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The International Trade And Income Convergence

Aims and Background

International economics considers trade as an engine of growth as well as the solution of global income inequality through fair distribution of income among the trading partners. One of the main economic arguments for promoting international trade, in the broader sense economic globalization, has always been the “gains from trade” arising out of specialization and economies of scale. Based on this underline concept, World trade has grown at an average of 6 percent per year from 1950 to 2002 (WTO 2005) that was the causes of the growth of world economy about 3.5 percent per year from 1960 to 2000, compared to only 1 percent per year in the mid-19th century. As a consequence, total world income has risen rapidly during the last 50 years than it did in 19th and first half of 20th century (Maddison 2001: 264). Though international trade increases the overall economic growth and production globally, it has failed to distribute the benefits of trade equally among the trading partners, where some nations enjoy majority share of incomes than others. These unequal distributions of global income create a debate about the objective of trade – to reduce or to cause of global inequality.

The theoretical advocacy for trade as a way forward for global economic growth with equitable sharing of the gains among participating nations are based on several assumptions, which are currently unrealistic due to imperfect competition among the nations in terms of political and economic powers, levels of industrialization and competency, and changing the quantitative and qualitative nature of factors of production. Therefore, instead of gaining the potential benefits of free trade, the real world is divided into widely unequal north and south, strong and weak, rich and poor, developed and developing, industrialized and industrializing countries that leads to a centre-periphery relationship in production power structure in which the developing industrializing periphery countries become dependent on the industrialized developed centre countries for their production and trade. The industrialized and more developed nations regard economic globalization as a means primarily to facilitate acquiring their imports, mostly the primary products, at the lowest prices from developing countries and selling their industrial and financial products to those countries at the highest prices; so that they can exclusively enjoy the entire gains from specialization under globalization. Historically, it has been observed that the prices of primary commodities have declined relative to manufacturing goods (Ram 2004, Reinhart and Wickham 1994). In the twentieth century, the real primary-product prices declined at an average annual rate of 0.6% (Lutz 1994). Stiglitz (2002:7) also said that after the trade agreement in 1995 (the eight), the net effect on the “terms of trade” was to lower the prices some of the poorest countries in the world received relative to what they paid for their imports, that made the condition for the poorest countries the worse off. So, over the time the terms of trade have tended to worsen for non-oil-exporting developing countries, but relatively improved for the developed countries (Todaro and Smith 2009: 598). On the other hand, developing countries cannot deny the necessity of trade because of their more dependency on foreign trade in terms of its share in national income than that of the developed countries. Therefore, it is no longer a question of whether or not, but how much and what nature of trade and what frameworks are required for a developing economy to operate gainful trade and to reduce the income gap through catching-up with the developed trading partners. These broader problems are highlighted in the following specific research questions:

Does international trade important for the economic growth, especially for LCDs?

Does the benefit from international trade equally distributed and the income is converging among the trading partners?

Does LDCs need to follow the outward-looking policy, or inwards-looking policy, or combined policy such as regional economic cooperation with strategic trading to achieve their development objectives?

Based on these research questions are in mind, our prior study on Malaysia revealed that through globalization Malaysia has made significant achievements in terms of most of the national macroeconomic goals, but in spite of following very selectively and cautiously defined its own model of globalization, it has failed to reduce income gaps over the time with its two major trading and investment partners - USA and Japan (Molla et al. 2009a, 2009b). This remarkable finding urge me to conduct a rigorous study on this issue to check the situation for other developing countries, rather than developing countries as a whole or individual but different group wise, based on income level, geographical location, regional economic cooperation, and level of globalization, etc. The proposed study will be focused on the following basic objectives:

To determine the impacts of trade liberalization on economic growth among different groups of countries

To investigate the relationship between trade and income convergence among different groups of trading partners

To analyze the relationship between the level of trade liberalization and distribution of trade gains among the trading partners

To provide a some of specific policy guideline in terms of international trade, especially for developing countries

Review of Related Literatures

Theoretical Arguments

By applying international trade theory and neoclassical growth theory, many scholars developed theoretical models to explain trade-convergence relationships, both supporting and opposing, that are briefly providing below:

