Executive Summary

The main purpose of this paper is to use a “generic” computable general equilibrium model in order to understand the poverty reduction impact of trade liberalization policies in South Asia. Understanding the impacts of trade liberalization policies in South Asia on poverty is important because of the vulnerability of the poor as a group in developing economies in general and in South Asia in particular.

There are at least two aspects of any poverty impact analysis for a particular policy. These are: i) the impact on economic growth; ii) the impact on income and asset distribution. The growth effect on poverty reduction is then given by some estimated growth-poverty elasticity. In the second case, a more (less) favorable income/asset distribution for the poor may reduce (increase) poverty. A distributional neutrality assumption in a model simply allows one to look at the growth aspect by itself. Here, too, different sectoral growth rates and different sectors themselves may affect poverty differently.

The paper is structured in such a way that the connection between the basic policy issues and the particular modeling approaches can be discussed in a transparent manner. It begins with a discussion of the general macroeconomic policy issues arising out of program lending and their relevance to the poverty reduction strategy in the "post-Washington consensus" policy environment. This raises some relevant questions regarding the measurement of poverty and the nature of macroeconomic environment in the developing economies. Consequently, it becomes necessary to discuss these measurement issues in the context of particular environments in South Asian economies. Thus the measurement aspects of poverty are followed up by a discussion of some pertinent issues regarding the generic structure of macro-models for South Asian economies. A concrete discussion of reforms, in particular, trade liberalization in South Asia is taken up next.After this section, the question of what is the relevant class of CGE models for an analysis of trade liberalization and poverty in South Asia is addressed in section 6. Specifically, this section explores the questions related to income distribution and poverty in CGE models for South Asian developing economies. In the penultimate section (section 7), I discuss the structure of what has been termed the "dual-dual" model. Results from a modified "dual-dual" model using largely a data set from India are presented and discussed.

Within this particular CGE model, the policy experiments show that in this region, trade liberalization can lead to further poverty reduction. This is true at both the national level and at the level of the various household groups. This is indeed good news that conforms to the general prediction of the standard comparative advantage based trade theory.

Under the assumptions of the model, the results show that in general, both the extent and depth of poverty decline for each household group. The largest headcount ratio drop is recorded for the rural unskilled group. Poverty severity also falls for each household group with the exception of the urban unskilled workers. But when the tariff rates fall from 15 to 12 percent, this group benefits as well. In general though, much of the poverty reduction impact of trade liberalization can be reaped earlier. Further reductions leading to a rate below 10 per cent may not have much more of an impact than earlier tariff reductions. One surprise, however, is the largely nonlinear impact of tariff reductions on poverty. There seems to be a big jump nationally when the tariff rate is finally reduced to a low range of 15 to 18 percent.. However, there is very little change for even lower rates, for example, From 15% to 12%.Given the stylized nature of the exercise, no magical properties need to be attributed to these particular numbers. The general lesson is that tariff reduction will ultimately benefit the poor; but the trickling down process is uneven and may require some time to work through the socio-economic system.

The extent of poverty reduction impact of trade liberalization turns out to be limited. There are several reasons for this. The main reason is that the Harris-Todaro mechanism allows reverse migration to lower paid jobs for the potentially unemployed as protection is removed. Furthermore, the impact of further tariff reductions becomes attenuated for most groups when the tariff levels are lowered sufficiently. On the whole, the high tariff barriers should be dismantled, but beyond a certain point---say about 15 per cent average tariff rate--- the further impacts become negligible.

Several policy conclusions can be reached regarding poverty reduction strategies in South Asia in light of the findings here. Trade liberalization certainly does not conflict with poverty reduction and hence can be pursued without fearing adverse poverty impact. However, the approach may need to be a firm but gradual liberalization with special sensitivity to agriculture and the rural poor. It should also be kept in mind that trade liberalization can certainly help reduce poverty, but by itself it may not be the magic bullet against poverty. The actual poverty reduction impact in South Asia is most likely to remain small for this policy instrument. Hence other growth enhancing reforms need to be pursued simultaneously.

Furthermore, targeted poverty reduction programs may also be needed with emphasis on increasing the efficiency of targeting and improving their cost-effectiveness.Programs such as food-for–work and other employment schemes,microfinance, agricultural credit etc. need to be pursued with a focus on making them more effective in terms of reaching the targeted groups at minimum cost to the programs. Rural industrialization and increase in productivity through investment in social sectors and human capital also remain viable policy options. In terms of Sen’s capabilities approach, the capabilities of the poor--- particularly their basic functionings--- need to be enhanced so that they can better participate in income earning activities. Some of these policy areas are related to trade, but many are not .This paper does not analyze these further policy issues that are not related to trade directly but the need to use existing works along these lines and to continue doing careful research in the South Asian context in particular is apparent.

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