International trade, free markets, and financial deregulation are not working the way we wanted. We as a society need to start asking us why and look for new ways of fighting poverty.

International trade, what is it?

We live in an interconnected world, where countries and people share and interchange almost every aspect of their lives between one and other. Nowadays because of technology and the reduction of barriers we can be connected with almost everyone around the world.

With this rapid increase in the interconnection of the world, we can be in contact with culture and different styles of living and thinking, make everything multicultural and open about different new stuff.

But this interconnection of the world does not only apply to cultural, ideological, and aspects of the way of living, but products, services, and all kinds of outputs and inputs in the production and assembly line of things.

This new contact that technology has brought us has helped create and develop what we call the “global economy”, that is a world-wide economy that let countries exchange goods and to have access to services and products that years ago were impossible to obtain due to restrictions in the production and factor endowments.

This rapid development of the global economy and interconnection has lead countries to take advantage of it and to join efforts to reduce trade barriers with the creation of new agreements that help them open their economies and accept the flow of foreign products into their economy.

This openness of the markets will lead to a more competitive industry and obligate producers to invest more in their production system, helping to enhance the quality of products and services offering better outputs to consumers and with better prices due to the increase of technology use in the assembly. Also, due to the huge competition, prices will rapidly drop and will make only the more competitive enterprise survive in the industry, being all these benefits for consumers.

This increase in competition will raise production, leading to the creation of more jobs and helping countries to increase their money flow.

Are openness, free markets, and international trade the best way to promote growth and fight poverty?

So to the moment all the stuff that international trade can bring are benefits, but are all these theories real? Will all countries benefit from the increased production in the economy? There are lots of mixed opinions about this topic and a lot of well-know economists have had an interest in the subject.

It is imperative that we start objectively analyzing this topic, and to see the impact international trade has had in developing countries, and see if it has helped them reach a new standard of living, improving their incomes and mitigated inequality, also it will focus on poverty and how this increase in economic flows on poor countries has helped (or worsen) poverty and inequality.

Rigorous investigation on the correlation between poverty and trade is something relatively new. Until recent years there was a preconceived idea that the faster an economy grows its poverty ratio will drop rapidly, so following this same idea, the only way to mitigate poverty was by promoting the economic growth of countries.

So, because trade theory supports that the liberalization of markets is a necessary condition for growth, we tend to think it is a sufficient one and we tend to forget that trade may even affect large groups of individuals, making it not a viable option in some countries.

“The mainstream narrative pitches “comparative advantage” as a “win-win” boost to economic efficiency and social welfare, without specifying the conditions under which such beneficial outcomes can occur or how any negative effects could be reduced.” (UNCTAD, Trade and development 2018).

Nowadays, the argument is that globalization and trade liberalization is the promoter of growth and poverty mitigation, but for some others, globalization is just a scheme for enterprises to establish stronger market positions and increase their presence in different regions.

And it’s because of this rapid increase in the trade skeptics that a grate focus is being put into understanding and researching the negative effects free trade has brought to poor and developing countries. The theoretical aspect of free trade sometimes can be encouraging into making us apply it, but it does not mean it will work in all its splendor.

Countries before implementing it need to start specifying when international trade would work and even in some situations stay away from it, creating protections for their industries and promoting the development of their production system.

One aspect of globalization and trade is that it can only be beneficial to some individuals and countries. People with higher incomes and in developed countries tend to benefit more from trade than poor people.

“Processes have tilted the distribution of value-added in favor of capital, especially transnational capital, whose owners remain mostly headquartered in developed countries.” (UNCTAD, Trade and development 2018)

“Although trade reforms may raise average incomes in the medium term, in the short term some segments of society can suffer losses. Because the poor or near-poor have fewer assists to protect them during economic hard times, they are less able to absorb adjustment costs than other segments of the society.” (International Trade and Poverty Alleviation. IMF Working Paper 2001)

Some of the reasons why in the short term poor may be more affected by trade than people with higher incomes are because they cannot adapt to this new economic reform in their countries due to the lack of financial or human capital and that makes them not able to get the advantage of trade making them vulnerable to economic changes and fluctuations in the short term.

According to the International Monetary Fund in an article published in the Finance and Development magazine in 2002, International trade has helped the increase in the inequality and income distribution in developing countries around the world, even though the GDP has increased.

