In addition to this static analysis, which compares the situation before and after a given change, a growing body of literature has identified dynamic gains from change. International trade can affect the growth process through its effect on the accumulation of capital and on technological change. Classical growth theory focuses on the effect of trade on capital accumulation via its impact on the prices of factors of production and products.
The nature of trade taking place is therefore key in determining how trade affects growth. By contrast, an analytical framework that focuses on the determinants of technological progress yields different, and sometimes conflicting, conclusions on the relationship between trade and growth. Some studies suggest that the removal of trade barriers could under particular circumstances encourage specialization in sectors with low growth potential. But this conclusion is challenged by studies that capture mechanisms that associate more open trade with higher growth. Such mechanisms include increased market size, knowledge spillovers, greater competition, and improvements in the domestic institutional framework. While some studies have pointed to possible offsetting effects, many others establish strong links between growth and trade. These studies do not, however, mean that more trade means more growth. Work continues on the causal direction and true causes of this observed relationship.
The location of production and the organization of firms
The Report also examines the determinants of the location of production within the world economy. Work on the so-called new “economic geography” and offshoring explains the location decisions of firms and why they sometimes choose to spread their production processes across different countries.
Falling trade costs — as a result of trade-opening, trade facilitation and new technologies — can help to explain both why firms may concentrate geographically (agglomeration) and why they might break up the supply chain across different locations (fragmentation). The economic geography literature makes three important predictions. First, countries will tend to export products for which there is a large domestic market (the home market effect).
The domestic market allows increasing returns to scale to operate, establishing a base for exports. At the same time, agglomeration permits various kinds of productivity “spillovers” to strengthen the competitive position of firms. Second, the home market effect will be amplified by falling trade costs, at least in the first instance (the magnification effect). Third, while falling trade costs will result in an initial period when manufacturing is concentrated in the “core”, with the “periphery” specializing in non-manufactures, further reductions in trade costs, along with emerging limits to the advantages of agglomeration, will eventually reverse this process and lead to a dispersion of manufacturing activity.
Available evidence suggests that offshoring is on the rise, driven by declines in the absolute costs of trading goods and services and advances in telecommunications technology. Recent work points to other factors, besides the traditional elements typically associated with comparative advantage, that also influence the evolution of production fragmentation. These include the quality of institutional frameworks, the costs of establishing a business and the quality of infrastructure. For these reasons, low-income countries may be at a significant disadvantage when it comes to participation in international production networks.
The distributional consequences of trade
The Report also examines the distributional consequences of trade — a major aspect of the tension detectable in public attitudes towards globalization and trade. Studies have attempted to disentangle the various elements of economic change that increase inequality. Much points to a significant effect arising from technological change, which raises productivity and wages among skilled workers, leaving the relatively unskilled behind. But trade may also play a role, where demand for unskilled workers in richer countries falls as a result of specialization through trade with lower-income countries where skill levels are on average lower than in rich countries.
In the case of developing countries, one might have expected that trade would reduce both poverty and inequality through positive effects on growth and income distribution. But evidence suggests that trade liberalization has not always gone hand in hand with reductions in inequality. Empirical evidence suggest that this is partly due to trade liberalization triggering technological change. The timing of trade policy change, the pre-existing level of protection and a range of factors relating to such factors as the structure and functioning of markets and basic infrastructure may also play a part.
In considering the relationship between trade and poverty, the Report notes that trade reform can help to alleviate poverty, which is one of the biggest challenges facing the world community today. Even though most of the literature concludes that trade has helped to reduce poverty on average, not all poor households have been able to take advantage of this. The relationship is complex, since trade affects growth, employment, revenue, consumer prices and government spending, all of which are factors entering the calculus of income effects upon households.
The social consequences of trade opening
Opening to trade implies adjustment, with some workers losing their jobs in import-competing firms that seek out efficiency gains, contract in order to survive, or simply fold. Exporting firms, on the other hand, may grow after a trade reform. A policy challenge of managing change will nevertheless remain. In many countries, policies are in place to assist displaced workers. Adjustment policies aimed specifically at trade have not always proved successful, in part because it is frequently difficult to distinguish in a meaningful way among various potential reasons for job losses.
Trade-specific adjustment programmes may nevertheless be attractive in order to help sell nationally beneficial trade-opening policies. In countries where general social protection is available, trade-specific programmes may be harder to justify, but in developing countries that lack general social protection, such specificity may make more sense. More research and experimentation is needed to identify the most effective means of addressing the adverse social consequences of desirable economic change.
Global integration and international cooperation
Despite continuing gaps in our knowledge and understanding, the theoretical and empirical case for the gains from trade is strong. But certain factors have the potential to reduce those gains or to skew their distribution. The final section of the Report contemplates how international cooperation, including through the WTO, may help to mitigate the adverse effects of these factors. In addressing trade costs and supply constraints that diminish potential gains from trade, much depends in the first instance on national policy action. Public investment to enhance physical infrastructure is key, as is a willingness to lower trade costs through trade and regulatory reform.
But international cooperation can also make a big difference. In the context of the WTO, including the ongoing Doha Round, trade opening, actions to reduce trade costs, and the implementation of multilateral agreements can all contribute to enhanced opportunities to gain from trade. The market access negotiations in agriculture and non-agricultural market access (NAMA) offer the possibility of coordinated trade opening, where governments gain from both their own reduced trade costs and those of others. The trade facilitation negotiations focus on a particular set of trade costs.
The Aid for Trade initiative helps developing countries to build supply capacity and to reduce other constraints on trade. Technical assistance also offers opportunities for strengthening the ability of governments to manage trade policy in ways that will enhance national competitiveness.
Finally, technology can be spread through trade, by making technologically more sophisticated intermediate goods available for production, by a process of learning and adaptation to new technologies conveyed through trade, and through person-to-person communication associated with trading relationships. Technology transfer and diffusion can be enhanced through international cooperation, accompanied by appropriate property rights in order to ensure that technologies are developed which are suited to the domestic environment.
