Would poorer countries be better off by cutting off all trade with rich countries?

Question

A 2017 Guardian article covered research that outflows from developing countries, primarily by way of unrecorded capital flight, significantly outstrips inflows.

... for every $1 of aid that developing countries receive, they lose \$24 in net outflows. These outflows strip developing countries of an important source of revenue and finance for development. The GFI report finds that increasingly large net outflows have caused economic growth rates in developing countries to decline, and are directly responsible for falling living standards.

does this in any way imply if all developing countries cut off all trade from developed countries and declined all offers of aid (theoretically of course), they would be better off to the tune of $3tn per year and their living standards would rise? I imagine a lot depends on where the cut off is between the definition of developed and developing countries is and what the benefit per capita is when population sizes are taken into account. My guess is that the loss of intangible benefits like lack of access to advanced technology and education would make these poorer countries fall further behind the rest of the world.

This question is related to another thread, but rather than hijack that thread I am posting my angle on it here.

Answer 1

Would poorer countries be better off by cutting off all trade with rich countries?

Almost certainly not.

1. One of the largest consensus in economic profession is that free trade and openness is beneficial for a country. According to various surveys more than 90-95% economists believe this (e.g. see this poll). This is almost as strong consensus as the consensus among climate scientists that climate change is happening.

   In fact Paul Krugman (1987), who won Nobel Prize for his contributions to international trade, once stated: "If there were an Economist's Creed, it would surely contain the affirmations 'I understand the Principle of Comparative Advantage' and 'I advocate Free Trade'".

2. Just so this answer is not just appeal to consensus, there are numerous studies that show that economies open to trade develop economically faster and are generally more prosperous.

   For example, Grossman and Helpman (1991), Young (1991), Lee (1993), Rodríguez and Rodrik (2001) and Obstfeld and Taylor (2003), show that trade can have positive effects on long run economic growth (which increases living standards). Free trade is also one of the inclusive institutions that are according to seminal work of Acemoglu and Robinson (2012) important preconditions for economic development (although it is not the only one or necessarily sufficient one).

   There are several mechanisms through which countries benefit from trade (Krugman, Obstfeld & Melitz, International Economics: Theory and Policy. 9th ed.).

• Absolute advantage: some countries have absolute advantage in producing some good or service. That is they can produce it better than all other countries. In that case trying to produce the good locally, as opposed to specializing in something local economy excels at, hurts local economy, as scarce resources are devoted to producing something economy is bad at, instead of importing the same thing from countries that are good at producing it in exchange for something we are good at producing.

• Comparative advantage: even if country is not best at producing anything it will likely be comparatively better in producing something. For example, a city might have neurosurgeon that is best neurosurgeon but also best cook. In that case it still makes sense that the neurosurgeon specializes in area that offers the highest return, and just trades their services with some second best cook who does not have any training in neurosurgery. In this case still both can be show to benefit, and the same argument extends to whole countries.

• Difference in factor endowments. Some countries can be rich in capital, other countries in labor, other in land and so on. In a world without perfect factor mobility, trade between countries allows capital poor countries to get capital intensive goods cheaper, land poor countries can get land intensive goods cheaper etc. Hence it is mutually beneficial for countries with different factor endowments to trade between each other as that allows them enjoy higher standards of living compared to situation where they would not specialize in areas where they are well endowed, and tried to produce goods which are intensive in factors that are scarce in those countries.

• Diversity of tastes. Most people have diverse taste. Different cultures produce different art, clothing etc. Thanks to trade an European can enjoy authentic Japanese Shogi set, and Japanese people can enjoy traditional French wine for example.

• Economies of scale. Trade allows countries to produce goods and services at a larger scale, especially when we talk about small countries. Taiwan, can manufacture semiconductors for the whole world at low prices precisely because it produces semiconductors for whole world. Other countries can specialize in different products or services and trade them for the semiconductors with Taiwan, and again both parties benefit.

• Technological spillers. Trade leads to spillovers of technology which allows countries to grow faster.

• Dynamic gains from trade. Trade has additional dynamic benefits, as specialization leads to also more and faster innovation. Close countries technologically stagnate (e.g. China after isolationist policies of most of Ming and Qing dynasty, Japan under Tokugawa before Meiji restoration, USSR or North Korea are recent examples).

It is difficult to put precise number on it but they would almost certainly be worse off not better off if they would cut trade ties with developed countries. Also, that number from the Guardian article does not even come from some economic analysis, it just assumes that any financial outflow is bad for a country, which is absurd prima facie. That kind of mercantilist thinking was debunked already 300 years ago by classical economists.

does this in any way imply if all developing countries ... declined all offers of aid (theoretically of course), they would be better off ... and their living standards would rise?

When it comes to foreign aid evidence is more mixed. Prominent economists such as Easterly are claiming that foreign aid is harmful to economic development, because it leads to wrong incentives and de facto subsidizes dictatorial regimes (e.g. according to news HAMAS enriched itself thanks to international aid at an expense of people in Gaza). You can see Finckenstein (2021) Lebanon case study as an example.

However, when foreign aid is used to build basic infrastructure it can certainly have positive effects on economy.

