Background

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1. Research hypothesis and objectives of the project

Globalization poses both risks and opportunities for developing countries. Access to new markets for exporting firms in low and middle income countries potentially creates employment and increases the salary of workers in those sectors. Local firms can also access better inputs and technology, helping to close the productivity gap observed in most developing countries. However, for gains from trade to materialize, resources need to be reallocated from less to more productive activities. In the presence of imperfect labor markets it is not clear that the gains from trade will be observed. Even more, globalization can increase unemployment, poverty and income inequality in the short and medium term, making it unsustainable socially, economically, and politically. This suggests that the relationship between international trade and labor market outcomes is complex and that there are important complimentary between trade and labor market policies. The overall effect of globalization in a developing country may depend on the provision of complementary policies, institutions, and infrastructure, highlighting the importance of public policies.

The objective of this project is to thoroughly analyze the challenges and opportunities created by globalization in developing countries. The emphasis of the program is on the effects of international trade in domestic labor market outcomes, that is, the creation of employment opportunities both in the formal and informal sector, the effects on unemployment and the impact on wages. We will also assess the subsequent impact on poverty and inequality. The research also seeks to identify the policies that would moderate the negative effects of globalization and maximize its benefits. We will study the role played by skill development policies, the provision of transport infrastructure, labor market reforms, and export promotion policies. The work program is organized in six modules:

Module 1 – Global Trade Reforms with Labor Mobility Costs

Module 2 – Wages and Employment Gains from Exports: Evidence from Developing and Low-Income Countries

Module 3 – Trade and Unemployment in Developing Countries

Module 4 – Trade and Informal Labor Markets in Developing Countries

Module 5 – Making Globalization more Inclusive in Developing Countries: The Role of Skills Development, Transport Infrastructure and Export Promotion Policies in Employment and Wages

Module 6 – Policy Lessons: How can employment and trade policies maximize the opportunities and cope with the risks of globalization in developing countries?

2. State of research and link to national and international development debates and policies

There is a rapidly growing theoretical and empirical literature that combines models of labor markets imperfections and international trade. The estimation of the impacts of trade liberalization in the presence of imperfect labor mobility is a major ongoing theme in the recent trade literature. Labor immobility is documented in Wacziarg and Wallack (2004), who show little inter-industry flows after liberalization across countries, and Muendler (2010) and Menezes-Filho and Muendler (2011), who show that the absorption of displaced workers from de-protected industries in Brazil was very slow. Labor immobility is also indirectly suggested by the presence of wage differentials, created in part by tariff protec-tion (Attanasio, Goldberg and Pavcnik, 2004; Goldberg and Pavcnik, 2005; Galiani and Porto, 2010). There is also a growing literature that relies on structural models to study the dynamics of costly labor adjustment following trade policy and trade shocks. This literature includes Artuc, Chaudhuri and McLaren (2008, 2010), Artuc (2012), Artuc, Lederman, and Porto (2012), Cosar (2010), Cosar, Guner and Tybout (2010), Davidson and Matusz (2000; 2004a; 2004a; 2006b, 2006, 2010), Dix-Carneiro (2011), and Kambourov (2009).

While the literature on trade reforms and labor mobility costs is both theoretical and empirical, most of the existing work on the link between trade, labor market frictions and unemployment is exclusively theoretical (e.g. Helpman and Itskhoki 2010, Brecher 1974, Egger and Kreickenmeier 2011, Davidson, Martin, and Matusz 1999). Some existing studies combine theory and empiricals (Davis 1998, Dutt, Mitra and Ranjan 2010), but the link between the two is tenuous.

There is also a large literature exploring the correlation between exports, exporting firms, wages and employment. It is a very well-documented fact that exporting firms are very different from non-exporting firms in various characteristics. For instance, Bernard, Jensen, Redding and Schott (2007) calculate the export premium in U.S. manufacturing in 2002 for different firm characteristics. Several other papers have found a positive correlation between exports and firm outcomes, both in developed and developing countries. Since the seminal work by Bernard and Jensen (1995), Bernard and Jensen (1999) and Bernard and Wagner (1997), a large literature has looked at the links between exports and wages in more detail. An interesting finding of this literature is that, while it is clear that good firms become exporters, it is less clear that exporters remain significantly better than non-exporters (Clerides, Lach, and Tybout, 1998). Bernard and Jensen (1999), for instance, conclude that while employment growth and the probability of survival are higher at exporters, productivity and wage growth are not. A large literature that follows Bernard and Jensen’s methodology to has established the existence of export premium in wage regressions. Examples include Meller (1995), Alvarez and Lopez (2005), Sinani (2003), Arnold and Hussinger (2005), Hahn (2004), Bernard (1995), Zhou (2003), De Loecker (2007), Farinas and Martin-Marcos (2003), Hanson and Lundin (2004), Aw and Batra (1999), Liu et al. (1999), Tsou et al. (2002), Greenway and Yu (2004), Bernard and Jensen (2004), Van Biesebroeck (2005), and Isgut (2001). Brambilla, Carneiro, Lederman and Porto (2010) establish a positive link between the skill premium at the industry level and sectoral exports in a set of Latin American countries. Most of the literature has focuses in developed and high-middle income developing countries. The evidence for low and low-middle income countries is instead scant. We will seek to address this gap in the literature.

