is generallythrough its contribution to economic growth. This indirect effect canbe substantial and often outweighs more direct poverty reductioneffects (Frankel and Romer 1999). Efficiency gains from trade can alsoincrease employment or investment opportunities (includinginvestments in human capital), or increase availability ofcomplementary factors of production that raise the productivity of thepoor. Access of the poor to these potential benefits is a critical factorin determining the poverty reduction effect.

While trade liberalization and expansion benefits the poor ingeneral, not all of the trade-related effects on poverty are necessarilypositive. In general, changes in trade flows or patterns alter the natureof risks and uncertainties faced by the poor. Changes in trade flowsor patterns have the potential to disrupt social stability, unsettlingconditions particularly for those on the margins of society. Changesin terms of trade or exchange rates particularly affecting tradablesectors involving large numbers of poor or near poor, such as small-scale agriculture, can have large impacts (positive or negative) on theincidence of poverty. Trade-related environmental changes may alsonegatively affect the poor. The potential adjustment costs may be highfor some individuals, arguing for complementary policies to ease thetransition.

The Domestic Context

Effects of trade and trade policy on poverty are influenced by thenature of poverty in an economy, including the institutional contextand the international trading environment. The domestic contextinvolves the sectors of greatest interest to, or involvement of the poor,such as agriculture and labor-intensive manufactures, as well as thedegree and distribution of poverty within and between households.Agriculture is a key sector for poverty alleviation, due to the strongconnection between small-scale agriculture and poverty in mostdeveloping economies, its linkages to other sectors, its products’potential for greater trade, and the potential of farm households toserve as a broad base of demand for other domestic products. Growthin small-scale agriculture can also help stimulate nonfarm ruralactivities involving the rural poor.

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Computer simulations of multilateral trade liberalization indicatethat the largest gains (almost half) would come from OECDagricultural policy liberalization, but the greatest gains to developingcountries would come from liberalizing their own policies (Anderson2002).2 However, removing protection in OECD markets would lead toan increase in producer prices for agricultural products, benefitingproducers of those products in developing countries. Removal ofdeveloped country agricultural production and export subsidyschemes would yield an increase in world agricultural prices of anestimated 12 percent (USDA 2001). At the household level, net sellersof food would be better off on average from the higher prices followingagricultural trade liberalization. Most of the other net buyers of foodare unskilled labor, the demand for which would rise when cuts aremade in textile and clothing protection abroad with the approachingend of the Multifibre Arrangement. Consequently, even net foodimporting developing countries could be better off (Anderson 2002).

Growth in export-oriented sectors can benefit poor women wherethese sectors are more likely to employ women, as in SoutheastAsia’s electronics industry. Traded services are also becomingincreasingly important in regional economies, are rapidly growingdestinations for foreign direct investment in developing Asia, and canfacilitate substantial poverty reduction through expansion both ofservices available to the poor and of employment opportunities. Tradedservices—including tourism, finance, and information processing—also employ a high proportion of women (McGill 2003).

The geographical distribution of poverty and logistical hindrancesto trade play a role in how trade-related changes in poverty occur,emphasizing the importance of transport infrastructure.3 Logisticsimprovements can reduce transport costs and the time for productsproduced by the poor to reach their destinations, and increase thereliability of that timing.

2 Most welfare gains from OECD trade liberalization would accrue to consumersin OECD economies.3 For example, a reduction in logistics costs of US$200 per twenty-foot equivalentunit (20-foot container) in East Asia could increase the volume of trade in eachcountry by about 13 percent (Carruthers and de Monie 2002).

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The institutional context partially determines the possibilities andpotential methods for maximizing the gains from trade. It alsoinfluences how much of, and how, those gains reach the poor. Thisis particularly true for flexible labor markets, institutions assigning andprotecting property rights and encouraging innovation, equitabledispute resolution systems, social services that augment the humancapital of the poor, and efficient financial intermediation. Withdeepening integration of the economies in the region, domestic “behindthe border” issues such as competition and investment policiesincreasingly affect the transmission mechanisms by which tradecontributes to poverty reduction.

The International Trading Environment

In the international trading context, multilateral commitmentssuch as the negotiations, agreements, and dispute resolutions of theWorld Trade Organization (WTO) can ensure that trade liberalizationis met by reciprocal liberalizations from trading partners, but alsorestricts policy options. Regional and subregional tradingarrangements also affect trade and investment flows and may act aseither building blocks or stumbling blocks to progress on multilateraltrade liberalization.

