8 March 2005

1. PSIA: Key Issues in Trade Policy Reformor How to Measure the Linkages between Trade Growth and Poverty Maurizio Bussolo DECPG The World Bank 8 March 2005 Based on the PSIA note on Trade Policy reform authored by Maurizio Bussolo and Alessandro Nicita.

2. Intro • Assessing the sign and the strength of the trade and poverty links is a complex task • No clear consensus/generalization has yet emerged, thus we should not push one-size-fits all policy advice • However important lessons are being learned: • Distributional effects need to be addressed • Country specific detailed studies are useful • Trade policy can only play a part in a comprehensive development strategy

3. Trade and Poverty Links: an overview 3 4 1 2

4. 1st group of studies: the growth-inequality-poverty regression approach • Many recent studies [de Janvry and Sadoulet (1995,2001), Ravallion and Chen (1997), Dollar and Kray (2000)] focused on the statistical relationship between growth and poverty across countries and time periods • Main conclusion: growth strongly reduces poverty, Ravallion and Chen find an ε of 3; • Policy implication: if the ε is sufficiently high, poverty reduction strategies based mainly on growth may be justified.

5. The regression approach: some refinements • This approach postulates a constant ε across countries/time periods • Such an approach entails a naïve model that does not take into account the existence of an identity that links poverty reduction with growth and changes in the income distribution • A graphical representation…

6. Poverty-growth-income distribution Z Reduction due to Growth Reduction due to distribution change

7. Trade and Poverty Links: an overview 3 4 1 2

8. Trade Reforms • Reduction of protection of domestic markets by elimination of quantitative restrictions (quotas), by lowering tariff rates, and regulate the use of Non Tariff Barriers (NTBs) • Typology: • Multilateral liberalization (WTO negotiations) • Unilateral liberalization • Discriminatory liberalization (regional, bilateral agreements) • Different institutional arrangements and different effects

9. Income distribution implications of Multilateral and Regional liberalizations, an example for Nicaragua Kernel Distribution of Gains for Nicaraguan households for a multilateral (full) and a CAFTA liberalization scenarios

10. Trade and Poverty Links: more details • goods prices (expenditure channel) • factor prices, employment (income channel) • government fiscal position (transfers, tariff revenues, other taxes) • Investment/productivity changes (long term growth) • Short run adjustment costs (volatility, risk) • Other external shocks (global lib., TOT) Standard small country H-O-S model main predictions (focus on a. and b., magnification effect, type of lib.)

11. 2 other groups of studies +1 • partial equilibrium / cost of living analyses (detailed micro) • general equilibrium (macro top-down approach) • micro-macro synthesis These are all quantitative studies, data requirements can be a limitation in their implementation

12. Partial equilibrium / cost of living analyses: intro • Based on real households rather than representative ones • Have a central equation of this form: • The change in welfare is function of: a) the change in output prices, b) inputs prices, c) factor prices and d) consumption goods prices

13. Partial equilibrium analyses: advantages/disadvantages • the ’s are household specific: full heterogeneity is included • Key characteristics of the poor inform the analysis • Examples: Ethiopia export/food crops regional segmentation, and own consumption in Nicita Olarreaga (2003); Madagascar booming textile in Nicita Razzaz (2003) • Problems: • price changes are partial equilibrium • no substitutability (i.e. no quantity response) • Extensions (panels, ex-post studies: Winters on Vietnam, McCulloch on China’s province)

14. General equilibrium analyses: advantages/disadvantages • Based on representative households, disaggregated in many groups as to minimize the intra-group income heterogeneity • Generate GE consistent prices, accommodate different degrees of resource mobility and substitution, perfect identification • Many studies, starting Adelman and Robinson (1978) for Korea, up to a recent one for Brazil (Harrison, Rutherford and Tarr 2003) • Main result: poorest household earn 4 times more than richer households • Decomposition exercises; test different type of liberalization • Problems: • Within group variance is fixed • No heterogeneity across the poor • Perfect price transmissions

15. Micro-Macro synthesis • Top-down sequential approach • Inclusion of the full household sample in the CGE model • Feed-back full models

16. Top-Down sequential approach: an example • Macro model is a global multi-sectoral CGE model • Link variables are commodity and factor prices (from CGE model to micro data) • For the incidence analysis we use four household surveys—Brazil, Chile, Colombia and Mexico • Two policy experiments: FTAA and multilateral global liberalization

17. Other approaches • CGE + more complex micro model: Bourguignon, Robilliard and Robinson (2002) on Indonesia and Bussolo and Lay (2003) on Colombia • CGE+full household sample: Cogneau and Robilliard (2000) on Madagascar, Cockburn (2002) on Nepal • Full feed-back models: Savard (2003) on Philippines

18. Off-the-shelf methods • simSIP • PovStat • Both the above methods assess the (ex-ante or ex-post) effect of aggregate economic growth on poverty • Poverty Analysis Macroeconomic Simulator (PAMS) • Maps macroeconomic results (differential output, employment, labor revenues across sectors) into poverty effects • 123PRSP

19. Difficulties • As Kanbur (2001) puts it: trade and openness is the archetypal, emblematic, area around which there are deep divisions, and where certainly the rhetoric is fiercest • Level of aggregation • Time horizon • Market structure • Domestic policies (regulation and competition)

20. Other elements in a good PSIA: Stakeholders analysis • Trade policy is an economic inefficient but politically efficient re-distributive tool • Trade policy normally favors import-competing sectors (and factors) rather than export-oriented ones (for historical reasons  revenues collection) • Predictive analysis of the distributional effects is crucial for a successful and sustainable trade policy reform: • Approach 1: the factor endowments model • Approach 2: the sector specific model

21. Institutions • Globalization and governance • WTO commitments • Effects on domestic institutions Bonaglia, Braga, Bussolo (2002) • Coordination across different public institutions • Example: trade liberalization in Colombia • Trade reform as part of a larger development agenda

22. Conclusions • Poverty impacts are different across countries and scenarios • We show that at least for one case, Mexico, a simple approach is detecting a reduction in poverty, in contrast to an increase, as shown by an approachconsidering distribution • Strong distribution effects can dominate the average growth effects • Useful information for the design of trade reforms (capture, rent seeking) and compensatory measures (targeting); different emphasis for the short run and the long run • Volatility and risk (Loyaza on Managing Volatility Handbook) • MDG context: Halving poverty requires about 5% yearly reductions, with full trade lib, in the good cases, we get about 2% (static gains only)