Causes of Poverty, Dangers of Free Trade to Poor Countries, and Ways of Reducing Poverty - Literature review Example

Introduction The problem of poverty and its reduction and/or elimination has been amply researched and written on, and remains one of the global issues in contemporary world. The data collected by World Bank shows that, as of 2005 about 1.4 billion people (one of four) – lived below the poverty line of $1.25 a day (Chen & Ravallion, 2008). In the same survey we see that the number of people living below the poverty line has decreased from 1.9 billion (one of two) in 1981. Taking into account intensification of world economic integration of the last 20 years, it would be logical to connect it to decrease of poverty. For example, Bhagwati (2003) tends to support the claim that trade enhances growth and growth reduces poverty. On the other hand, integration of world economy is also perceived as malicious, as poor countries would not profit from free trade unless complementary policies are launched (in Harrison, 2007). This question therefore remains a highly disputable one. The purpose of this paper is to explore this question and attempt to present a discussion of the problem presented. Research conducted within this project indicates that genuine free trade is an opportunity to be used. Such opportunity can present a number of significant benefits as well as a number of substantial threats to poor countries. The overall effect of free trade and globalization on poor counties will vary depending on the government’s policy. Free trade The concept of free trade was first voiced by Adam Smith in his “Wealth of Nations”, where he maintained that countries could benefit from trading with other countries (Bhagwati, 2003). In essence, the theory is based on comparative advantage theory. Free trade is understood as free movement of commodities, which is not encouraged, nor restricted with direct government intervention (World Bank, 2004). The concept of free trade fits into a bigger concept of globalization – a cluster of economic changes (including free trade) that are increasing interconnectedness of the world (Croucher, 2004). As a matter of fact, if we speak of free trade we can freely speak of globalization because free trade is the basis for globalization other factors enabling – like IT, communication, mobility of capital, cultural integration etc. only globalize the world further. Harrison (2007) introduces what appears to be a topical definition of globalization in relation to its effects on the poor. She maintains that in order to research the questions of poverty and globalization two aspects should be focused on: 1) International trade of goods and 2) International movements of capital building foreign investment, portfolio flows and aid. These two aspects will be the focus of this paper. As attractive as free trade can be in theory, on a practical level, local governments introduce protectionist tariffs and taxes to create barriers for free trade. Genuine free trade therefore shall be understood as trade without any government interference. It shall also be understood that governments of all countries have minimal influence onto economics and generally conduct a ‘laissez-fairies’ economic policy, that is do not resort to protectionism. Poverty and its causes Poverty can be defined as a lack of the essentials needed for a minimum level of living. According to Sakiko-Fukuda Parr (2006) poverty is a multidimensional phenomenon and it has several aspects: income poverty (low income), material lack or want (lack of wealth and/or need for quality assets), capability deprivation (includes skills and physical abilities and self-respect in society). In contemporary literature different poverty theories can be found. Conservative theories claim that the root causes of poverty are individual deficiencies; liberal or progressive theories state that poverty is a structural or institutional phenomenon. For example, poverty is explained as a result of “flawed characters or restricted opportunity” (Shiller, 1989). Rank (2004) maintains that poverty is a result of failures in political, social and economic spheres. Whatever the theory, poverty is impossible to eliminate through economic means only – free trade tackles this issue on a level of an institution, whereas individual poverty remains. For example, according to Saez (2009), income gap in the world’s riches country – the US – appears to be the largest in the world. This issue requires further research, however it is indicative of the fact that poverty exists in strongest economies and therefore neoliberal approach would solve the problem of poverty. The next section of this paper will focus on analysis of threats of free trade to poor countries. Dangers of free trade to poor countries Harrison (2007) offers a sound overview of the dangers, which globalization brings to the poor. In her analysis she heavily criticizes those, favouring the idea of globalization helping the poor. She maintains that according to Heckscher-Ohlin model (H-O model), countries should export those goods, which are abundant within their territories, and import those, which are scarce. Poor countries are believed to have unskilled labour in excess. Consequently, within the framework of this model, many scientists claim that in return for offering unskilled labour, poor countries would be importing goods, which will increase wealth within the exporting country. Appealing as it is, - she points out, ­- this assumption contains several gaps, which require attention. First, within the HO model, all countries are believed to be manufacturing goods. This cannot be the case, as poor and developed countries have lower production rates, a factor which cannot be dismissed. In addition, trade reforms will remove protection, which governments of poor countries set in order to protect specific branches of economics, where most often unskilled labour is used. The danger in this case comes out from the fact that same sectors in developed and poor countries require greater amounts of skill workers should possess. In this case workers with higher skills, their work being more productive, will have a competitive advantage in relation to workers of the poor countries. This, in turn, can prevent equal distribution of wealth. William Easterly (in Harrison, 2007) explores possibilities for the poor from a neoclassical point of view. According to him, globalization can have two ways of impacting poor countries: it can either reduce it or deepen it. Reduction of poverty is realized at the expense of relaxing constraints on global trade, which will open the country to the capital. At the same time, globalization can have a negative effect on the poor – by differences in productivity, and production rates across trading countries can lead to different incomes per capita because capital will move from a weaker economy to a stronger economy. Collins and Graham (2004) in their analysis of poverty and globalization maintain that population of the poor countries can be divided into two main categories: the self-employed and wage-earners. Those, who are self-employed, are either small farmers or petty artisans working in shops and small firms. The most important constraints the working