One of the most striking features of the global economy since the start of the millennium is the increasingly significant role played by developing countries. Many developing countries have recorded high growth rates and made significant progress in reducing poverty. This process has gone hand in hand with their progressively integration in the global economy.
Figure 1 shows growth rates for developed and developing/emerging economies since 1980, as well as smoothed trend growth rates for each group. From the early 1980s until the late-1990s developing economies did not grow appreciably faster than developed ones and in some years grew more slowly, largely due to a prolonged period of weakness in prices of primary commodities that developing countries export disproportionately. Starting from 2000, developing countries growth rates significantly exceeded that of developed countries. Emerging economies such as China and India regularly posted double digit growth rates.
Small divergences in GDP growth between countries can produce dramatic differences in living standards over time. For example, a country that sustains a 3% per capita GDP growth rate can expect to see its income double in 23 years, whereas another country that only manages to grow 1.5% per year will have to wait 47 years to experience the same proportional change. An economy growing at 7% can double its income in a decade, and it would be less at even higher rates.
Despite this progress, rates of income convergence differ significantly across developing countries. The income gap between the richest and poorest countries remains large. LDCs remain far behind, with per capita income of just 4% of developed countries' average (WTR, 2014). Among the factors that have driven the success of some developing countries and explain why some countries have lagged behind trade had a clear role to play.
GDP per capita grows in two instances. One is when countries accumulate resources, invest in physical, human or knowledge capital. The other one is when countries utilize their resources more efficiently. Technologies and the institutional framework in which countries operate directly affect the way resource endowments are used and therefore how countries grow. Growth economists point to persistent technological gaps between nations as the primary source of the persistent large income gaps (Acemoglu, 2009). By the same token, technology diffusion on the other hand has been a key factor in the patterns of convergence that we have experienced since the beginning of the millennium.
Opening up to trade affects growth positively through a number of channels. Trade improves resource allocation. It allows each country to specialize in the production of the good or service it can produce relatively cheaper and import the other goods and services, thus exploiting comparative advantages. By extending the size of the market in which the firm operates beyond national border, trade allows firms to exploit economies of scale and become more productive. Trade also affects long-term growth since it gives access to more advanced technological inputs available in the global market and because it enhances the incentives to innovate.
For most developing economies, accessing and deploying new technologies is the primary source of economic growth. Imported capital goods and technical intermediate inputs can directly improve productivity by being placed into production processes. There is significant evidence that global value chains are a powerful channel of technology. Supply chain linkages intensify contacts between foreign firms and domestic suppliers and therefore open up channels for flows of knowledge and know-how. When a foreign firm and a local supplier are part of the same production chain, they need to interact and coordinate to guarantee a smooth functioning of the chain. Face-to-face communication with key foreign personnel will facilitate the transfer of non-codified knowledge and increase domestic innovative capacity. Also, foreign outsourcing firms are more willing to transfer the know-how and technology required for an efficient production of the outsourced input, because they will eventually be the consumer of that input. When an intermediate input is specifically designed to match the needs of a single final good producer, the latter has an incentive to reduce the cost of investment required for customization of the input, and to monitor production. This includes providing the necessary technology and increasing face-to-face interaction to ensure an adequate investment in technology learning by the local supplier. High-skilled personnel thus often flows within multinational firms across borders to assure technological as well as managerial cohesion across production units in different countries. The increasing offshoring of production stages created significant amounts of manufacturing jobs in those developing countries that established linkages to global value chains. GVCs have been key in the early stages of China’s industrial transformation, as well as in the growth of manufacturing employment in economies such as Vietnam, Indonesia, and Mexico. Offshoring of tradable services has also been key in the development of these industries in India.
Over the last quarter of a century, the impressive opening of the world economy, combined with the rapid pace of technological change, have improved the welfare and living standards of billions of people around the world, including its poorest citizens. Although other factors affect poverty too, the strong trade driven growth in developing countries has been the strongest driver for the reduction by half of the number of people in extreme poverty between 1990 and 2010. GDP growth helps generate resources needed to improve people's standards of living, to improve health, education, water safety and provide housing.
Trade can also directly contribute to poverty reduction. By making more affordable goods available at home, trade enables poor households to purchase more with their income. Better access to foreign markets for the goods, for example agricultural goods, that the rural poor produce opens up new employment opportunities for poor farmers. Trade can play a key role in empowering women and assisting them in dealing with poverty. Across developing countries, exporting firms generally employ a significantly higher share of women than non-exporters. This has, in turn, an impact on other household decisions, such as education.
