T C A Srinivasa-Raghavan: Trade liberalisation and poverty

OKONOMOS

The Communists and their supporters have been going on and on about how trade liberalisation in India has been hurting the poor. And it turns out that they are right, so liberalisers, please bow your heads in shame.

But before the Commies enhance that permanently smug look that they sport by a notch or two, here is a piece of research* they should consider. The bad news for them is that they are the reason why trade liberalisation has hurt the poor.

The author, Petia Topalova of Yale, has measured the causal impact of trade liberalisation on poverty and inequality in India. She says this is the first study "to document such a relationship between trade liberalisation and poverty within a developing or developed country."

After a fairly exhaustive analysis of the data, she concludes that "the impact of trade on relative poverty in India was most pronounced in areas with inflexible labour laws, where labour mobility was hindered. If some of the immobility of labour is institutionally driven, complementary measures to trade opening "" such as labour market reform "" can ease the shock of liberalisation and minimise its unequalising effects."

So "to minimise the social costs of inequality, additional policies may be needed to redistribute the gains of liberalisation from winners to those who do not benefit as much."

But labour market reform is what the Communists have been opposing. It is easy to understand what has been happening. While liberalisation has forced capital into relocating into business where the returns are higher, labour has not followed suit "" or has not been allowed to do so.

So capital productivity has increased but labour productivity has not. In other words, profits are up but wages are not.

"In India, these trade-induced productivity increases were likely not shared with the workers, or were insufficient to offset the relative downward pressure on factor returns."

And guess who is responsible?

Furthermore, "There is no evidence of significant reallocation in the sample of all Indian states, though in the sample of Indian states with flexible labour laws (emphasis added by me), employment is positively correlated with industry tariffs. This correlation is consistent with previous findings of faster growth of output and employment and a higher elasticity of labour demand with respect to output price in states with flexible labour laws."

Another thing has happened. Trade liberalisation has increased the number of industries whose products are traded.

But the people employed in these, says Topalova, were not as well-off in terms of wages as those employed in industries whose products are not traded. That means the public sector. So the wages of those in the traded sectors fell in relation to the non-traded sectors and contributed to the slower rate of poverty reduction.

The story doesn't end there. "This effect was aggravated by the slower overall growth in registered manufacturing employment in areas with inflexible labour laws, which retarded the pull out of poverty of the poorest subsistence farmers."

But where reallocation was possible, growth was faster and people suffered less than the people in areas where labour laws were rigid.

"In those areas, the changes in the income distribution seem to have taken place in the high end, as some workers tapped into the benefits of liberalisation, thereby increasing the consumption inequality."

Now contrast this with China. It began to liberalise its trade regime almost 30 years ago. At the same time, it refused to offer workers much job protection.

The result, China is where it is and we are where we are "" down the spout. Meanwhile, the key question that needs to be asked is, how have states with relatively flexible labour laws fared politically? Have the ruling parties there always lost the elections there? If not, surely there is a lesson to be drawn.

Trade Liberalisation, Poverty, and Inequality: Evidence from Indian Districts, NBER Working Paper No. 11614, September 2005