poor self-employed face, are coming from inadequate availability or absence of credit, storage, marketing, insurance; technology, infrastructure and extension services. They are also in need of proper government regulation (venal inspectors, insecure land rights, etc). Resolving these problems and improving overall living and working conditions require major and substantial government reformation and control. In principle, most of the above mentioned constraints can be with solved in the process of globalization; however without government support they would soon go out of business, unable to compete with world giants. In case such enterprises get involved in exports of their goods, they will be mostly suffering from inadequate level of globalization, because such spheres being traditionally protected by state, they encounter additional barriers while exporting their goods. Another issue such entrepreneurs can face is agricultural subsidies in the rich countries, which will not allow them to enter new markets. This, as Collins and Graham (2004) puts, creates the need for big business come into play, which is able to deal with protectionists and lobbyists in rich countries far more effectively than smaller producers. Another issue small entrepreneurs face in selling their goods in a globalized environment is lack of proper marketing, including creating a strong brand name and reputation, create an image of a reliable company with timely and quality delivery. Alongside with this, ensuring proper quality of products can be another issue. Costs for quality control for smaller businesses can get quite high, resulting in increase of price and thus depriving them of their advantages. Again, attaining this task can be difficult without global businesses come into play to reconcile these issues. At the same time, appearance of global companies can be a danger to the small local manufacturer by increasing the variance of prices. Even though it can raise the mean incomes for the poor, trade liberalization can heighten their vulnerability for a number of reasons: attitude to foreign companies, unwillingness to bring down the prices. Winters, McCulloch and McKay (in Collins and Graham, 2004) present evidence of how trade liberalization helped to mitigate post-food crisis in Bangladesh in 1998 with private imports and stabilized prices. At the same time evidence is presented on Cote-d-Ivoire, where ending domestic marketing arrangements have increased the variance of prices. The second group of working poor is the wage earners. For them, liberalization of trade can be both a threat and an opportunity. For example according to one of the fundamental theorems of international trade, the Stolper-Samuelson theorem, when a country opens up to trade, the abundant factor should see an increase in its real income (Harrison, 2007). If the abundant factor in a poor country is unskilled labour, then this country will gain from trading it. However, other researchers claim this theorem is not working (ibid.), claiming that if a poor country engages in free trade, then the prices in the previously state-protected sectors will have to go down to withstand competition. Lowering of prices will also reduce the wages of the unskilled workers, shifting down the demand for labour. Ways of reducing poverty Besley and Burgess (in Harrison, 2007) maintain that poverty can be reduced by growing the country’s economy by trade, by means of foreign direct investment (FDI), in improvement of income distribution or both. If a country is not growing or growing slowly, its measures to improve distribution of income will result in decreasing poverty. Besley and Burgess (in Harrison, 2007) have calculated that one standard deviation reduction in inequality in Sub-Saharan Africa will reduce poverty by more than half. If gains from openness to trade result in increasing inequality, it means that the poor might not share its benefits. Consequently the primary task of the government is to ensure equal income distribution. Harrison (2007) claims that in order for trade reforms to be effective and aid poverty elimination, complementary government programs are required. Examples in support of this statement include results of government help of farmers in Zambia, Mexico, Ethiopia. Conclusions As any virtually any process, liberalization of free trade and globalization can be both beneficial and harmful. In an attempt to answer the question whether genuine free trade helps resolve the poverty issue, it can be seen that free trade can present a considerable number of benefits for the poor countries. At the same time a considerable number of substantial threats can be also found. Therefore free trade processes and globalization can be viewed as an opportunity, the results of which differ depending on the way such opportunity is used. The best way to take the most of such opportunity is to invest in education and training, increase competitiveness of exports, which in turn will lead to increased export attractiveness. Most efforts should be directed towards developing infrastructure, especially telecommunications. Another effective means is designing appropriate and effective policies, including well designed industrial policies, access to credit, trade protection, export subsidization and tax intervention; and finally there should be incentives for foreign as well as domestic investments. Preference in this case is given to labour-intensive sectors as well as firms with strong backward and forward links (report on Africa). Alongside with these steps incentives geared towards equal income distribution are required. Such conditions will ensure that globalization will bring maximum benefit to the poor. Bibliography 1) Bhagwati, Jagdish (2003). Free trade today. New Jersey: Princeton University Press. 2) Chen, Shaohua & Ravallion, Martin (2008). The developing world is poorer than we thought, but no less successful in the fight against poverty. Retrieved on October 22, 2009 at http://ideas.repec.org/p/wbk/wbrwps/4703.html 3) Collins, Margaret & Graham, Carol (2004). Globalization, poverty, and inequality. Washington DC: Brookings institution press. 4) Economic Commission for Africa (2005). Economic report on Africa. Retrieved on October 20, 2009 at http://www.uneca.org/ERA2005/full.pdf 5) Harrison, Ann (2007). Globalization and poverty. Chicago: The University of Chicago Press 6) Hunter, Wade Robert (2004). Is globalization reducing poverty and inequality? London: Elsevier Ltd. 7) Saez, Emmanuel (2009). Striking in richer: The evolution of top incomes in the United States. Berkeley: Univestiry of California. 8) Rank, M. R. (2004). One Nation, Underprivileged. Oxford: Oxford University Press. 9) Sakiko-Fukuda Parr (December 2006). The Human Poverty Index: A Multidimensional Measure. Poverty In Focus. International poverty center, pp. 7-10. 10) Sheila R. Croucher (2004). Globalization and belonging: the politics of identity in a changing world. Lanham, MD: Rownman and Littlefield Publishers Inc. 11) Schiller, B. R. (1989). The Economics of Poverty and Discrimination. Englewood Cliffs, NJ: Prentice Hall. 12) World Bank (2004). Glossary. Retrieved on October 19, 2009 at http://www.worldbank.org/depweb/english/beyond/global/glossary.html Read More