“International trade is reinforcing income inequalities. Because exports are growing faster than global GDP, they have an increasingly important bearing on income distribution. And world trade shares mirror income distribution patterns. Thus, for every $1 generated through export activity, $0.75 goes to the world’s richest countries. Low-income countries receive around $0.03. Unless developing countries capture a far larger share of exports, trade will continue to fuel widening gaps in absolute income.” (IMF, Finance and development magazine).

This increase in income inequalities is working as a restraint in the fight against global poverty reduction.

This increase in inequality and lack of effectiveness against the poverty proves that free trade, liberalization, and deregulation is not the only mean to an end in the fight for eliminating poverty, and rather, it should be applied in combination with other policies that restrict and empower people with low incomes to take advantage of this new trade policies.

Governments should have a strong posture supporting redistributive policies. These new economic standards can be achieved by implementing minimum wages that go accordingly to what a good living standard is up to, also the taxation system can help manipulate the distribution and welfare “free-trade” bring to an economy and this can be done to progressive taxes system.

There is evidence, that this openness to trade is not working right now for developing and the so call “south” countries. A good example is Latin America.

Latin America has had a strong interaction with trade liberalization since the 1990s, a lot of the countries adopted the Neo-liberal economic system and opened their barrier to the flow of products and services coming from the outside. This with the idea that they could benefit from this and also export their products and force their industry to be more productive.

But this was not the case, in almost all Latin America, trade liberalization has been related to the increase in poverty and inequality, and that is for a reason, “free-trade” with the deregulation of markets doesn’t work for the poor.

“Countries with low levels of income inequality can expect to register far higher rates of poverty reduction than highly unequal countries. The reasons are obvious. If the poor account for only a small share of national income, the rate of poverty reduction will be far slower. A highly unequal country like Brazil has to grow at three times the rate of Vietnam to achieve the same average income increase among the poorest one-fifth of its population.” (IMF, Finance, and development).

Some other authors specify that growth based on trade liberalization can happen but when it is combined with other poverty reduction strategies, for example access to health care and education and investing in infrastructure. Even protection for small industries and minimum-wage protection.

Trade and openness are not a solution to end poverty and inequality and promote development. Deregulation and liberalization have only work for developed countries, that`s why governments need to establish limits to free trade to promote the way the gains are distributed and to make it work for the majority of people in the country where it is adopted.

“Governments, international financial institutions, and civil society need to engage in a real dialogue over how to make globalization work as a more powerful force for poverty reduction and social justice. At a national level, trade policy has to be brought into the mainstream of national strategies for poverty reduction and redistribution.” (IMF, Finance and development)

In many countries that have adopted this economic posture of trade liberalization, it has only benefitted the exporter and big firms.

“It is evident that increased trade under hyper globalization has created opportunities for structural change… only a few countries have managed to leverage trade as a means for mobilizing and reallocating productive factors away from primary commodities towards higher value-added manufacturing and service activities” (UNCTAD, Trade and Development 2018)

But this hyper globalization and interaction between countries not only is in industries dedicated to the production of final goods. Nowadays, a lot of economists are talking and theorizing about the impacts that the interconnection of finances has on the global economy and how it disrupts the distribution of gain, welfare, and income.

Some would say that the access to the financial markets by the developing countries could lead them to gain access to more resources in the form of debt so they could invest in being more productive, but there is a great risk to it.

This openness of developing countries to the financial markets and its economic flows have let them vulnerable to the risk of financial boom and bust cycles, something developing countries cannot handle with ease.

Also, this financial flow to developing countries has not served the means which it was originally intended. Much of the investment has only been done for short times and in a speculative intention. This increase in economic flow also affects prices (which damage the poor a lot harder) and the economic policies, disrupting the potential economic growth of the country, and that´s because economic policymakers need to act accordingly to the expectancy of the financial markets.

This deregulation of finance in developing countries let governments with less power to take actions that protect the consumer and people in the lower incomes.

“Excessive private capital inflows, particularly those of an unstable or speculative nature, affect the configuration of net factor payments, exchange rates, interest rates and other prices, and influence monetary and fiscal policy stances in perverse ways” (UNCTAD, Trade and development 2015).

So, what should be done? We need to search for new ways to promote economic growth.

