# Trade Policy And Poverty In Peru How Do Free Trade Agreements (Fta) Impact Rural Poverty?

## Introduction

The lin k between trade li beralisation  and economic growth does not appear to be conclusive. For some authors, li beralisation favours economic growth, while  others indicate that it is an export-le d strategy, rather than the elimination  of trade barriers for imports, that promotes economic growth.

To understand the relation between international trade and poverty in 

## 1.

Evidence from Peru shows that the FTA with the US could produce a Peru, it is fundamental to explore how trade impacts on agricultural activities since most of the poor depend on them to sustain their livelihoods.

2.

In Peru, given that the great majority of the poor depend directly or indirectly on agricult ural and farming activities in order to sustain themselves, in order to evaluate the impact of international trade on poverty we need to examine how trade influences these activities. What is the effect of trade li beralisation  on the agricult ural and farming sectors in Peru? The answer to this question is comple x, because in our countries tradable  agricult ural and farming goods, that is, products for export or for the substitution of imports, coexist with non-tradable  goods, or products that are exclusively for the domestic market and do not compete directly with imports. 

An increase in rural poverty will have collateral effects as the deterioration financial gain of US$ 575 millions in urban Peru, but losses of US$ 158 in rural Peru. This situation highlights the need for pro-poor complementary policies that can secure the livelihoods of the poor.

3.

Meanwhile , glo ball y, the unilateral  international trade li beralisation  in the 1980s and the beginning of the 1990s has been replace d by free trade agreements between two or more countries. In the case of our country, a free trade agreement (FTA) has been signed with our principal trading partner, the United States of America. Do traditional trade policies , which constitute unilateral li beralisation  to facilitate  imports from the rest of the world, and new trade policies , based on bilateral  agreements, contribute to the development  of the agricult ural and farming sector, and, thus, to poverty reduction?

The establishment of specific product subsidies is not convenient to tackle the of family expenditure in education, while also a massive school drop out that will push children and adolescents to engage in economic activities. Access to health services may also be affected.

4.

potential negative impacts of the FTA in Peru. A better policy option would be that conditionalcash transfers programs –as Juntos- focus their actions in generating economic opportunities for the poor affected by the FTA.

«The experiences of East Asia 
and, recently, China have 
framed the discussion: is it 
the insertion in international 
markets through exports, 
rather than opening up 
to imports, that favours 
economic growth? »

The objective of this article  is to answer this question. In the follo wing section, I will  present a recent analysis that connects trade polic y and poverty, at the international le vel. In section 2, the same issue is discussed, but in the Peruvian case. In section 3, I will  review Peru's FTA with the United States and its implications  for poverty. Finall y, section 4 will  present some conclusions and implications  for economic polic y.

## 1. Trade Policy And Poverty: International Evidence

The lin k between trade li beralisation  and economic growth is far from clear 2. According to one school of thought3, trade li beralisation  favours economic growth. According to these authors, the countries that are the most open to international trade grow more than those that are less  open (open countries converge more rapidly to the le vel of develope d countries). In this way, the poverty reduction observed in recent decades, economic growth, and the increasing glo balisation  of trade would be considered to be aspects of the same phenomenon. However, there are other economists who are less convinced of the benefits of international trade. Authors such as Rodrik (1995) and Stiglit z (2006), among others, caution that the relationship  found between trade li beralisation  and growth could be spurious, due to the difficult y of establishin g an exogenous indicator of trade li beralisation . Moreover, these authors claim that it is export-le d strategies, not the elimination  of trade barriers, that act as the motor for growth. The notable  growth of the Chinese economy over the past few decades contributes to the strength of this analysis4. The experiences of East Asia and, recently, China have framed the discussion: is it the insertion in international markets through exports, rather than opening up to imports, that favours economic growth? The economic growth in China of the past 20 years has certainly contributed to an important degree to 400 million people  rising out of poverty.

Trade polic y, thus, under certain conditions, can contribute to economic growth. And what does the international experience tell  us about the lin ks between economic growth and poverty reduction? According to Mendoza and García (2006), at the international le vel, the positive relationship  between macroeconomic performance, as measured by GDP, and poverty, as the percentage of the population whose le vels  of consumption or income do not reach the cost of the basic basket of goods to satisfy their needs, is evident. According to Dollar
 
and Kraay (2001), economic growth is fundamental for permanent poverty reduction. The Chinese experience of notable  poverty reduction, as depicted by Sachs (2006), is another convincing example  of the importance of economic growth. Finall y, according to Sala -i-Martin (2007), over the past three decades, glo bal economic growth has accelerate d and poverty rates have been reduced to about two-thirds of prior le vels .

