Trade Adjustment Costs in Developing Countries: - World Bank ...

Trade Adjustment Costs in Developing Countries 3at the more disaggregated 4-digit industry level. This somewhat counter-intuitiveresult – also found by many other studies (see Hoekman and Winters, 2007for a survey) – in part reflects the relatively short time frame of many empiricalanalyses, and the fact that many tend to focus on the formal manufacturing sector,on which there is generally (much) better data. In a longer-run perspective,of course, by definition economic development entails significant structuralchange, with large numbers of people leaving agriculture and finding employmentin manufacturing and services industries.There is more evidence for the reallocation and adjustment processes within industries:the more productive domestic firms in an industry expand by drawingresources from less productive firms that shrink or go out of business. Recenttheoretical developments and empirical analysis have emphasized the importanceof recognizing that there is much heterogeneity of firm performance and efficiency/productivitywithin industries, and that this is a significant source of thewelfare gains from trade liberalization (Melitz, 2003). Recognition of the heterogeneityof firms within and across industries helps to understand the empiricalobservation that there is much churning within sectors following trade reforms.It also helps to understand why trade liberalization is important for economicgrowth over time. As the more efficient firms expand and the less efficient onescontract, the overall productivity of the economy increases. If there are scaleeconomies and imperfect competition, liberalization will allow more efficientfirms to further reduce unit costs as their market expands.Whether the impacts of more open trade operate more or less through wagesas opposed to employment depends significantly on labour market institutions,the efficiency of capital markets and social policies. In developing countries, wageresponses seem to be greater than impacts on employment. There is substantialevidence that trade liberalization decreased industry wage premiums in thosesectors that experienced the largest tariff reductions. The recent global crisis hasgenerated additional evidence that wages bear the brunt of adjustment to externalshocks. Based on a sample of 41 middle-income developing countries,Khanna, Newhouse, and Paci (2010) conclude that the impact of the economicdownturn during 2008–2009 fell disproportionately on the quality of employmentrather than on the number of jobs. Slower growth in earnings accounts fornearly three quarters of the total adjustment for the average country, driven bya reduction in working hours, as well as a shift away from the better-paid industrialsector and toward informal or rural employment.One implication of the finding that large-scale reallocation of workers acrosssectors is not the norm following a trade liberalization episode is that the directeffects of trade reform on aggregate employment tend to be limited. Policymakersare often very concerned about the effects of trade on overall employment. Itis important to recognize that in principle trade opening or trade shocks shouldnot have an effect on overall employment levels in the long run—this will be determinedby macroeconomic variables and labour market institutions. Trade mayaffect the quality of jobs – through increased demand for workers with higherskills or by providing workers with greater access to productivity-enhancing