an empirical investigation of the relationship between trade liberalization and poverty reduction: a...

8/13/2019 An Empirical Investigation of the Relationship between Trade Liberalization and Poverty Reduction: A Case for Pak

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The Lahore Journal of Economics12 : 1 (Summer 2007) pp. 99-118

An Empirical Investigation of the Relationshipbetween Trade Liberalization and Poverty

Reduction: A ase for Pa!istan

"uhammad #hahbaz A!mal$% &azi "asood Ahmad$$%"ohsin 'ussain Ahmad$$$and "uhammad #abihuddin(utt$$$$

Abstract

In this paper, we have addressed a key issue in the

current debate on economic development: the effect of trade

liberalization on poverty. e investi!ated the relationship

between trade liberalization and poverty levels both in the

lon! run as well as in the short run for "akistan. To

measure trade liberalization, we used standard indices of

trade openness, financial openness and public intervention in

the country, while the head#count ratio was used for poverty

measurement, and $%" per capita controlled for economic!rowth. &pplyin! the Johansen 'o#inte!ration Techni(ues

and Error 'orrection )ethod, for lon!#run and short#run

analyses respectively, our findin!s su!!est that trade

liberalization has a cumulative effect on poverty reduction in

the lon!#run but not in the short run in "akistan. Lower

poverty is associated with low ta*ation and hi!h forei!n

direct investment, while trade openness does not have a

si!nificant impact on poverty reduction, particularly in the

short run, in "akistan.* Corresponding Author/Research Officer at Social Policy and Development Center,Karachi**Associate Professor/President of Research !ing at "nstitute of #usiness Administration,

$niversity of Karachi*** Staff %conomist/Assistant Professor at Applied %conomics Research Centre,

$niversity of Karachi**** Associate Professor/Senior Research %conomist at Applied %conomics Research

Centre, $niversity of Karachi


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JEL Classification:)*+% )*,% I,*

Keywords:Trade% Liberalization% Poverty

Introduction

World trade has been increasing or centuries ase!plorers ha"e disco"ered trade routes and the technolog#o transport has impro"ed $%a"id and Scott& (200'). he

last t*o decades o the t*entieth centur# obser"ed aremar+able mo"ement in the pace o openness orglobali,ation. he integration o countries through lo*s ogoods and ser"ices& inancial assets& technolog# andcultural interaction has reached unprecedented le"els$Stern& (2001). o* it is *idel# accepted that openness isas an important element o good economic polic# andtrade liberali,ation is a necessar# step in achie"ing it$bstled and /ogo& (199) Winters& (2001) and ac+a#and Winters& (2003). So the *orld is becoming moreintegrated& goods and trade in ser"ices are crossing

borders in line *ith globali,ation and regionali,ationprocesses. rade liberali,ation is generall# an all# in theight against po"ert#: it tends to increase incomes& pro"idemore resources to tac+le the problem o po"ert# and *hileit *ill generall# aect income distribution& it does not do soin a s#stematicall# ad"erse *a#1 $Winters& (2001) and%a"id and Scott& 200').

4conomic theor# gi"es man# reasons or tradeliberali,ation to enhance economic gro*th $Winters&(2002) Stern& (2001) 5erg and 6rueger& (200) ac+a#

and Winters& (2003). 5# allo*ing easier imports o capitalgoods& greater allocati"e eicienc#& technological and+no*ledge spillo"ers as *ell as increased competition&trade can enhance gro*th and also lead to the a"ailabilit#o a greater "ariet# o goods to consumers at cheaperprices. he re*ards rom e!ploiting globali,ation can be

& 'ost trade li(erali)ation ill hurt some one, and that some reforms may increase

overall poverty even hile they (oost incomes in total +!inters, --.

