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The links between trade, growth and poverty

Trade openness tends to generate economic growth and helps reduce poverty, according to a policy issues paper commissioned by the IDB’s Integration and Trade Sector.
The study, written by Columbia University economics professor Xavier Sala-i-Martin, reviews empirical evidence on the links between trade openness, economic growth, inequality and poverty reduction. It also takes a close look at the potential impact of regional trade agreements, stating that their benefits tend to outweigh potential short-run increases in inequality.

Trade liberalization can bring benefits through many channels, such as increased specialization, economies of scale, technology transfer, improved competitiveness and increased availability of capital, according to the study. But its most significant benefit could well be the effect it has on  institutions and public policy.

The paper uses the example of  Southern European countries joining the European Union much later than the more advanced economies. By adopting the policies that had worked for the founding member countries, these late members experienced dramatic improvements in their institutional framework.

When a less developed country  signs a free trade agreement with a more developed one, argues the study, the poorer partner tends to benefit from the knowledge spillover and the policy credibility of the richer counterpart, making it more attractive to investors.

While Sala-i-Martin is buoyant about the benefits of trade openness, his brief includes some warnings for policymakers. Like virtually all policy choices or even technological breakthroughs, economic integration can produce winners and losers. “After every modification, there will be citizens, companies, sectors or regions that will lose,” he notes.

But that should not halt the process of opening markets, Sala-i-Martin says, since gains will more than compensate for losses. Authorities must also put in place safety nets to assist those affected by increased foreign competition. The focus of such mechanisms should be on helping individuals adapt to the evolving environment. Training workers for new employment opportunities, for example, would be a better decision than protecting their old jobs.

Countries should also make efforts to spread the benefits of trade openness throughout their whole territories. The experiences of Mexico and China show that isolated regions tend to lag behind the areas better positioned for trade. The Chinese and Mexican governments are now making huge investments in basic infrastructure to connect the lagging areas with the more dynamic zones of their economies.

Sala-i-Martin also warns that rich countries refusing to open their markets to less developed neighbors might face increased tension with groups who may feel excluded from the benefits of globalization, potentially prompting protectionist or populist backlashes.

The IDB’s Integration and Trade Sector commissioned the policy paper as part of its work to assist borrowing member countries in their economic integration efforts. Sala-i-Martin’s paper was presented at a recent high-level meeting of Central American and Dominican officials, whose countries have a free trade agreement with the United States.

IDB contact:
Mariana Sobral de Elía
Integration and Trade Sector
Phone: 202-623-1758
Fax: 202-623-2169