NBER, Working Paper No. 16322, National Bureau for Economic Research, Cambridge, MA. Krishna, Pravin, Devashish Mitra, and Asha Sundaram. 2010

An empirical study of the impact of international trade on poverty alleviation in “leading” versus “lagging” states in India finds trade to be associated with reduced poverty but to a statistically insignificant extent in lagging states and to a greater magnitude in urban rather than rural areas in leading states; geographic remoteness and imperfect price transmission is found to impede poverty reduction in lagging regions.

Rapid economic growth in South Asia from 1990 to 2005 – averaging 6% per annum for the region – was experienced alongside policy changes that allow for greater international trade. Trade liberalization, such as lower trade tariffs and transportation costs, and technological improvement, led India to more than double its trade-to-GDP ratio and to improved trade performance in Bangladesh and Sri Lanka. Economic theory dictates that trade will increase returns to abundant factors in an economy. Unskilled labour in South Asia should, therefore, benefit the most from trade and this would lead to a reduction in poverty. How this benefit is distributed across regions and sectors (rural or urban) in a country is the subject of this paper.

While the literature agrees that international trade contributes to economic growth, empirical evidence is not decisive. Krishna et al contribute to the empirical trade literature with sub-national data on India to measure the impact of trade on poverty, the differential between “leading” and “lagging” states, and the variations among rural and urban sectors. They argue that an economically lagging region would benefit less due to geographical remoteness, slowly adjusting prices and wages, and the lack of productivity gain from economic activity that tends to agglomerate geographically. A series of regressions are used to estimate the impact, and data on poverty and trade liberalization from 1990-2005 are obtained from a variety of reputable sources. The estimation is repeated several times with different measures of poverty (i.e. World Development Indicators and Human Development Index) to ensure that results are not subject to variations in definition.

There is strong evidence for the role of trade liberalization in declining poverty rates in India, and findings confirm the suspected differential between leading and lagging states. In leading states, trade significantly affects poverty reduction and a greater impact is found in urban areas than in rural. In lagging areas, however, trade is found to affect urban areas by less and no significant impact of trade is found on poverty in rural areas.

The authors go on to examine why the differential between leading and lagging state occurs. Firstly, the argument for geographical remoteness is supported by the finding that lagging states are, on average, 25% further from ports than leading states. The measure of absolute distance from capital provides more ambiguous results since it does not capture methods of travel and quality of infrastructure. Secondly, price transmission is found to be less perfect in lagging states than in leading states. In other words, as liberalization reduces tariff expenses, prices will take longer to adjust downward in lagging states. This would affect economic development by lowering export demand, and indeed only leading states are found to specialize in production of export-oriented goods. Finally, it is thought that the agglomeration of economic activity in leading states increases competition and stimulates investment in R&D, which leads to productivity gains. Productivity is found to be on the rise across India, but with only weak evidence that gains are lower in lagging states it cannot describe the differential impact of international trade among states.

The impact of trade liberalization on poverty in South Asia is estimated to determine if the results in India hold more generally across the region. The proportion of population in lagging regions is used instead of region-specific data. There is strong evidence that poverty is declining, but with an ambiguous impact of international trade. The implication is that once trade liberalization has occurred, the greater the proportion of population living in lagging regions, the greater is the downward pressure on GDP growth. The accumulation over time of this effect will negatively impact economic development.

The authors conclude with two major implications for international trade in South Asia. First, initial conditions of poverty, inequality, and geographical characteristics will determine benefits from trade. A policy priority would be, therefore, to “ensure integration of backward regions” and target inequality. Secondly, results highlight the importance of infrastructure, credit, development of human capital, flexible labour markets, and institutions in enabling states to participate in trade. It is suggested that it is not “competition to domestic production from international trade” that impedes economic development, but rather the lack of ability to participate in international markets.