--


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substantial& since openness to international trade andin"estment acilitates the acuisition o inputs andtechnologies *hich strengthen gro*th and increaseeicienc#. ccess to *ider mar+ets and more di"ersee!ports reduces the ris+s o trade "olatilit# and e!clusionb# particular countr# mar+ets. penness to the ree lo* ocapital helps to attract %;& *hich can stimulate domesticin"estment& thus contributing to emplo#ment generationand economic gro*th. inancial openness also helps toincrease the depth and breadth o domestic inancial

mar+ets& leading to increased eicienc# in inancialmar+ets through lo*er costs and impro"ed resourceallocation& i inancial mar+ets are *ell de"eloped $bstled

and /ogo& (199) and Sharer et al& (1998)2.

he debate about the impact o globali,ation on the*ell-being o people has generated a substantial literature.;t is important to reali,e that the impact o tradeliberali,ation on po"ert# is important because o the"ulnerabilit# o the poor in de"eloping countries. ;t is*idel# argued b# man# commentators that in the short

run& trade liberali,ation harms poor actors in the econom#and e"en in the long run& successul open regimes ma#lea"e some people belo* the po"ert# line $Winters&(2002b) and ac+a# and Winters& (2003).

/ecent *or+ on this issue has concluded that theprocess o trade liberali,ation in


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impact o trade liberali,ation on po"ert# reduction b#appl#ing the >ohansen ?o-integration pproach or thelong-run and the Standard 4rror ?orrection ethod (4?)or the short-run. he literature on trade liberali,ationemphasi,es the elimination o distortions leading to bothgains rom trade and an increase in domestic economicacti"ities leads3. o the e!tent the poor are alsobeneiciaries o these outcomes& po"ert# is e!pected todecline. his paper e!amines the impact o tradeliberali,ation on po"ert# le"els in the long-run as *ell as in

the short run. he organi,ation o the paper is as ollo*s:Section ;; is a brie re"ie* o the literature& Section ;;;e!plains the model and data collection procedure& Section;@ describes the methodolog# and Section @ presents theempirical results. inall#& Section @; gi"es the conclusionsand polic# recommendations.

II- Literature Review

"er the 1990s& the con"iction that Aopenness isgood or gro*thB *as ostered b# se"eral highl# "isible and

*ell promoted cross countr# studies $see %ollar (1992)Sachs and Warner (199') 4d*ards (1998)'. ;n themedium term& reaping static beneits o trade could loo+rather li+e gro*th. ;n the long run& potential positi"e orcesinclude access to technolog# and appropriate intermediateand capital goods& the beneits o scale and competition&the le!ibilit# induced b# rel#ing on mar+et signals& and theconstraint on go"ernment incompetence or corruption

$Crossman and Delpman (1991) and =ucas& (1989).Enortunatel#& none o the beneits is guaranteed and it is

9

4rade li(erali)ation also leads to reduction in monopoly rents and the value ofconnections to (ureaucratic and political poer "n developing countries, it may (e

e6pected to increase the relative ages of loer2s0illed or0ers +#erg and Krueger,--.: Recently, they have (een su(;ected to criticism and re2or0ing (y Rodrigue) and

Rodri0 +--&, ho argued that their conclusions rest on very ea0 empirical functions

such as flaed measures of openness and serious econometric shortcomings8 !ei +---, on the other hand, suggests that losses from corruption increase ith

openness, (ecause corruption impinges disproportionally on foreign transactions, and as a

result open economies have greater incentives to develop institutions

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not diicult to construct a model in *hich openness pushescountries into less d#namic sectors e.g. primar# e!tractionand harms gro*th $/odrigue, and /odri+& (2001). hetraditional theor# o trade e!plained b# Stolper-Samulsonpredicts that a rise in the relati"e price o a commodit#leads to a rise in the real return to actors used intensi"el#in producing that commodit# $%i!it and orman& (1980)7.

urther& liberal trade is usuall# one o se"eralindicators o openness used& and one *hich oten seems to

*eigh rather signiicantl# in o"erall results $Darrison&(199). n alternati"e approach is to speci# the lin+sbet*een openness and gro*th and e!amine themseparatel#. Some studies associated openness strongl#*ith greater *ealth accumulation $=e"ine and /enelt(1992) and #lor (1998) and stronger gro*th& especiall#o"er relati"el# short periods. ilat (2002) ound thatopenness has no robust lin+ *ith long term gro*th andsuggested that short-run eects out-*eigh the percei"edbeneits o globali,ation& *hich means an increase inpo"ert# and a lo*er economic gro*th rate. o in"estigate

