Although trade liberalization is being actively promoted as a key component in development strategies, theoretically, the impact of trade openness on poverty reduction is ambiguous.

On the one hand, a more liberalized trade regime is argued to change relative factor prices in favor of the more abundant factor. If poverty and relative low income stem from abundance of labor, greater trade openness should lead to higher labor prices and a decrease in poverty. However, should the re-allocation of factors be hampered, the expected benefits from freer trade may not materialize. The theoretical ambiguity on the effects of openness is reflected in the available empirical evidence.

This paper examines how the effect of trade openness on poverty may depend on complementary reforms that help a country take advantage of international competition. Using a non-linear regression specification that interacts a proxy of trade openness with proxies of various country structural specificities and a panel of 30 African countries over the period 1981-2010, we find that trade openness tends to reduce poverty in countries where financial sectors are deep, education levels high and institutions strong.

Introduction

Most economists accept that, in the long run, open economies fair better in aggregate than do closed ones, and that relatively open policies contribute significantly to development. Many commentators fear, however, that in the shorter run, one of the steps towards openness – trade liberalization – harms the poorer actors in the economy, and that even in the longer run successful open regimes may leave some people behind in poverty. Africa remains the poorest continent of the world. Yet, at the same time, African countries have experienced significant improvements in trade liberalization. It seems that the large gains expected from opening up to international economic forces have, to date, been limited in Africa, especially for poor people.

While the traditional trade theory predicts welfare gains from openness at the country level through specialization, investment in innovation, productivity improvement, or a better resource allocation, the theoretical impact of trade on the poor remains uncertain. Besides, empirical results do not converge on this point and it seems that developing countries are not equally able to make use of the opportunities arising out of increased access to markets in the developed world.

The contribution of this paper lies in providing new cross-country empirical evidence focused on Africa on how the poverty reduction effect of greater trade openness depends on a variety of structural characteristics, including some that are subject to reform. Using a panel of African countries over the period 1981-2010 and testing for non-linearities in the trade-poverty relationship, this paper explores the empirical link between trade openness and poverty. Its results uncover an interesting pattern of reform complementarity: trade openness tends to reduce poverty in countries as their financial sector grows deeper, their education level higher and their institutions stronger.

Our concern is with poverty, not inequality. Since trade liberalization tends to increase the opportunities for economic activity, it can very easily widen income inequality while at the same time reduce poverty. Consequently, statements about its effects on inequality cannot be translated directly into statements about its impact on absolute poverty. There may be sound positive and normative reasons for interest in inequality, but they are not the concerns of this paper.