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

Trade Adjustment Costs in Developing Countries 17An implication is that governments should promote entry by new firms and removebarriers to exit, which may include restrictive labour market regulation –see for example Besley and Burgess (2004). Given that managers of firms confrontincentives to improve performance as trade openness increases, measures to promoteinnovation (R&D) and to assist on upgrading of existing firms can makesense (Motohashi, 2002; Pakes and Ericson, 1998). This can include policies thatfacilitate learning about managerial performance and measures that encouragethe use of new technology to improve performance (Hoekman and Javorcik,2004). More generally, many of the chapters in this volume suggest that takingaction to reduce transactions costs, improve access to credit, and improve accessto information through trade support services can be very beneficial from apoverty reduction and trade expansion perspective. Much of this agenda is increasinglybeing supported through various aid for trade programs that are providedby bilateral donors and multilateral development agencies.Turning to factor market ‘‘distortions’’, a key feature of the theoretical modelsthat are used to assess the magnitude of adjustment costs is that factors of productioncannot move freely from sectors that shrink due to liberalization to thosethat expand. The trade literature on adjustment costs has emphasized frictions inlabour markets so that the costs of adjustment to trade occur during labour reallocation.Displaced workers cannot easily find jobs in expanding sectors because,for instance, the new jobs require specific skills that need to be acquired, a processthat takes time.The quantification of the welfare costs of these barriers to labour mobility inthe literature tend to use of structural models and involve calibration exercises.A potential next step in this research is to make more use of micro (survey) datain the estimation of costs. Another potential extension of research in this area isto explore additional sources of labour immobility such as adjustment costs in thecapital stock and in investment (as in the business cycle literature). In the presenceof complementarities between investment (i.e., desired capital stocks) andlabour, the cost of adjusting the capital stock can affect employment and wages.If capital cannot easily adjust to reforms, is this a sizeable source of welfare lossesfor workers?The work done on adjustment costs in Africa provides some answers to thisquestion. The chapters by de Melo and by Cadot, Dutoit and Olarreaga (and theliterature they review) argue that the welfare costs of reforms are generated byfeeble supply responses in agriculture and by barriers to exit from subsistence intomarket agriculture. Given that the resource allocation involves farm labour(among other factors), the problem can be framed in terms of a labour mobilitycost theory. A major reason identified by these authors to explain the limited adjustmentin rural Africa is insufficient capital investment. The sunk costs argumentthat is presented in these chapters is, to a large extent, a manifestation ofthe impossibility to adjust capital and non-labour inputs like trees (vanilla, coffee,cashews), seeds, machinery, pesticides, etc. The list of possible barriers to exitfrom subsistence is large. It would be very helpful for policy analysis and designto have a broad menu of the possible barriers and a tentative ranking of their rel-