Free Trade Won’t Help World Poverty

Ian Fletcher
The propaganda for free trade tells us that not only is it the master key to our own prosperity, but also the master key to lifting the world’s poor out of poverty.  So if we don’t support free trade, we’re in for a guilt trip like the one that used to  make us stick quarters into UNICEF boxes.

Unfortunately, free trade just doesn’t work as a global anti-poverty strategy.  The spreading Third World affluence one sees in TV commercials only means that the thin upper crust of Western-style consumers is now more widespread than ever before. But having more affluent people in the Third World is not the same as the Third World as a whole nearing the living standards of the First.

This is actually not a terribly big secret, and is fairly well known to the people who promote free trade.  For a start, the World Bank standard for poverty is $2 a day, so “moving people out of poverty” can merely consist in moving people from incomes of $1.99 a day to $2.01 a day. In one major study, there were only two nations in which the average beneficiary jumped from less than $1.88 to more than $2.13: Pakistan and Thailand. Every other nation was making minor jumps in between.

The developing world’s gains from trade liberalization (insofar as there are any) are concentrated in a relatively small group of nations, due to the fact that only a few developing nations have economies that are actually capable of taking advantage of freer trade to any meaningful extent.

Although it depends a bit on the model, China, India, Brazil, Mexico, Argentina, Vietnam, and Turkey generally take the lion’s share. This list sounds impressive, but it actually leaves out most Third World nations. Dirt-poor nations like Haiti aren’t even on the radar. Even nations one notch up the scale, like Bolivia, barely figure.

So forget helping starving children in Africa this way.  They’re not even in the game of international trade—let alone winners of it.

Like it or not, this is perfectly logical, as increased access to the ruthlessly competitive global marketplace (which is all free trade provides) benefits only nations whose industries have something to sell which foreign trade barriers are currently keeping out. Their industries must both be strong enough to be globally competitive and have pent-up potential due to trade barriers abroad, a fairly rare combination.

As a result, the most desperately impoverished nations, which have few or no internationally competitive industries, have basically nothing to gain from freer trade.

What progress against poverty has occurred in the world in recent decades has not been due to free trade, but due to the embrace of mercantilism and industrial policy by some poor nations.  (This is, of course, the same way nations like the U.S. and England became prosperous hundreds of years ago.)  According to the World Bank, the entire net global decline in the number of people living in poverty since 1981 has been in mercantilist China, where free trade is spurned. Elsewhere, their numbers have grown.

The story on global economic progress for poor nations in the last 30 years is roughly as follows:

1.      China (one fifth of humanity) braked its population growth, made a quantum leap from agrarian Marxism to industrial mercantilism, and thrived—largely because the U.S. was so open to being the “designated driver” of its export-centered growth strategy during this period.

2.      India (another fifth) sharply increased the capitalist share of its mixture of capitalism and Gandhian-Fabian socialism after 1991. It did reasonably well, but not as well as China and not well enough to reduce the absolute number of its people living in poverty, given unbraked population growth.

3.      Latin America lost its way after the oil shocks of the 1970s, experienced the 1980s as an economic “lost decade,” and tried to implement the free market Washington Consensus in the 1990s. It didn’t get the promised results, so some nations responded with a pragmatic retreat from free market purism, others with a lurch to the left, the former showing results in the last five years or so.

4.      The collapse of Communism left some nations (Cuba, North Korea) marooned in Marxist poverty, while others (Uzbekistan, Mongolia) discovered that the only thing worse than an intact communist economy is the wreckage of one. Much of Eastern Europe and the ex-USSR got burned by an overly abrupt transition to capitalism, then recovered at various speeds.

5.      Sub-Saharan Africa spent much of this period in political chaos, with predictable economic results (except for South Africa and Botswana). Washington Consensus policies in the 1990s did not deliver, and the few recent bright spots have yet to deliver increased per capita income or lower unemployment.

6.      Other poor countries followed patterns one through five to varying degrees, with corresponding outcomes.

China is unquestionably the star here. But all its brutally efficient achievements in forcing up the living standards of its people from an extremely low base, it  still has serious problems. Its growth miracle has been largely confined to the metropolitan areas of the country’s coastal provinces. Of the 800 million peasants left behind in agriculture, perhaps 400 million have seen their incomes stagnate or even decline.