the relationships bet*een trade openness& gro*th andpo"ert# one must irst consider the eects on total actorproducti"it# $Winters& (200). or sustained economicgro*th and de"elopment& impro"ed producti"it# isnecessar# b# uni"ersal agreement. ;t ma# not be suicientand& because o its distributional implications& its beneicialeects on po"ert# could be less that those o gro*themanating rom other sources. or e!ample& i higher

eoffrey and

4hugge, --& #ecause in many countries the poor are not ;ust connected to la(or mar0ets

for hich it is possi(le to do Stolper2Samulson e6ercises and those la(or mar0ets do not

display the re=uired inelasticity of supply +!inters, --

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producti"it# relected declining inputs rather thanincreasing outputs& its short-run eects could be to reduceemplo#ment and e!acerbate po"ert#.

oreo"er& despite the strong presumption in moderngro*th theor#& *ith its inerences to increasedcompetition& access to ne* technologies& betterintermediate goods and so on& the response o producti"it#to openness is ultimatel# ambiguous. sceptical "ie* othe earl# literature on this lin+ is DP

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rate o change (atima et al& 200). ;n man# cases& thelatter *ill be immediatel# and directl# po"ert#-alle"iatingand in the long-run& the# are a necessar# part o an#"iable po"ert# reduction strateg#. lso it is not diicult toimagine ad"erse short-run implications or Gobs andpo"ert#. rade liberali,ation is usuall# associated *ithhigher lo*s o oreign direct in"estment *ith attendantspillo"ers o technologies& ne* business practices andother eects in domestic irms that increase the o"erallle"el o producti"it# and gro*th and also alle"iate po"ert#

le"els $Da# (2001) erreira and /osi (2001). "er#important concern about openness is that it *ill reducego"ernment re"enues. he share o trade ta!es in totalre"enue is negati"el# associated *ith the le"el oeconomic de"elopment& *ith man# lo*-income countriesearning hal or more o their re"enues rom trade ta!es9.either theor# nor e"idence suggests a simple lin+bet*een trade liberali,ation and re"enues& ho*e"er intheor#& a number o actors are important (Creen*a# andilner& 1991). ;n the case o taris& re"enues *ill increase*ith liberali,ation i the initial tari le"el e!ceeds itsre"enue ma!imi,ing le"el10. al"e# (1993) e!plains that aWelare ;mpro"ing /e"enue 4nhancing (W;/4) tari *illal*a#s e!ist unless the compensated radial elasticities oall goods are the same. Do*e"er& designing such aspac+age is *ell be#ond most go"ernmentsB capabilities&especiall# since long and short-run responses ma# dier(e.g. 5a"en 2000). he alternati"e response to a all inre"enues is to cut public e!penditures. here is a "astliterature describing the eects o structural adGustment inde"eloping countries on po"ert# and the impact eltthrough public e!penditures and social sector

4his reliance may reflect various factors, including difficulties in administering a ta6

system effectively and the relatively small share of the formal sector +%(rill, Stots0y and

>ropp, &&-4he revenue ma6imi)ing tariff ill (e &+/+ dsdst += here t is the ad

valorem tariff rate, s is the elasticity of import supply and d is the elasticity of

import demand +%(rill, Stots0y and >ropp, &

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e!penditures in particular11. 5ut e"idence romadGustment resulting in cuts in social e!penditures ismi!ed at best (@an der Caag& 1991). @an der Caage!amines spending in the three #ears beore and aterdonor inanced adGustment programs began& and ind& nopattern o increase or decrease in real total le"els and

social sector e!penditures. Similarl#& Sahn et al (1997)argued that& e!cept in a e* cases& those declines insocial e!penditures that ha"e occurred ha"e not beenHpart o the e!tended attempt to balance the

go"ernmentBs iscal position.I

III- "odel and .ata

he model under consideration en"isages an in"erserelationship bet*een openness and po"ert# le"els&thereore "arious indices on openness are ta+en asindependent "ariables (%;& /%4 and a!) *hile C%< percapita is included as a control "ariable or the basicspeciication o the model belo*

t"'$%"T+&%ET&23%I"ov +++++= 3721 (1)