Developments in individual economies can alter the internationaltrading context. For example, the accession of the People’s Republicof China (PRC) to the WTO has important implications for regionaland global trading patterns, with the full effects still unclear. Economicmodels suggest the net effects are likely to be significant for the PRCitself, small and positive for Republic of Korea; Taipei,China; and HongKong, China; and small and negative for Southeast Asia(Ianchovichina et al. 2003). However, many private businesspersonsexpect the effects to be more substantial, highlighting the likelyunevenness in distribution of the impacts both between and withineconomies, as well as on poverty.

Policy Implications

To some extent, trade liberalization creates conditions that helpthe poor to capitalize on the efficiency gains from trade. It forcesgovernments and societies to become more transparent when facedwith benchmarks from international standards. It imposes or reinforces

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market discipline. A society can try to maximize the static welfaregains from trade for the poor with policies targeting the sectors orgeographic regions of most importance to the poor to increaseproductivity and the efficiency of trade. To raise investment andproductivity for greater growth, trade liberalization should beaccompanied by priority investments in transport and communicationsinfrastructure, market facilitation, education, and governanceimprovements (McCulloch et al. 2001).

Studies suggest that factor markets provide the key linkagebetween trade liberalization and poverty, since households aretypically much more specialized in their income sources thanconsumption patterns (Reimer 2002). Policies that increase accessfor the poor to the gains from trade—by facilitating participation inmarket activities through more flexible labor markets, easier accessto credit for small-scale enterprises (especially in rural areas wherethe majority of the poor are), or enhancement of an individual’s skilland ability—can have a snowballing effect on poverty reduction. Theability of greater trade to attract informal sector workers into the formalsector through a flexible labor market can reduce poverty, whilesimultaneously raising government revenues as more economictransactions become recorded. Furthermore, each new job in theformal sector typically generates additional informal-sector jobsthrough subcontracting chains and increased demand. Policies thatexpand market opportunities for the poor in particular can thus havethe greatest impact on relative as well as absolute poverty reduction.

A recommended policy mix for successful implementation oftrade liberalization includes factors conducive to growth in generalsuch as macroeconomic stability, a competitive exchange rate, labormarket flexibility, competitive product markets, and policies that donot discriminate against foreigners in investment. It also includespolicies and infrastructure to enable the poor in particular to takeadvantage of the gains from expanding trade through institutionalreforms that enable both input and output markets to expand andfunction more efficiently, and to be more accessible to the poor. Tominimize transitional costs of trade liberalization for the poor, reformsshould be as broad-based as possible, sequenced, and phased toallow for ease of adjustment, and accompanied by social safety netsand other reforms that facilitate the adjustment (Bannister and Thugge2001). Land titling and secure property rights play an essential rolein ensuring the poor can take full advantage of the changes.

A society can use trade in the broader development context toenhance the dynamic efficiency of economic growth and distribution

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of gains to the poor. The actual path of adjustment will be influencedby initial endowments and policies, the types of trade reformimplemented, progress on reforms behind the border, and tradefacilitation, among other factors. Thus, the optimal policy mix remainscountry-specific, but with a conducive policy environment, internationaltrade can make a substantial contribution to poverty reduction.

References

Anderson, K., 2002. “Agricultural Trade and Rural Poverty Reduction:Market Access.” Paper presented at the 4th Asia DevelopmentForum, Seoul, 4-5 November.

Bannister, G. J., and K. Thugge, 2001. International Trade and PovertyAlleviation. IMF Working Paper WP/01/54. InternationalMonetary Fund, Washington, D.C.

Berg, A., and A. Krueger, 2002. “Trade, Growth, and Poverty: ASelective Survey.” Paper presented at the World Bank’s AnnualBank Conference on Development Economics, Washington, DC,29-30 April.

Carruthers, R., and G. de Monie, 2002. “Trade and Logistics inDeveloping East Asia.” Paper presented at the Institute ofSoutheast Asian Studies and World Bank Trade and PovertyWorkshop, Singapore, 20-21 September.

Cooper, R. N., 2002. “Growth and Inequality: The Role of Foreign Tradeand Investment.” In Annual World Bank Conference onDevelopment Economics 2001/2002. World Bank, Washington,D.C.

Dollar, D., and P. Collier, 2002. Globalization, Growth and Poverty.Washington D.C.: Oxford University Press for the World Bank.

Frankel, J. A., and D. Romer, 1999. “Does Trade Cause Growth?” TheAmerican Economic Review 89(3):379-99.