We can say that truly trade liberalization has helped many countries and it has brought a lot of development and improvement in the economic matter around the globe, we cannot deny it has not had the sufficient impact that we as a collective -governments and international institutions- would have wanted in solving the poverty and inequality problem we are having this times.

There is know that it does not work for the poor and data and this research has proven it. Trade organizations are looking for a different way of attacking and solving this problem.

The idea of having stronger governments and institutions that control, regulate, and implement programs to redistribute and to help the gains of trade being captured by more people is now a day a trend among economists and finance experts.

Another main interesting aspect is this all-new research about how finances affect the development of poor countries and how this massive flow of money can even affect them in some way if it’s not controlled. A deregulated financial market can have really hard impacts on the monetary and economic policies because it can skyrocket the prices of some important indicators such as interest rate, wages, and exchange rates.

“Foreign capital inflows, depending on their size and composition, may increase or reduce economic policy’s room for maneuver and, more generally, support or undermine growth and development.” (Trade and development 2014, UNCTAD).

This means that the deregulation and massive income flows make governments powerless and disrupt the economic policies they make, affecting the population in general, but affecting the poor negatively a lot more than people with higher incomes, that because they cannot withstand external shocks as effectively as people from other socioeconomic class.

“Overabundance of foreign capital inflows usually generates financial bubbles,

currency appreciation, current account deficits and rising indebtedness of domestic agents. These developments also affect policy space, as they weaken the likely impact of monetary and credit policies and the regulation of key macroeconomic prices” (Trade and Development 2014, UNCTAD)

But the problem just does not stop there. Like is known, after this grate income flows that leads to a bubble, it will at some time explode, creating huge problems for developing countries that find it hard to protect themselves from this financial crisis that even lead them to be worse off than they were before. What this means, is that after a developing or transitioning country find itself in a situation where they have no management of free capital income in financial markets it will lead to a hard burst of the bubble that will create a sudden stop of capital inflows which will put them in a situation where they would stop receiving money and a period of capital scarcity would follow.

“They exacerbate the fragility and vulnerability of domestic financial systems and lead to unsustainable current account deficits. indeed, excessive exposure to external capital flows and the fact that in large part they were not oriented to productive uses were major factors in the build-up of economic crises in developing and emerging economies in the past few decades, beginning with the Latin American debt crises in the 1980s.” (Trade and Development 2014, UNCTAD).

This kind of crisis created by the de-regulation of free trade and finance in developing countries is sometimes created by the same nature of it. Financial incomes are not designated to very productive stuff, rather they are used for the acquisition of financial assets, real estate investment, or consumption credit.

So even though free trade, hyper-globalization, and global finance may help to develop and promote growth in a country, it is not a sufficient way. International institutions and developed countries have tried to spread it as is it was the only one even knowing it hasn’t worked, they have invested lots of money and resources in trying to make it work, but is not about that, is about to look to how far we have come with it and start to ask us: why has it fail? Why despite all the efforts we have not eradicated the problem of poverty or at least reduced it to minor states.

All this does not mean that free trade will not ever work, the things are that it won´t help in the way it has been forced to do it.

References

UNCTAD. (2018). Current Trends and Challenge in the Global Economy. Noviembre 10, 2018, de UNCTAD Sitio web: https://unctad.org/en/PublicationsLibrary/tdr2018_en.pdf

UNCTAD. (2015). La financiarización y el malestar en la macroeconomía. noviembre 10, 2018, de UNCTAD Sitio web: https://unctad.org/en/PublicationsLibrary/tdr2015_en.pdf

UNCTAD. (2014). International Finance and Policy Space. Noviembre 14, 2018, de UNCTAD Sitio web: https://unctad.org/en/PublicationsLibrary/tdr2014_en.pdf

Hoekman, B. (2007). Making Globalization Work for the Poor. Noviembre 14, 2018, de IMF Sitio web: http://users.nber.org/~wei/data/FinGlobal-F&D.pdf

David, D. . (2001). Trade, Growth and Poverty. Noviembre 14, 2018, de IMF Sitio web: http://users.nber.org/~wei/data/FinGlobal-F&D.pdf

Harrison, A.. (2007). Globalization and Poverty. Noviembre 10, 2018, de The National Bureau Of Economic Research Sitio web: https://papers.nber.org/books/harr06-1