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

6Bernard Hoekman and Guido Portowould in fact only reduce white collar workers by 5 percent, blue collar workersby 10 percent, and capital by 5 percent. In contrast, if a firm wants to double factorusage, it would only increase white collar workers by 12.5 percent, blue collarworkers by 15 percent and capital by 5 percent. This suggests high adjustmentcosts in both hiring and firing. The authors also find that the creation and destructionof factor employment is interdependent in an asymmetric way. Whenfirms want to hire more factors, they adjust one factor at a time. However, whenthey want to employ fewer factors (labour or capital) they tend to reduce the useof all factors together. Finally, the pattern of adjustment depends on the intensityof tariff protection: firms that experienced higher tariff cuts destroyed morecapital and jobs than firms that faced lower tariff cuts.The chapters by Jaime de Melo and by Olivier Cadot, Laure Dutoit and MarceloOlarreaga take a different approach. The focus of much of the literature on themagnitude of adjustment costs tends to be on adjustment in labour markets. Butin low-income developing countries, trade involves primary products that are,in many cases, produced by small farmers. What is the nature of the process offactor use adjustment in such countries? De Melo focuses on the cashew sectorin Mozambique and the vanilla sector in Madagascar following market liberalizationreforms in the 1990s. Analyzing the scarce available data, he concludesthat while the reforms did increase producer prices, there were negligible supplyresponses at the farm level. In both cases, the simulations run by de Melo showvery small gains, and thus limited impacts on either the distribution of incomeor on poverty. He attributes the low supply response following these reforms totwo major factors. The first is the initially low participation in cash cropping.The second is high sunk costs in agriculture. For both vanilla and cashew production,there are significant sunk costs associated with planting new trees, aninvestment that requires a credible pricing policy. This credibility is, in turn,linked to the nature of prevailing institutions. The implication is that the impactsof agricultural (trade) policy reforms depend primarily on other factors.Cadot, Dutoit and Olarreaga provide concrete examples of the role of transaction-relatedcosts as determinants of adjustment following reforms (or shocks) inAfrica. They note that while market agriculture dominates subsistence production,many African farmers remain in virtual autarky. Using data for Madagascar, theauthors calculate that subsistence farmers could increase household incomes byover 40 percent by switching to selling for the market. This finding can be largelyexplained by high barriers to exit from subsistence, including risk, missing markets,and various transactions costs. In consequence, to understand why marketsfail and farmers are not responsive to price incentives it is necessary to identifywhich transaction costs are prohibitive, for whom, and why. Three such costsstand out. First, variable transaction and transportation costs create a wedge betweenfood farm-gate prices and local market prices (from neighbours or localdealers if there is a village market). Cadot et al. report estimates of such variabletransaction costs ranging from 15 to 30 percent. Second, there are fixed transactioncosts. These include searching for partners, enforcing contracts with distantbuyers, and establishing quality. Here, the estimates range from a low of 15