Where the dependent "ariable is the po"ert# inde!12

(Dead-?ount). mGad and 6emal (1997) e!plained po"ert#trends in


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the World 5an+ and go"ernment de"elopment agenciessuch as %;%& *hich are concerned *ith po"ert# inde"eloping as *ell as in de"eloped countries& the absolutemeasure is more appropriate than relati"e ones.

n indicator that has recei"ed onl# scant attentionrom economic theorists is the degree o openness$Darrison& (199). or trade openness o an econom#& *euse (;mport J 4!port) as share o C%DP&9 4he most sceptical vie of the openness process (lames the li(erali)ation of glo(al

financial mar0ets for their allegedly negative effects in terms of increase in financial

speculation, unemployment and poverty or e6ample, studies collected (y Cornia and

5ipum(a +&, sho that, in the case of Africa, li(erali)ation of financial mar0ets hasattracted large short2run speculative in flos hich included large saving in nominal and

real e6change rates A ma;or result of such speculative movements is a lac0 of ade=uateincentives to potential private investors in the trada(le sector&:or a comprehensive survey of the ne6us (eteen D" and groth as ell as for

further evidence on the D"2groth relationship see 'ody and 'urshid +-- See

Cha0ra(arti +--& on the determinants of D"&8!e also 0no that this measure does not fully account for (oth levels of financial

openness1 capital account li(erali)ation and national treatment of foreign (an0s and other

operations of entering in the local mar0ets

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latter& it is important to deal *ith the complementar#measures that ma# ha"e been implemented to tac+leboth macroeconomic instabilit# and ad"erse eects oadGustments and stabili,ation programmes. a! re"enue isused as a pro!# or the Arole o the stateB. he data hasbeen ta+en rom the ;S (;nternational inancialStatistics)& W%; (World %e"elopment ;ndicators) and

Economic 6urvey of "akistan ("arious issues)& or theperiod 197-200.

I/- "ethodology

When testing time-series properties and co-integration e"idence& the preliminar# step in that anal#sisis concerned *ith establishing the degree o integration oeach "ariable. he distinction bet*een *hether the le"elso dierences o a series is stationar# leads to substantiall#dierent conclusions and hence& tests o non-stationarit#17

(that is unit roots) are the usual practice toda#. 4ngle-Cranger (1987)& deine a non-stationar# time series tointegrated o order AdB i it becomes stationar# ater being

dierentiated AdB time. his notion is normall# denoted b#;(d).

he test or co-integration proceeds in t*o steps:irst& the indi"idual series are tested or a common ordero integration. ; the series are integrated and are o thesame order& it *ould impl# co-integration. Esing theugmented %ic+e# uller (%) test& the stationarit# othe series is tested. he % test is a standard unit roottest it anal#,es the order o integration o the data series.hese statistics are calculated *ith a constant and a

constant plus time trend and these tests ha"e a nullh#pothesis o non-stationarit# against an alternati"e o

&


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stationarit#. he % test to chec+ the stationarit# seriesis based on the euation o the orm gi"en belo*:

t

m

t

titt yyty ++++= =

1

1121 (2)

Where t is a pure *hite noise error term and

)( 211 = ttt yyy & )( 722 = ttt yyy & etc.

hese tests determine *hether the estimates o are eual to ,ero. uller (197) pro"ided a cumulati"edistribution o the % statistics i the calculated-ratio("alue) o the coeicient is less than the critical "aluerom the uller table& then K is said to be stationar#18.

?onsider or e!ample t*o series Lt and Kt bothintegrated o order (d). 4ngle and Cranger ha"e describedthat their linear combination *ill in general also be ;(d).

;t is an empirical act that man# macro economic

"ariables appear to be integrated o order (d) $or ;(d) inthe terminolog# o 4ngle and Cranger (1987) so that theirchanges are stationar#. Dence& i ohansen and >uselius (1990). ;n the multi"ariate case& i

