Davos, Globalization and the Poor edit

Jan. 25, 2006

Are the poor made better off by globalization, as most orthodox economists and certainly the IMF and World Bank believe? Or are the poor hurt by global competition, as many anti-globalization activists would suggest? The orthodox view (the so-called «Washington Consensus») is frequently wrong: at best, openness to trade needs to be accompanied by many other policies that will allow the poor to take advantage of what globalization has to offer. New evidence suggests that there are four important lessons world leaders need to take into account.

-->First, the poor in countries with an abundance of unskilled labor do not always gain from trade reform. Many economists have argued that trade liberalization will raise the incomes of the poor in developing countries. These arguments are based on the idea that countries with an abundance of unskilled workers have a comparative advantage in exporting goods that use low-wage labor. In theory, those workers should be helped when developing countries expand into world markets. Yet the preconditions necessary for the poor to gain from trade reform do not always exist. To reap the gains from trade, workers need to be able to move easily move from factories that have been closed down to new jobs that have been created by globalization. Yet in many countries, including China and India, it is very difficult for workers to move. In addition, even workers in poor countries cannot benefit from the global market place unless they have sufficient training and education. The countries which have been able to exploit global markets best are those which have also developed their educational systems, their infrastructure, and their labor markets.

The second lesson is that the poor are more likely to share in the gains from globalization when there are complementary policies in place. Globalization is more likely to benefit the poor if trade reforms are implemented along with other changes to help the poor. In Zambia, for example, poor farmers only benefited from the recent opening up of markets if they also had access to credit, technical know-how, and other complementary inputs. Governments need to put programs in place that will protect the poor from the unintended consequences of globalization. In Mexico, poor corn farmers competing with increasing imports received payments from the government. Without those transfers, falling corn prices would have cut their incomes in half during the 1990s.

Since other policies are needed to ensure that the benefits of trade are shared by the poor, relying on trade reforms alone to reduce poverty, is likely to be disappointing. In practical terms, this means that relying exclusively on the outcome of the Doha Round to alleviate world poverty is very misguided. Assistance from developed countries in the form of aid, loans, and projects to develop help, education, and infrastructure must accompany efforts to open up trade.

The third lesson is that financial crises are very costly to the poor. In Indonesia, poverty soared following their currency crisis in 1997. Contrary to expectations that greater integration in global financial markets would smooth fluctuations in consumption, new evidence shows the opposite. One implication is that low income countries are more likely to benefit from financial integration if they also create reliable institutions and pursue macroeconomic stabilization policies. However, foreign investment flows have very different effects from other types of capital flows. While unrestricted capital flows are associated with a higher likelihood of poverty, foreign direct investment inflows are associated with a reduction in poverty. The poverty-reducing effects of FDI are clearly documented in countries such as India and Mexico.

Finally, globalization produces both winners and losers among the poor. Even within a single region, two sets of farmers may be affected in opposite ways. In Mexico, while some small and most medium corn farmers saw their incomes fall by half in the 1990s, large corn farmers gained. Across different countries in the 1980s and 1990s, poor wage earners in exporting sectors gained from trade and investment reforms. Yet poverty rates increased in sectors that faced increasing competition from imports. Within the same country or even the same region, a trade reform may lead to income losses for rural farmers and income gains for rural or urban consumers of those same goods.

These lessons have key implications for the globalization debate. First, developing countries need access to developed country markets, which is why a successful conclusion to the Doha Round is so important. Second, there are losers among the poor from trade reform. The fact that many poor lose from globalization means that social programs are necessary to help them make the transition to a more open economy. Those most likely to be hurt include the poor in countries hit by financial crises, as well as the smallest farmers who cannot compete with the more efficient larger farmers or with expanding import competition.

Finally, relying on trade or foreign investment reforms to generate gains for the poor is not enough. For the poor share in the gains from globalization, governments need provide them with better education, access to infrastructure, and access to credit, health care and technology. Workers need assistance moving out of sectors hit by import competition and into expanding sectors. Arguing that freer global trade alone will help the poor is the wrong message; it is also dangerous because free trade cannot possibly deliver on the promise of poverty reduction unless governments actively reach out to help the disadvantaged.