Saturday, September 8, 2007

Trade Liberalization Not Always Great

Pinelopi Koujianou Goldberg and Nina Pavcnik


While trade liberalization was expected to help the less skilled, who are presumed to be the relatively abundant factor in developing countries, there is overwhelming evidence that they are generally not made better off relative to workers with higher skill or education levels.

One of the few uncontroversial insights of trade theory is that changes in a country's exposure to international trade, and to world markets more generally, affect the distribution of incomes within the country. Not surprisingly, the entry of many developing countries into the world market in the last three decades coincides with changes in various measures of inequality in these countries. What is more surprising is that the distributional changes went in the opposite direction from what the conventional wisdom suggests: while trade liberalization was expected to help the less skilled, who are presumed to be the relatively abundant factor in developing countries, there is overwhelming evidence that they are generally not made better off relative to workers with higher skill or education levels.

In Distributional Effects of Globalization in Developing Countries (NBER Working Paper No. 12885), authors Pinelopi Koujianou Goldberg and Nina Pavcnik attempt to explain this paradox. They question whether the underlying conventional wisdom is too stylized to capture the reality of the developing world and they ask whether other forces at work may have overridden the effects of globalization. They also examine the mechanisms through which globalization has affected inequality and try to determine whether general lessons can be drawn from the experience of the last three decades.

The authors' findings suggest a contemporaneous increase in various measures of globalization and inequality in most developing countries, although establishing a causal link between these two trends has proven more challenging. However, the evidence has provided little support for the conventional wisdom that trade openness in developing countries would favor the less fortunate.

The authors also find little support for the premise that adjustment to changing economic conditions would occur through labor reallocation from declining to growing sectors of the economy, at least at the aggregate industry level usually considered in traditional international trade models of comparative advantage. A common finding of studies of the effects of trade reforms in developing countries is the lack (or small magnitude) of sectoral labor reallocation. In some instances, the data also suggest that the wage response to trade barrier reductions is more pronounced than the employment response.

The cumulative evidence points to constrained labor mobility as one plausible explanation for the lack of sectoral reallocation. Indeed, the strict labor market regulation that many developing countries had in place prior to the recent reforms is a potential source of labor market rigidities. The importance of these rigidities is likely to diminish in the long run, especially since many developing countries have by now significantly liberalized their labor markets.

The authors' findings highlight several globalization-based explanations for the increased relative demand for more educated workers within industries. In some cases, trade reforms that liberalized, in addition to goods flows, factor flows (most importantly capital) may have generated additional demand for skilled workers. In other instances, globalization affected not only trade in final goods, but also trade in intermediate goods that, from the developing country perspective, were skill-intensive. Even in those cases where liberalization was concentrated on final goods, the highest trade barrier reductions often were concentrated - contrary to conventional wisdom - on low-skill sectors that originally had enjoyed a higher level of protection. Technological change that favored skilled workers may have interacted with trade reforms to further depress the relative demand for low-skilled workers. Increased exposure to currency fluctuations boosted exports from developing count!
ries in some cases and
provided incentives to upgrade the product-mix of their domestic plants. These compositional changes may have fostered a quality upgrading of plants that further contributed to the widening of the wage gap between skilled and unskilled.

Overall, it appears that the particular mechanisms through which globalization affected inequality are country-, time- and case-specific; that the effects of trade liberalization need to be examined in conjunction with other concurrent policy reforms; and that implementation details of particular policies matter. This conclusion may seem disappointing, according to the authors, as it offers no simple predictions regarding the distributional impact of globalization and hence no straightforward recipe for remedial measures to alleviate potentially adverse impacts. Yet, it is hardly surprising given the heterogeneity of countries, reforms, and overall globalization experience within the developing world.

Finally, the authors emphasize that most of the existing evidence refers to narrow measures of inequality such as the skill premium, or wage inequality. Broader concepts of inequality that focus on consumption and general well-being have received substantially less attention. The very scant evidence that exists on these issues, however, seems to suggest that the labor market effects of globalization dominate its effects on consumption through relative price changes, so perhaps the focus on wages alone is not as limiting as one would have thought.

-- Les Picker

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