&?Ft7 ratio of coefficient alays has a negative sing

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the ;(1) "ariables are lin+ed b# more than one co-integrating "ector& the 4ngleMCranger procedure is notapplicable. he test or co-integration used here is theli+elihood ratio put or*ard b# >ohanseen and >uselius(1990)& indicating that the ma!imum li+elihood method ismore appropriate in a multi"ariate s#stem. hereore& thisstud# has used this method to identi# the number o co-integrated "ectors in the model. he >ohansen and >useliusmethod has been de"eloped in part b# the literaturea"ailable in the ield and reduced ran+ regression& and the

co-integrating "ector ArB is deined b# >ohansen as thema!imum 4igen-"alue and trace test or statics. here areArB or more co-integrating "ectors. >ohansen (1988) and>ohansen and >uselius (1990) proposed that themulti"ariate co-integration methodolog# could be deinedas:

St N (ohansenBs method in"ol"es the estimation o theabo"e euation b# the ma!imum li+elihood techniue&and testing the h#pothesis Do )( = o HrI co-integrating relationships& *here r is the ran+ or the matri!

)&0( r is the matri! o *eights *ith *hich the"ariable enter co-integrating relationships and is the

matri! o co-integrating "ectors. he null h#pothesis onon-cointegration among "ariables is reGected *hen the

estimated li+elihood test statistic i +=

=p

rt

n1

O

1ln(P iQ

e!ceeds its critical "alue. Ci"en estimates o the eigen-

-


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"alue )(O

ithe eigen-"ector (i) and the *eights (i)& *e can

ind out *hether or not the "ariables in the "ector (S t) areco-integrated in one or more long-run relationships among(


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in the case o


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Table0*: 1nit Root Estimation

Level *st.ifference

/ariables onstant onstantand

Trend

onstantand Trend

onstantand Trend


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Table0,: 5ohansen05uselius )irst Information "a6imumLi!elihood Test for o0integration

7ull0'ypothesi

s

Trace0Test

values

8 Percentritical/alue

* Percentritical/alue

7ull0'ypothesi

s

"a6imumEigen

values

8Percentritical/alue

*Percentritical/alue

-=R 197.70R

87.1 9.'8 -=R 90.8'R 7.'2 32.

&R 10.8'R

2.99 70.0' &=R '8.98R 1.3 .'

,R 37.8RR

32.33 38.3' ,=R 27.1'RR 2'.'3 0.3

.R 20.71 2'.2 0.3' .=R 1.87 18.9 2.'

9R .83 12.2' 1.2 9=R .83 12.2' 1.2

Note:R(RR) represent signiicant at 1 (')& >ohansen ?o-integration test pro"ides three ?o-integrating euations at1 and ' signiicant le"els.

ter establishing that all the indi"idual series under

consideration are stationar#& the traditional co-integrationmethod is used to estimate the long-run relationshipamong the "ariables& particularl# po"ert#& oreign directin"estment& ta! re"enue as share o C%< trade& and C%arue-5ara test ornon-normalit# o errors.

able-3 reports the results o the 4? (4rror?orrection odel) ormulation o euation 3. ccording to4ngle-Cranger (1987)& co-integrated "ariables must ha"e an4? representation. he 4? strateg# pro"ides an ans*erto the problem o spurious correlation& the short rund#namic relationship bet*een trade liberali,ation and thepo"ert# rate estimated rom the 4? ormulation. he longrun d#namics appear in the set o regressors. echnicall#&4? (4rror ?orrection erm) measures the speed oadGustment bac+ to co-integrated relationships. he 4? isposited to be a orce returning the integrated "ariables to

their long-run relation *hen the# de"iate rom it and thusthe longer the de"iation& the greater *ould be the orce

tending to correct the de"iation $5anerGee& et al& (1993).he coeicients o lagged "alues o

T+&%T&23%I" &&& and "'$%" are short run

parameters measuring the immediate impact o theindependent "ariables on P . ;n euation 3& the coeicients

o lagged "alues o T+&% and "'$%" are statisticall#

insigniicant sho*ing no impact on the po"ert# rate in theshort run. he coeicients o lagged "alues o 3%I and

T& are statisticall# signiicant& indicating the immediateimpacts on the po"ert# rate in short-run d#namics. Whereas

the "alue o 1t'E (4rror ?orrection erm o the euation)

is statisticall# signiicant at 1 suggesting po*erul long runcorrections in the model each #ear. "erall& our resultssupport the h#pothesis that trade liberali,ation alle"iatespo"ert# mostl# in the long run. he short-run diagnostic test

4


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sho*s non-normalit# o errors& *hile the /?D test sho*sno second order serial correlation in the short-run model.