So here it is more complicated. You could make a sound argument that foreign aid hurts those countries, but you can certainly point towards some successful aid projects as well.

Answer 2

The Guardian article reports that poor workers make the rich richer.

That may be unjust (the Guardian thinks so), but "Making the rich richer" is not the same as "making the poor poorer".

The Guadian has reported the resource flow imbalance. Cutting all trade and aid would certainly zero that imbalance: it would also zero the balanced trade. The balanced trade makes everybody richer:

Cutting off all trade and aid would make everybody poorer. It would make rich people poorer. It would make poor people poorer. Current conventional belief is that poor people would be affected worse, because going from "poor" to "destitute" is worse than going from "rich" to "less rich" (Note this has not always been the universal understanding: another view was that destitute people should just die).

Answer 3

Let us assume there are two countries, country A is developed and country B is developing.

Country A is a producer of timber which country B does not have access to because the terrain does not support trees. Country B has low labour costs and can produce furniture at competitive prices.

The trade goes like this:

Country A exports timber to B Country B exports furniture to A

Without trade, the above exchange, which is beneficial to both countries would not be possible.

Answer 4

A country is not monolithic. Your question almost answers itself if you are more specific: "Would the poorest 10% be better off?" Or "would the top 1% be better off?"

You also should ask what you try to measure. For example, GDP may rise enormously without the lower 10% profiting, as has been the case in the U.S. since the 1970s (see e.g. https://www.epi.org/publication/charting-wage-stagnation/, fig. 4). Even in the most developed country with a more or less working democratic government, the poor do not benefit from trade and economic growth at all. The idea that the poor profit more in kleptocracies or countries run by autocratic governments, which is the case in much of Africa and Asia, is not plausible.

For a case study, I recommend the documentary "Darwin's Nightmare". It shows the effects of opening the fish economy around lake Victoria for the international market on the local population. That the poorest do not profit is not a singular observation:

the postulated [by the Stolper-Samuelson theorem] narrowing wage gaps between skilled and unskilled labour have not been observed in many developing countries, particularly in Latin America and Africa. [Machiko Nissanke/Erik Thorbecke, UNU-Wider]

This is corroborated by Nina Pavcnik from Dartmouth College:

However, workers who were employed in sectors that were initially shielded by higher tariffs experienced a drop in relative wages as tariffs were eliminated. Many countries, such as Mexico and Colombia, had shielded industries that employed a high share of less educated workers. When the tariffs were eliminated, these unskilled workers were disproportionately affected by declines in industry wages. These are short-term costs of globalization, and over time you would hope that these workers would be able to move toward the exporting sectors and share in the benefits of globalization. But that is not occurring as fast as we would like because worker mobility in many of these countries is quite constrained.

Hope never dies, but I'd like to point out that what should be short-term effects in theory turn out to be long-term in practice.

The eminent Ann Harrison has written a very readable 2006 paper Globalization and Poverty for the National Bureau of Economic Research which one can succinctly summarize with the following quote (p.7):

Globalization produces both winners and losers among the poor.

She explores cross-country, cross-region and cross-sector differences and notes that because globalization affects sectors differently, labor mobility is a key factor mitigating negative impacts on the poor, together with a number of other factors. Here are some key findings:

• "Measures of export activity and foreign investment are generally associated with poverty reduction, while removal of protection (an ex ante measure of globalization) or import shares (an ex post measure) are frequently associated with rising poverty." (p.8)
• "Don Davis and Prachi Mishra argue that 'Stolper-Samuelson is dead'. They write eloquently that applying trade theory to suggest that liberalization will raise the wages of the unskilled in unskilled-abundant countries is 'worse than wrong—it is dangerous.'"
• "Easterly finds that increasing trade integration is associated with falling inequality within developed countries and greater inequality within developing countries."
• "To summarize, there is no evidence in the aggregate data that trade reforms are good or bad for the poor"

On the other hand, a David Dollar and Aart Kraay could show convincing statistical evidence that globalization is beneficial for the poor. They divide the nations into "non-globalizers" and "globalizers" and show that the globalizers experience larger economic growth in the 1980s and 1990s. Because there is no significant change in inequality, this growth translates directly into income gains for the poor.

How can these contradicting findings be reconciled?

One hint can be found in Dani Rodrik's One Economy/Many Recipes, Princeton Press 2007. In the last chapter he asks "Globalization for Whom?" and notes that India and China "house more than half of the world’s poor, and their experience is perhaps enough to dispel the collective doom elsewhere."

He continues to show that these strongest-growing and "strongest-globalizing" economies yielding the statistical evidence in "globalizers vs. non-globalizers" studies were not playing by the WTO free-trade rules but instead protected their markets and, in the case of India, actually grew already fast before opening up to more trade. That aligns somewhat with Harrison's findings above that simple liberalization is less beneficial for the poor than direct investment.

Bottom line: It is a mixed bag, there are winners and losers among the poor between countries and within countries. Opening an economy for trade hurts the poor less when accompanied by policy measures enabling labor mobility. Free trade is less beneficial than direct investments.