Structural Transformation

Trade Openness, Structural Transformation, and Poverty Reduction: Empirical Evidence from Africa

Zerihun G. Kelbore

Post-Doctoral Research Fellow, Bureau of Market Research, College of Economic and Management Sciences, University of South Africa,

Abstract

This paper examines the poverty reduction effects of trade openness and structural transformation in Africa. The study uses a panel data covering the period from 1981 to 2010 and constituting 43 African countries. Using System generalized methods of moments, findings show that trade openness initially exacerbates poverty by about 1.3% and after one period lag, it reduces it by about 1.2%. Structural transformation lagged two periods, on the other hand, led to poverty reduction of about 3%.

That is we hypothesise that trade openness promotes structural transformation leading towards the production of value added export items whose price in the international market is likely to be less volatile and have higher income elasticity. This indicates that countries at the early stage of structural transformation where agriculture dominates the economy, the benefits from trade openness are not impressive. Rather trade openness may exacerbate the poverty incidence and the negative consequences outweigh the expected benefits. This is mainly due to the following three reasons. First, in the agriculture-dominated economy, the exportable items appear to be primary products whose terms of trade continue to drop overtime in the face of many challenges in the supply side. Second, in such setting, it is more likely that agriculture appears to be the largest employer, the production technology is rudimentary requiring lower skills; hence, the unskilled labor is not prepared to seize the opportunities that trade openness would create. Third, the existing few export-processing firms tend to employ the available technology imported from overseas and this requires skilled labour to work with the imported machineries and equipments. As a result, the improvement in production technologies of the existing few export-processing firms or incoming new foreign firms into the economy increases the demand for skilled labor thereby the demand for unskilled labor in the sectors other than agriculture drops or remains stagnant. Thus, at the early stages of development trade openness tends to benefit the skilled labor and the unskilled labors who seek employment may not be absorbed. This inverted U—shape effect of trade openness was raised in Agenor (2004) who shows the same characterizing the relationship between globalization and poverty.