able-3 also sho*s that %; has a negati"e sign *ith astatisticall# signiicant "alue i.e. %; is associated *ith lo*erle"els o po"ert# *hile the L (role o go"ernment orpublic inter"ention) "ariable has a positi"e and signiicant"alue *hich means that a ta! increase is lin+ed *ith ahigher incidence o po"ert# in the long run as *ell as in theshort run. %; and L can be regarded as an argument in

support o openness. he "ariable "'$%" is included in themodel as a control "ariable or the le"el o de"elopment inthe countr#& *hich is negati"el# lin+ed to po"ert# but notsigniicant in the short run& *hich emphasi,es thateconomic gro*th is not pro-poor.

While the "ariable /%422has a positi"e sign& it isnot statisticall# signiicant in the short run *hich does notsupport the openness theor#. his ma# be the result o theact that our e!ports are cotton based and mainl# dependon the climate. hereore& increases in e!port prices in

international mar+ets do not ha"e a signiicant impact onthe incomes o peasants because o disguisedunemplo#ment and underemplo#ment in the agriculturalsector& a maGor contributor to C%


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openness and public inter"ention in the countr#& *hilehead-count ratios *ere used or po"ert# measurement andC%< per capita *as controlled or economic gro*th.

ur results impl# that trade liberali,ation reducespo"ert# le"els in the long run& *hile in the short run inancialopenness lo*ers po"ert# and the si,e o go"ernment (orpublic inter"ention) is associated *ith higher po"ert# le"els&supporting the argument o openness. either tradeopenness nor C%< per capita has a signiicant relation *ith

po"ert# in the short run. o achie"e the maGor obGecti"e oreducing po"ert#& the go"ernment needs to design andimplement an acti"e de"elopment strateg# not onl# tobeneit rom openness& but also to help counteract thenegati"e eects o openness. penness should not be"ie*ed as a reliable substitute or a domestic de"elopmentstrateg# but should be accompanied b# impro"ed trade-related inrastructure $%ollar and 6raa#& (2001). ;nstead& thego"ernment needs to pursue more acti"e trade liberali,ationand acti"e domestic de"elopment policies *hich ma# beneitmore poor people in the countr#. he go"ernment should

ocus on promoting oreign direct in"estment& *hich *ill be acomplementar# reuirement or trade liberali,ation to besuccessul or the promotion o e!ports.

here is also a need to enhance the ta! re"enues othe state through better collection o re"enues& andadministrati"e reorms rather than e!penditure cut bac+s&*hich can reduce the eecti"eness o the public sector.he go"ernment needs to adopt a ne* approach oallocation o unds to social sectors so as to bring theissue o po"ert# reduction to the central stage o

economic polic# ma+ing. here is also the need or arealistic assessment o po"ert# or an eecti"e po"ert#reduction strateg#. ore reorms in the ban+ing sector areneeded to enable the poor to get access to eas# creditbecause the poor ha"e smallTe* assets and are unable tomeet their consumption needs during e"en short spells ounemplo#ment. hus& short run adGustment *ill not onl#increase po"ert# but also raise the intensit# and se"erit#

7


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o po"ert# among the poor. rade polic# reorms ha"e thepotential or impro"ing gro*th and de"elopment and thusalle"iating po"ert# in


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5e"an& %. 2000& Aiscal ;mplications o rade =iberali,ationB

in 5e"an& %. et al(eds.). rade and iscal adGustmentin rica& e* Kor+: St. artinBs


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4ngle& / . and Cranger& C.W.>& 1987& H?o-integration and4rror ?orrection: /epresentation& 4stimation and

estingI. Econometerica, ''& 2'1-27.

al"e#& /. 1993& H/e"enue 4nhancing ari /eormI&

eltwirtschaftliches &rchiv 10(1): 17'-90.

erriera&


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>onsson& C. and Subramanian . 2001& H%#namic Cainsrom rade: 4"idence rom South ricaI& ; Sta


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/odrigue,& . and %. /odri+& 2001& Hrade


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/eorms and


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+elationship between Trade Liberalization and "overty +eduction1

an empirical investigation of the relationship between trade liberalization and poverty reduction: a...

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