The Adjustment Costs of The Adjustment Costs of Trade Liberalization Trade Liberalization

David Tarr, World Bank and Steve Matusz, Michigan State University

• The views expressed are those of the authors and do not necessarily reflect those of the World Bank or its Executive Directors.

Prepared for the World Bank Institute Course in Moscow, Russia

““Trade Policy and WTO Accession for Development in Russia and the CIS”Trade Policy and WTO Accession for Development in Russia and the CIS”

 March 28-April 8, 2005

Benefits of trade liberalization are well knownPolicy-makers fear adjustment costsLess known about adjustment costsWe survey the literatureWe identify areas for additional research

1. Social versus private costs of 1. Social versus private costs of adjustment adjustment

Social adjustment costs equal the value of the lost output due to the transitionSocial adjustment costs of labor terminate after workers find new employmentBenefits of trade liberalization continue into the indefinite futurePrivate adjustment costs would include revalued factors in the new equilibrium

2. Evidence 2. Evidence

A. 19 countries in Papageorgiou, Michaely and Choksi –One year after trade liberalization, manufacturing employment increased with one or two exceptions [see table 1]

Manufacturing employment in developing countries

B. Parker et al. for 5 African CountriesEmployment growth in existing MSES was strong

C. Harrison And RevengaIn Costa Rica, Peru and Uruguay, employment growth was not trade liberalization.

Caveats: Not Controlled Caveats: Not Controlled Experiments Experiments

AG Employment? Would employment have increased more absent trade liberalization?But evidence does not contradict the notion that trade liberalization is consistent with growth of manufacturing employment.

3. Formal Studies of Adjustment 3. Formal Studies of Adjustment Costs Costs

Benefit/Cost Studies A. Magee (1972) – the first empirical study – US trade

liberalizationAdjustment costs =

Number of unemployed Duration of unemployment Average wage rate

  Benefits/costs = 6 after 1 year= 19 after 15 years  See table 4

B. Baldwin et al Tokyo round impact (50% tariff cut) on 367 US industries.The study includes the costs of idle capital in its adjustment costs estimate.  Benefits/Costs – 24Results are elasticity dependent, but Baldwin et al argue no reasonable variation would reverse the qualitative results.

C. Morkre and Tarr (1980, 1984)9 partial equilibrium studies of US industries.Most of the important cases of US protection.

Benefits/Costs protected – between 7 and 68 Costs per job measure (done in politically charged atmosphere):Less scientific but easy for a politician to understandWelfare costs per job protected – from about $65,000 to almost $200,000 per year (above private costs of the job)

D. Takacs and WintersOn average, 17% of British footwear workers voluntarily leave their jobs every year.Estimate that trade related displaced workers would become re-employed within 7 weeks.Benefit/cost ratio = 153 (after one year) and it increases over time.Even if turnover is only 8%, then the unemployment time is about 14 weeks, and benefits/costs are about 80.

E. Dixon et al for AustraliaThey estimate that between 2 and 14% of the Australian workforce would have to change jobs due to a 25% tariff cut. But between 32% and 142% changed jobs in a typical two year period between 1961 and 1976. Time is about 14 weeks.Benefits/costs are about 80.

F. Other studiesDe Melo and Tarr (1992) us general equilibrium model for 3 autos, steel and textiles.Only two in developing countries.De Melo and Roland Holst (for Uruguay)Rutherford, Rutstrom and Tarr (for Tunisia—not in the paper)Mutti for the US.

Are these studies relevant for developing Are these studies relevant for developing countries?countries?

Theoretical considerations—In developing countries, labor markets are less flexible in the formal sector.But much employment is in agriculture and informal sectors, where flexibility is great.

EmpiricalEmpirical

Liedhom and Meade –7 developing countriesMicro and small enterprises were created at just over 20% per year, faster than in industrialized countries [see table 6].Aggregate employment studies are for developing countries and manufacturing employment increased after trade liberalization.

4. Private Costs of Adjustment 4. Private Costs of Adjustment

Jacobsen (1978); Jacobsen et al (1993), American Economic ReviewUS Workers – Workers in low wage industries increase earnings two years after displacement (us textile and footwear workers).If large specific human capital, or wage premia (due to efficiency wages, union power or high government wage scale) then displacement will lead to high private costs of adjustment.

If low specific human capital, or wage premia (due to efficiency wages, union power or high government wage scale) then there are non-private adjustment costs after six years.

Compare apparel workers in the US (very low adjustment costs) with steel and autos in the US with high adjustment costs due to union wage premia.

Other studies of low private costsOther studies of low private costs

Public sector workers in Slovenia and Ghana—higher wages after displacement.High private costs in Ecuadorian Central Bank (Rama); privatized Turkish cement firm (Tanzel).

Political Economy Problem Political Economy Problem

So why protection?Concentrated losses but dispersed gains.Fernandez and Rodrik: gainers often can’t self-identify, so they may oppose trade reform.

Solution: Uniform tariff • Eliminates the benefits of lobbying and creates a

free rider problem for lobbying for protection. E.g., Chile - in 1998, the National Association of Manufacturers lobbied for a reduction of the uniform tariff from 11 to 6 percent.

What can policy-makers do about trade What can policy-makers do about trade adjustment costs?adjustment costs?

Designing Trade Adjustment AssistanceNote that zero adjustment costs are not optimal since it implies poor job matching (search models).Why provide to only trade displaced workers? Why not also to displaced workers for any reason?

US experience shows that it is difficult to target trade-displaced workers (workers frequently received adjustment assistance and become reemployed with the original employer—redesigned program is now better targeted); and all displaced workers will try to claim they are trade displaced.

Biggest losers are relatively wealthy workers — not a poverty problem.Social safety net for the most vulnerable, not just trade displaced.Assar Lindbeck – don’t want to provide disincentives to work –e.g., Spanish unemployment problem.

Training?Training?

Requiring participation in training programs also has been ineffective in the US, i.e., unemployment compensation and earnings of trainees not different from those who do not receive training.Most effective programs are demand driven retraining led by the private sector, e.g., apprenticeship programs.

Complementary ReformsComplementary Reforms

Macro stability so that the private sector responds to the changed incentives.Labor market flexibility, competition and SOE reform.Macro, labor market, competition and SOE reform are valuable in their own right but taken together the reforms can reinforce each other.

Conclusion From the EvidenceConclusion From the Evidence

There are caveats that must be applied to any of the studies. But with so many studies pointing in the same direction, it is difficult to avoid the conclusion that adjustment costs are small in relation to the benefits.

Why these results:Why these results:

Manufacturing employment in LDCs went up one year after trade liberalization because:LDCs are labor intensive, so trade liberalization favors labor there.Intra-industry shifts, which minimizes dislocation costs.Normal turnover exceeds dislocation often, so trade displacement is easily accommodated without employment loss.

Why are Adjustment Costs Low:Why are Adjustment Costs Low:

Social adjustment costs are short term and terminate with new employment.Estimates are that the duration of unemployment is short, especially where workers were not earning rents.Labor turnover often exceeds dislocation from trade liberalization.