• EconAfterHours

Trading out of poverty? Not so fast…

Updated: Mar 11, 2020

In any discussion on South Asian Integration, the benefits of increased interregional trade are raised – and yet, there needs to be significant qualification attached to this idea. The inherent complementarities between the South Asian nations with regards to trade are undeniable [i], so much so that the possibilities of losers occurring out of intra-SAARC trade are often overlooked. This is unfortunate. South Asia is a volatile region; historic interregional conflicts within the area imply that the blame for any harm to local individuals could easily be shifted by opportunistic politicians on to other nations, something that could hurt regional integration even more significantly given how much of South Asian trade is informal in nature [ii]. South Asia’s people do not hate each other; and yet, it is all too easy to incite this hatred. The benefits of trade for poverty reduction in South Asia would be manifold, but would probably work through specialisation in comparative advantage sectors. Trade would also lead to growth and in turn promote employment in Labour Intensive industries – as is expected from South Asia, whose economies have traditionally been labour surplus. However, this assumes perfect competition, internal and external economic balance, no adverse effects on the world price of goods as a result of liberalisation, and, most importantly, the existence of sufficient institutional capacity to allow the economy to absorb the gains from trade. Research [iii] shows that the benefits to trade are reaped by nations with adequate political stability, law and order, human capital and relatively deep and well-functioning financial markets; nations without these may actually be worse off. In particular, trade can hurt nations afflicted by dualism, a phenomenon wherein the nation’s productive sectors diverge into two groups: one with high productivity and innovation levels, paying relatively high wages for educated labour, and the other with low productivity and innovation levels, utilising unskilled labour. The implications of trade for a dualistic economy include the perpetuation of poverty: firms in the “good” convergence club can utilise skilled labour and advanced technology but are capital intensive, as a result of which they enjoy scale economies but do not hire enough labour. Trade liberalisation can render the “bad” firms unprofitable relative to more modern producers, engendering a failure of the industrial sector to generate adequate employment opportunities for the poor, perpetuating overcrowding in agriculture. Dualism is pernicious, and yet, it could well be the natural by-product of certain political economies where Capitalists, earning incomes from profits from production, are not the ruling elite. India provides a prime example of this: after independence, a ruling political class formed an alliance with bureaucrats, local caste and landowning elites, and big business houses, creating a “Licence Raj” where rent-seeking via control over permits was more profitable than profit-making itself, choking off capitalist innovation, technology adoption and human capital investment by the state. After the 1980s, when “pro-business” policy measures reinstated public infrastructure and human capital investment and gradually liberalised the regime surrounding licenses, a fringe of large capitalists and a minority of educated “middle-class” individuals from elite institutions managed to establish a capital-intensive, advanced industrial sector, which would compete internationally after trade liberalisation after 1991. The majority of small enterprises were relegated to back-end suppliers of raw materials and inputs, ensuring costs were kept low for the modern enclave. Small enterprises and a wealthy urban “middle class” ensured an urban demand for low-value services – barbers, electricians, shopkeepers – which would provide employment to migrant labour from villages, perpetuating poverty. The result: India’s pace on poverty reduction has been slower [iv] than the East Asian, or even South Asian average, despite above average growth. The lessons from India are clear: trade is not a panacea for poverty reduction. What happened when small Indian firms were destroyed by competition from East Asia, could happen in a liberalised South Asia as more markets open up to competition: Indian textiles could suffer as Bangladesh’s exports rise, for instance, something that would be politically disastrous. South Asian economic integration is evidently as much a normative issue regarding the losses from trade as it is a political one, and the impacts of freer trade in the region will be heavily contingent both on the current industrial structure and the nature of local government reactions towards the losses from trade to the nations.

[i] These have been studied in detail by economists in South Asia include Dr Selim Raihan. [ii] https://ideas.repec.org/p/ess/wpaper/id2752.html [iii] Bannister, G. J., & Thugge, K. (2001). International Trade and Poverty Alleviation. Washington DC: International Monetary Fund. Goff, M. L., & Singh, R. J. (2013). Does Trade Reduce Poverty? Washington: The World Bank. [iv] Data from the World Development Indicators Database.

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