Ianchovichina, E., S. Suthiwart-Narueput, and M. Zhao, 2003.“Regional Impact of China WTO Accession.” In K. Krumm andH. Kharas, eds., East Asia Integrates: A Trade Policy Agendafor Shared Growth. World Bank, Washington D.C.

McCulloch, N., L. Alan Winters, and X. Cirera, 2001. TradeLiberalization and Poverty: A Handbook. Centre for EconomicPolicy Research, London.

McGill, E., 2003. “Gender Issues in International Trade andInvestment.” In P. Macrory, A. Appleton, and M. Plummer, eds.,The Kluwer Companion to the World Trade Organization.

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Dordrecht, Netherlands: Kluwer Academic Publishers.Forthcoming.

McKay, A., L. Alan Winters, and A. M. Kedir, 2000. “A Review ofEmpirical Evidence on Trade, Trade Policy and Poverty.” Reportto the Department for International Development.

Reimer, J. J., 2002. Estimating the Poverty Impacts of TradeLiberalization. Policy Research Working Paper 2790, The WorldBank, Washington, D.C.

Rodriguez, F., and D. Rodrik, 1999. Trade Policy and EconomicGrowth: A Skeptic’s Guide to the Cross-National Literature.NBER Working Paper 7081, April. National Bureau of EconomicResearch, Massachusetts.

United States Department of Agriculture (USDA), 2001. Profiles ofTariffs in Global Agricultural Markets. Agricultural EconomicReport No. 796, Washington, D.C.

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ERD POLICY BRIEF SERIES

No. 1 Is Growth Good Enough for the Poor?Ernesto M. PerniaOctober 2001

2 India’s Economic ReformsWhat Has Been Accomplished?What Remains to Be Done?Arvind PanagariyaNovember 2001

3 Unequal Benefits of Growth in Viet NamIndu Bhushan, Erik Bloom, and Nguyen Minh ThangJanuary 2002

4 Is Volatility Built into Today’s World Economy?J. Malcolm Dowling and J.P. VerbiestFebruary 2002

5 What Else Besides Growth Matters to PovertyReduction? PhilippinesArsenio M. Balisacan and Ernesto M. PerniaFebruary 2002

6 Achieving the Twin Objectives of Efficiency and Equity:Contracting Health Services in CambodiaIndu Bhushan, Sheryl Keller, and Brad SchwartzMarch 2002

7 Causes of the 1997 Asian Financial Crisis:What Can an Early Warning System Model Tell Us?Juzhong Zhuang and Malcolm DowlingJune 2002

8 The Role of Preferential Trading Arrangementsin AsiaChristopher Edmonds and Jean-Pierre VerbiestJuly 2002

9 The Doha Round: A Development PerspectiveJean-Pierre Verbiest, Jeffrey Liang, and Lea SumulongJuly 2002

10 Is Economic Openness Good for RegionalDevelopment and Poverty Reduction?The PhilippinesErnesto M. Pernia and Pilipinas F. QuisingOctober 2002

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11 Implications of US Dollar Depreciation for AsianDeveloping CountriesEmma Xiaoqin FanNovember 2002

12 Dangers of DeflationDouglas H. Brooks and Pilipinas F. QuisingDecember 2002

13 Infrastructure and Poverty Reduction—What is the Connection?Ifzal Ali and Ernesto PerniaJanuary 2003

14 Infrastructure and Poverty Reduction—Making Markets Work for the PoorXianbin YaoMay 2003

15 SARS: Economic Impacts and ImplicationsEmma Xiaoqin FanMay 2003

16 Emerging Tax Issues: Implications of Globalizationand TechnologyKanokpan Lao-ArayaMay 2003

17 Pro-Poor Growth—What is It and How is It Important?Ernesto M. PerniaJune 2003

18 Public–Private Partnership for CompetitivenessJesus FelipeJune 2003

19 Reviving Asian Economic Growth RequiresFurther ReformsIfzal AliJune 2003

For information and to order, write toOffice of External Relations, Asian Development Bank

P.O. Box 789, 0980 Manila, Philippinesor e-mail adbpub@adb.org

20 The Millennium Development Goals and Poverty:Are We Counting the World’s Poor Right?M. G. QuibriaJuly 2003

21 Trade and Poverty: What are the Connections?Douglas H. BrooksJuly 2003

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Benefits of Trade for the PoorThe Domestic ContextThe International Trading EnvironmentPolicy ImplicationsReferences