International Trade and Income Convergence: Factor price equalization proposition predicts that under certain conditions, free trade should lead to the equalization of commodity prices and then entail equalization of factor prices across trading countries (Heckscher 1919, Ohlin 1933, Samuelson 1948). Equalization of the factors prices can usually be considered as a catalyst for the equalization of the total income (Ruffin 1988). As a consequence, free trade causes income convergence. Another group of models shows that lower-income economies benefit more from international trade than higher-income economies in terms of growth, which concludes that international trade causes convergence. International trade helps to flow technology, intermediate goods and knowledge, where lower-income countries benefit from this knowledge spillover and experience higher growth rate, because imitation is easier than invention (Grossman and Helpman 1990, 1991, Ben-David and Lowey 1998, Mountfort 1998, Murat and Pigliaru 1998). Moreover, when a lower-income country trades with a higher-income country, the direct cost of education and the resource cost of human capital investment decline so that the human capital investment increases in lower income country and the increased human capital generates a higher rate of technological change followed by higher growth rate (Eicher 1999, Ranjan 2003).

International Trade and Income Divergence: Several models maintained that developing countries do not benefit from trade with rich countries; as a consequence, international trade increases the gap between rich and poor countries. Based on Heckscher-Ohlin theory, Wood and Rodao-Cano (1999) argue that specialization requires poor countries to specialize in products that intensively use unskilled labor and rich countries to specialize in products that intensively use skilled labor so that the wage of skilled labor increases in rich countries and decreases in poor countries, resulting the difference of skill endowment increases due to the elastic supply, and such widening difference in skill endowment would cause income divergence. Moreover, in 1970 Alexander Hamilton, and in 1841 Friedrich List first formulated the argument of infant industry that underdeveloped countries need to build up a balanced industrial structure as existed in most developed countries to achieve level field so that infant industry needs to be protected. But the free trade argument undermines the development of infant industry that hampers the development in less developed countries (Criel 1985). International trade theory of comparative advantage promotes underdeveloped countries to produce primary products, but due to declining terms of trade and low elasticity of demand, classical economists predict that the poor countries gain less from trade (Spraos, 1980; Singer, 1950). Young (1991) presents a model indicating that the benefits of learning by doing spillover across goods produced within an economy but not between economies. Therefore, in the absence of international spillovers, the technical progress in underdeveloped countries cannot exceed that in developed countries, and the growth rates of the trading countries diverge according to their comparative advantage (Murat and Pigliaru 1998). Moreover, Galor and Mountford (2006:1) argued trade significantly influences the demographic transitions across countries where the gains from trade of industrial nations are directed primarily towards investment in education and growth in output per capita, and non-industrial nations are channeled towards population growth so that the expansion of international trade is a prime cause of 'Great Divergence' in income per capita.

Empirical Findings

In line with these contradictory theoretical predictions on trade-convergence relation, several empirical studies also exhibit inconclusive results. Dowrick and DeLong (2003) distinguished four periods where exploring income convergence and divergence in various countries of the world during the last 200 years. They showed that there was no convergence of economic development in the second half of the 20th century, and overall inequality between the world's countries increased except converging only in small groups (clubs) of economies, for example OECD countries after World War II (Dowrick and Nguyen 1989), East Asia after 1960 (World Bank 1994), and the regions of India in the end of 20th century (Bajpai and Sachs 1999). The developing countries in a group does not have income convergence with the rich industrialized countries as a group (Hubbard and O’Brien, 2006). Studies also mentioned that the gap between rich and poor countries has increased because the majority of countries and regions have become much richer during the past century, but those that were already richer have gained considerably more (Durlauf and Quah 1999, Dowrick and DeLong 2003).

Barro and Sala-i-Martin (1991) found significant evidence of economic convergence across 73 European regions since 1950, but other studies found convergence from the 1950s to the 1970s and then stagnated (Molle and Broeckhout 1995, Armstrong 1995). Neven and Gouyette (1994) found divergence (or stagnation) in the first half of the 1980s and strong convergence afterwards in Northern Europe, and in Southern Europe converged in the beginning of the decade and stagnated thereafter. Similar slowdowns in the convergence process after the 1970s have also been found for OECD countries (Andres et al. 1996), and for Japan, USA and five European countries (Sala-i-Martin 1996). Lee et al. (2005) found divergence of income between Japan and each of the ASEAN-5. But, Liew and Ahmad (2006) found that Hong Kong, Korea and Singapore are catching up, while Taiwan has yet to catch up, with the Japan economy. Liew and Lim (2005) revealed that Four Asian Tigers— Indonesia, Malaysia, Thailand and the Philippines - exhibit divergence behavior with respect to Japan’s income, as oppose to the Four Asian Dragons - Hong Kong, Korea, Taiwan and Singapore - which show otherwise.