Informality is prevalent feature of the labor market in developing economies. Maloney (2004) estimates that informal jobs cover from 30 to 70 percent of the labor market in the majority of the Latin American countries. This figure is even higher for most African countries. The introduction of informal sectors in a search general equilibrium model is not a novelty in the literature. For instance Albrecht et al (2009) analyze the impact of changes on payroll and severance taxes in search matching model in the presence of the informal sector. Zenou (2011) also incorporates informal sector in a search general equilibrium model. However, he models the informal sector without any search frictions. Ulyssea (2012) develops an entry model with heterogeneous firms, where firms can exploit two margins of informality: (i) whether or not to register their business; and (ii) whether formal firms hire informal worker. Araujo and Ponczek (2012) construct a search and matching model that captures the influence of labor justice on labor markets. Heckman, Urzua and Vytlaci, (2006) note that there is no consensus in the empirical literature if informality is mainly voluntary or involuntary. There are studies that validate the segmentation hypothesis (Harris and Todaro 1970, Gindling 1991), whereas others studies supports the hypothesis of voluntary informality (Yamada, 1996; Maloney, 1999 and Saavedra and Chong 1999). The classification model proposed in Davalos (2012) suggests that equilibrium job search models such as Burdett and Mortensen (1998) and El Badaoui et al. (2010) provide a unifying theoretical framework that nests this duality. Our work will fill some of the gaps in the literature considering informality in the context of an open economy and when workers are allowed to endogenously choose the schooling choice.

Our work will also contribute to the ongoing national and international policy debate on how to make globalization less unequal among and within countries. Trade creates incomes but the benefits and costs are not evenly distributed within a country. Following the 2008 crisis many countries took measures to protect their domestic markets worrying about the effects trade could have on domestic employment. Industrial countries feel threaten by emerging economies and pressures for protection are strong. At the same time, developing countries and specially LDCs have failed to use trade as a tool for economic development. That has led ILO recently to conduct a series of studies on the effects of trade on employment (the ETE project). Our project will also contributes to the debate on the role trade and labor policy should play in the Post-2015 Development Agenda.

3. Time frame and milestones

The project will last six years, divided in two periods of three years each. During the first stage modules 1 through 4 will be completed. Modules 5 and 6 will be completed during the second stage.

Milestone 1 (3rd month): Initial workshop in Geneva to discuss methodology and work program.

Milestone 2 (17th month): First draft for modules 1, 2, 3 and 4.

Milestone 3 (18th and 24th month): Two regional workshops (Latin America and Africa) to review work in progress.

Milestone 4 (32nd-36th month): Workshop and policy forum in developing country with findings of first four modules. Internal and external peer review and validation with stakeholders. Review of comments and publication of first two volumes. Discussion and development of methodology for second stage of program and selection of case studies.

Milestone 5 (50th month): First draft for eight papers in module 5.

Milestone 6 (51st and 58th) Two regional workshops (Latin America and Africa) to review work in progress.

Milestone 7 (68th-70th month): Final workshop and policy forum in a developing country with findings of complete work program. Peer review and validation with stakeholders. Review of comments and publication of last volumes.

Milestone 8 (72nd month): Project Wrap-up workshop in Geneva, presentation of volumes and lessons from the project.

4. Beneficiaries

Understanding the relationship between international trade and labor market outcomes is key for the health of the inter-national trading system and the improvement in the living standard of billions of people in both developed and developing countries.

The main beneficiaries of this research will be policy makers in developing countries working in trade and labor market policies and academic researchers working in labor economics, international trade, and development economics. The developing countries partners in this research consortium are in excellent condition to maximize the positive policy and development impact of this research program. This project will generate a series of outcomes that will benefit policy makers currently seeking improved capabilities to deal with effective labor market reform, skill development, and export promotion. It will also help trade negotiators better understand how trade and labor issues should be linked in regional and multilateral trade agreements. The project will generate a better understanding of the constraints faced by poor households to participate in the formal economy and in the dynamic export sector.