Over the last 30 years of greatly expanding free trade, most of the world’s poor nations have actually seen the gap between themselves and the rest of the world increase. As economist Dani Rodrik of Harvard summarizes the data:

The income gap between these regions of the developing world and the industrial countries has been steadily rising. In 1980, 32 Sub-Saharan countries had an income per capita at purchasing power parity equal to 9.3 percent of the U.S. level, while 25 Latin American and Caribbean countries had an income equal to 26.3 percent of the U.S. average. By 2004, the numbers had dropped to 6.1 percent and 16.5 percent respectively for these two regions. This represents a drop of over 35 percent in relative per capita income.

Today, because a few formerly poor nations are succeeding economically while most have been hit with economic decline, the world is splitting into a “twin peaks” income distribution, with a hollowing out of middle-income countries.

A significant number of nations have gone backwards, and are now poorer than they were a generation ago.  Most poor nations have high fertility, so population growth drags down their per capita income by a percentage point or two every year if economic growth does not outpace it.

Contrary to impressions in the media, economic success is actually becoming more concentrated in the Western world, not less. According to one summary of the data by Syed Murshed of Erasmus University in Holland:

Between 1960 and 2000 the Western share of rich countries has been increasing; to be affluent has almost become an exclusive Western prerogative—16 out of 19 non-Western nations who were rich in 1960 traversed into less affluent categories by 2000 (for example, Algeria, Angola, and Argentina). Against that, four Asian non-rich countries moved into the first group.

Most non-Western rich nations in 1960 joined the second income group by 2000, and most non-Western upper-middle-income countries in 1960 had fallen into the second and third categories by 2000. Of 22 upper-middle-income nations in 1960, 20 had declined into the third and fourth income categories, among them the Democratic Republic of the Congo, also known recently as Zaire, and Ghana. Most nations in the third group in 1960 descended into the lowest income category by 2000. Only Botswana moved to the third group from the fourth category, while Egypt remains in the third category.

We seem to inhabit a downwardly mobile world with a vanishing middle class; by 2000 most countries were either rich or poor, in contrast to 1960 when most nations were in the middle-income groups. (Emphasis added.)                                   

This is no accident. Free trade tends to mean that the industrial sectors of developing nations either “make it to the big time” and become globally competitive, or else they get killed off entirely by imports, leaving nothing but agriculture and raw materials extraction, dead-end sectors which tend not to grow very fast.

Free trade eliminates the protected middle ground for economies, like Mongolia or Peru, which don’t have globally competitive industrial sectors but were still better off having such sectors, albeit inefficient ones, than not having them at all. The productivity of modern industry is so much higher than peasant agriculture that it raises average income even if it is not globally competitive.

Nations which open up their economies to (somewhat) free trade relatively late in their development, and continue to support domestic firms with industrial policy, are far more likely to retain medium and high technology industry, the key to their futures, than nations which embrace full-blown free trade and a laissez faire absence of industrial policy too early in their development.

There are numerous documented cases in which trade liberalization simply killed off indigenous industries without supplying anything to replace them. To take some typical examples given by the International Forum on Globalization:

Senegal experienced large job losses following liberalization in the late 1980s; by the early 1990s, employment cuts had eliminated one-third of all manufacturing jobs. The chemical, textile, shoe, and automobile assembly industries virtually collapsed in the Ivory Coast after tariffs were abruptly lowered by 40 percent in 1986. Similar problems have plagued liberalization attempts in Nigeria. In Sierra Leone, Zambia, Zaire, Uganda, Tanzania, and the Sudan, liberalization in the 1980s brought a tremendous surge in consumer imports and sharp cutbacks in foreign exchange available for purchases of intermediate inputs and capital goods, with devastating effects on industrial output and employment. In Ghana, liberalization caused industrial sector employment to plunge from 78,700 in 1987 to 28,000 in 1993.

One unhappy corollary of this is the so-called Vanek-Reinert effect, in which the most advanced sectors of a primitive economy are the ones destroyed by a sudden transition to free trade. Once these sectors are gone, a nation can be locked in poverty indefinitely.

Ian Fletcher is Senior Economist of the Coalition for a Prosperous America, a nationwide grass-roots organization dedicated to fixing America’s trade policies and comprising representatives from business, agriculture, and labor. He was previously Research Fellow at the U.S. Business and Industry Council, a Washington think tank founded in 1933 and before that, an economist in private practice serving mainly hedge funds and private equity firms. Educated at Columbia University and the University of Chicago, he lives in San Francisco. He is the author of Free Trade Doesn’t Work: What Should Replace It and Why.
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