When analyzing the past, present and future of income convergence, the most terrific scenario has shown by Pritchett (1996). It was mentioned that between 1960 and 1990, income grew, on average, 2.6 percent per year in the Organization for Economic Cooperation and Development (OECD) countries, and 1.8 percent in other countries. Among the poor countries, 43 percent have grown more slowly than the slowest growing OECD country, and 70 percent have grown at a slower rate than the median for OECD countries. Since poor countries are growing more slowly on average, the dispersion in incomes among countries between 1960 and 1990 increased by 28 percent (from 0.86 to 1.1) and the ratio of the incomes of the richest to the poorest countries rose by 45 percent just since 1960.

Especially given the recent record of developing countries, it is very difficult to understand an upsurge of interest in convergence. Using the data for the 93 developing countries for which the World Development Report 1995 reports income growth rates for 1980-93, it calculated how long it would take various countries to achieve three levels of income: their own peak income level; the current income level of high-income countries; and the average future income of high-income countries, assuming that high-income countries also continue to grow. First, more than half of the developing countries had negative growth during 1980-93. These countries are not gaining on anything-their incomes are converging only on the floor of subsistence. Unless their growth rates accelerate, they will never reach even their previous peaks. Second, many developing countries had positive growth rates during 1980-93, but in more than four-fifths of these countries growth rates were still lower than the average (2.2 percent) registered by the highincome countries. Third, a few developing countries were actually "converging," that is, they were growing faster than the United States. When are these lucky "convergers" going to overtake the United States? India, for example, registered an annual average growth rate of 3 percent between 1980 and 1993. If India could sustain this pace for another 100 years, its income would reach the level of high-income countries today. And, if India can sustain this growth differential for 377 years, my great-great-great-grandchildren will be alive to see India's income level "converge." Fourth, since 1980 only 10 developing countries have had growth rates that were more than 1 percentage point higher than the average for high-income countries. These countries can be said to be converging rapidly to high-income country levels. If they can maintain this pace, these countries can look forward to attaining today's level of income in high-income countries within a couple of generations (50 years in the case of Indonesia), and they would actually reach the future income level of the high income countries in less than a century. It also mentioned convergence just hasn’t happened, isn’t happening, and isn’t going to happen without serious changes in economic policies in developing countries.

Approach and Methodology

This study will mostly rely on secondary sources of data. To categorize the countries into different groups based on the level of industrialization, level of per capita income, and stages of development, etc., standard categorization will be used that follows by international agencies such as World Bank, IMF, UN, etc. To categorize countries into different groups based on the level of trade liberalization, regional economic cooperation, etc., secondary sources of data will be used from UNCTAD, WTO, KOF Index of Globalization, etc. To analyze the terms of trade and other macroeconomic variables such as import, export, FDI, GDP, GNP, capital formation, employment, HDI, etc., data will be used from World Bank, IMF, UN, Penn World Tables (henceforth PWT), etc. Data will be analyzed using both descriptive and econometric frameworks by using E-Views, SAS, Pc-Gives, MS Excel and other relevant econometrics softwares.

To ascertain the contribution of trade on economic growth, trade liberalization on economic growth and trade liberalization on terms of trade, etc., panel regressions will be conducted among the several groups of countries. To analyze, income convergence, panel unit root, cointegration, and other relative tests will be conducted based on the literature and availability of data.

Expected Outcomes

The outcomes of the research will have empirical and policy aspects that will fulfil the objectives of the research. The outcomes of the research will also play a significant role to fulfil the gaps in the existing literatures. The findings of the research will help to draw a set of conclusions for the trade-convergence debate based on several categories and groups of countries. More importantly, the modes of trade liberalization, and the directions and approaches of trade for better economic growth as well as the historical contributions of trade for different cases will be revealed by this research. Finally, the recommendations will be highly helpful for international agencies, and both developing and developed countries to reduce the income gap among the trading partners.

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