It is clear that the answer to the question how does globalization and trade reforms impact economic development and growth in developing countries is not a simple one. Researchers and policy makers have been struggling with this question and the state of the economic literature in this area illustrates the complexities associated with the analysis of the interaction between trade and labor policies. Indeed, probably a third of the existing literature suggests that the impact of trade liberalization on unemployment is positive, whereas a third of the existing literature suggests that is negative, and another third that there is no impact. It is difficult for policy makers to navigate through this contradicting evidence. The objective of this project is to put some order and try to understand why sometimes the impact is positive, negative or nonexistent, giving the tools for policymakers to be ready to act when it is necessary, and allocate their rare resources where they are most needed and will have the largest development impact.

Let us provide a few examples. Suppose a country with a large unemployment problem, or a large informal sector is spending a large amount of resources trying to reduce labor market frictions or informality by providing market information and skills to workers. If trade reforms will tend to move the production structure of the economy toward sectors with less frictions or informality, then this could be a very efficient way of solving the unemployment or informality problem in that country. On the other hand, if trade reforms shifts the production structure of the economy towards sectors with more labor market frictions or informality, then it will be crucial that trade reforms are accompanied by an intensification of labor market policies that will limit the tendency towards more unemployment or informality.

Labor standards, and more generally negotiations related to labor policies have been kept outside the multilateral trade negotiations of the World Trade Organization, but have been pushed into North-South trade agreements, and are now part of what is expected from developed countries when negotiating preferential trade agreements with developing partners. The reluctance of developing countries to engage in labor standard negotiations is partly based on the idea that lower labor standard are part of the institutional comparative advantage of developing countries and that linking trade and labor issues is not in the interest of developing countries. In this research project we will explore the validity of this assertion in a more complex world, where changes in labor standards in partner countries affect the comparative advantage at home and by changing the production structure of the home economy may have impacts over aggregate unemployment or informality. We hope that this research project will bring some light into whether or not is in the interest of developing countries to link trade and labor issues in trade negotiations. A priority, these are complex issues, and therefore there is probably not a simple answer, contrary to what is often advanced.

5. The project’s pathway to impact

This research initiative is grounded in the belief that policy matters, and that there can be significant and lasting impact from helping development governments improve the way they develop and implement policies. To realize this mission, the research team believes that producing new and compelling intellectual content on the challenges and opportunities of globalization for developing countries will produce better informed policy decisions. To achieve this, the participating institutions will need to bring this content to policy-makers through advisory engagements and fruitful dialogue among different actors through advocacy and dissemination efforts. These efforts are focused on contributing to the long term impact of making globalization more inclusive in developing countries.

The research contribution to these long term impacts takes the form of three high level intermediate outcomes that speak to good policies, effective government capabilities and strong public-private collaborations that should ultimately foster economic transformation in developing countries. To achieve these three intermediate outcomes, the research will need to contribute in the short run to better understand:

  • the complementary nature between trade and labor market policies
  • the importance of skills development for economic transformation in developing countries in the context of a globalized economy
  • how trade and labor issues should be linked in regional and multilateral trade negotiations

The impact of our research depends critically on the interest it generates among policy makers and relevant stakeholders in developing countries and on governments having the institutional capacity to implement the policy recommendations from the study.

International economics has been slow in tackling the labor market dimension of trade policy. The research team has discussed the issue with several development practitioners and policy makers and they have all agreed that a long term and focused research program is needed to address this gap. To maximize the policy impact of the research and to create a “conversation” between researchers and stake holders, the consortium has created a Policy Advisory and Advocacy Group made up by a group of notable policy makers and academicians.

6. Capacity Development

The participating institutions have the organizational orientation to amplify and sustain the development impact of this project through the design and execution of a knowledge dissemination strategy and a capacity building methodology to ensure the main stakeholders can contribute to and benefit from this research. ACET has consistently emphasized drawing lessons from fast-transforming countries, such as Brazil, for African governments. As part of its advisory work, it has brought in Asian experts to advise and support African policymakers. Similarly, this project will connect North and South experts with African and Latin American policymakers. The research partners will take affirmative steps through the program to boost the analytical capabilities of other African and Latin American researchers and give African and Latin American policymakers new tools for making policy and the support systems for implementing them. We envision four components to our capacity development strategy:

  1. Internal learning and capacity building,
  2. African think tanks and research centers,
  3. Learning and training activities, and
  4. Knowledge sharing platform.