The positive effects of trade on economic growth and poverty reduction are detailed in recent reports by the World Bank Group and World Trade Organization (2015 and 2018). These reports also explain that one reason why poor people may not capture the full benefit from participation in international markets is that the goods they produce tend to be subject to relatively high trade barriers. In general, research shows that industries that face higher tariffs in the export market pay lower wages in all countries (Olarreaga et al. 2019). In his study on the US-Vietnam free trade agreement, McCaig (2011) finds that provinces in Vietnam that were more exposed to US tariff cuts experience greater declines in poverty rates. Similarly, Porto (2010) predicts that the elimination of trade and barriers on exports of agro-manufactures to industrialized countries would cause poverty to decline in Argentina.
Although trade reforms create new opportunities, they can also involve adjustment costs. Access to international markets may deliver higher average incomes to farmers who specialize in producing export crops, but may bring greater competition that reduces labor demand in import competing sectors. For example, in her study of the effects of India's liberalization in 1991, Topalova (2010), finds evidence of slower decline in poverty in rural districts, among the least geographically mobile at the bottom of the income distribution, and in regions where inflexible labor laws impeded factor reallocation across sectors.
Not all poor are affected equally by international trade. The effects will depend on where they live (rural versus urban areas), their individual characteristics (skill, gender), the type of trade policy change (increased import competition or export opportunities) and where they work (industry, firm, formal/informal sector). A general result of the literature is that the adverse effects stemming from trade adjustment are a result of worker mobility costs, costs to move across sectors, regions or tasks. An inclusive trade policy has to take these specificities into account.
Studies on labor market effects of trade also highlight that trade affects people and regions differently.
The important finding though is that typically trade tends to raise aggregate employment and real wages. Employment reductions due to direct competition from imports are typically offset by employment creation resulting from cost savings due to cheap imports and export opportunities in many sectors of the economy that do not necessarily trade directly but benefit from trade through input-output linkages.
Technological progress and trade have been key engines of global prosperity. Resistance to innovation or retreat from global integration are not an option that will help eliminate extreme poverty. At the same time, policy-makers need to ensure that benefits are spread more widely. A reallocation of resources is often necessary to reap the substantial benefits from trade. Citizens need to be better prepared for possible disruptions ahead and be able to take advantage of new opportunities.
Like other structural change - notably change triggered by technological progress - trade can create adjustment pressures for certain segments in society. It is therefore important to have in place appropriate complementary policies to ensure that the gains from trade are more evenly shared and the trade-related adjustment costs affecting certain regions and individuals are mitigated. Early and comprehensive policy action to improve labor mobility - across sectors, regions, and skills - is particularly important.
These actions at the domestic level need to be accompanied by maximizing trade opportunities for the poor at the multilateral level. To increase opportunities for the poor global actions include addressing distortions in agriculture to improve market access and reduce food price volatility which can benefit both poor farmers and poor consumers. It is also important to address modern areas of the global economy, such as services and e-commerce, that are not yet fully reflected in international trade policy. In deploying these efforts, it is the important role played by micro, small and medium enterprises should be recognized as a significant source of employment. As well as the role of investment in providing financing to increase capacity in resource-challenged countries. These are just some examples – and more are discussed in other parts of this report – that illustrate that openness and inclusiveness are not mutually exclusive and that there is room to have more of both.
To expand the inclusivity of trade more targeted action to overcome the constraints that the extreme poor face in benefiting from it is also necessary. The extremely poor suffer from a range of constraints that limit their capacity to benefit from the gains that others in society might enjoy from trade. Farmers and firms in rural areas face particularly high transport costs and delays when shipping to international and national markets. Production in rural areas is largely dominated by agriculture, and agricultural markets present particular challenges to trade integration. Those working in the informal sector face greater risks than those in formal activities. Workers in informal firms typically do not have the same employment rights as those in formal employment. Informal sector firms and households have limited access to finance to smooth over short-term economic fluctuations, like a sudden rise in food prices or a sudden contraction in economic growth. In addition, informal sector workers are not covered by social benefits such as health, pension or unemployment insurance, so tend to be less covered against risk than formal.