## 2. Trade Policy And Poverty: The Peruvian Case

Trade polic y in Peru has been determined by essentiall y macroeconomic needs, that is, to open the economy to international trade, correct external disequili bria or increase protections for local  industry, and not for its probable  effect, in one way or another, on poverty and inequalit y.5 The government of Velasco  Alvarado (1968-1975) deepened the import substitution model inherited by his administration, by imposing considerable tariffs and a bundle  of non-tariff measures, including the prohibition of a lar ge group of imports and the requirement of licenses  to import certain goods.

Towards the end of the 1970s, the turn towards greater trade li beralisation  began, with the elimination  
of the National Registry of Manufacturing, the dismantlin g of exchange controls  and the reduction of the average tariff rate to approximately 40% in 
1979, which was interrupted by the debt crisis and international recession. These events forced the government to increase the average tariff rate, and, with the election  of García in 1985, revive prohibitions, licensin g regimes and differentiated exchange rates. This development  model that emphasised the domestic market was eliminate d in the beginning of the 1990s, during the Fujimori administration, through one of the most radical li beral reform movements of Latin America. Between 1990 and 1991, the dominant trade structure was demolishe d, tariff rates were drasticall y reduced, quantitative controls  on imports were eliminate d, and almost  all  non-tariff restrictions as well  as the differentiated exchange rate system were repeale d6. Given that the vast majority of the poor in Peru directly or indirectly depend on agricult ural and farming activities for their survival, it is appropriate to focus attention on this sector in order to assess the effects of international trade on poverty. What is the effect of trade li beralisation , understood as a unilateral  tariff reduction, on the agricult ural and farming sector in Peru? The answer to this question is comple x7, because, in Peru, there are many agricult ural and farming sectors.

In aggregate terms, one can distinguish between two types of agricult ural and farming activities. The tradable  agricult ural and farming activities, whether exportable  or importable , where prices are determined by international prices, the exchange rate, and by 

«Given that the vast majority 
of the poor in Peru directly 
or indirectly depend on 
agricultural and farming 
activities for their survival, 
it is appropriate to focus 
attention on this sector in 
order to assess the effects 
of international trade on 
poverty.»

«The price reduction of 
importable goods causes a 
drop in the demand for non-
tradable agricultural and 
farming goods, depressing 
their prices and affecting the 
income of producers of non-
tradable agricultural goods»

tariffs and subsidies, and an excess of supply or 
demand are faced with more imports or exports, and 
non-tradable  agricult ural and farming activities, that 
are produced exclusively for the domestic market and 
that do not face foreign competition, where supply 
is given in the short term and prices are flexible  and 
adjusted based on the excess of supply or demand.

In this framework of general equili brium, tariff 
reduction for imported goods does not only affect 
price parity of imports and exports, but also  distinct 
functions of supply and demand of non-tradable  
agricult ural goods.

A reduction in tariffs can cause a decrease, in the 
first place , in the price of importable  agricult ural and 
farming goods, which would benefit consumers, by 
lo wering prices for those that have access to markets; 
but it would harm the producers of importable  goods, 
by reducing income from sales  of these producers. 
Given that agricult ural and farming tradable  goods 
are substituted by non-tradable  agricult ural and 
farming goods (Hopkins, 1994), the price reduction 
of importable  goods causes a drop in the demand 
for non-tradable  agricult ural and farming goods, 
depressing their prices and affecting the income of 
producers of non-tradable  agricult ural goods. 

In this way, trade li beralisation  can harm not only 
producers of agricult ural and farming goods for 
import, but also  producers of non-tradable  goods.

Thus, the beneficiaries of import li beralisation  would 
be agricult ural and farming exporters, because 
li beralisation  can cause a drop in the price of their 
imported inputs for the productive process.

«As the income of rural 
households drop, school 
attendance could be 
negatively impacted by 
the combined effect of 
a reduction in education 
spending and increased 
truancy, due to the need for 
children to generate income 
to help support the family.»

## 3. The Free Trade Agreement With The United States And Poverty

Over the past few years, the unilateral  li beralisation  for international trade of the 1980s and the beginning of the 1990s has been replace d by free trade agreements between two or more countries. According to Sala -i-Martin (2007), currently, 40% of world trade is supported by free trade agreements; there are approximately 200 free trade agreements in operation and another 60 under negotiations. Peru has signed a free trade agreement (FTA) with its principal trade partner, the United States. The FTA constitutes the deepening of a process of trade li beralisation  which has been underway in Peru since 1990. Subsequently, the Andean Trade Preferential Act (ATPA) was signed in 1991 and the Program for Andean Trade and the Andean Trade Programme and Drug Eradication Act (ATPDEA) was signed in 2002. With this treaty8, our country, rather than promoting a permanent extension of the ATPDEA and a gradual reduction, over a period of up to 17 years, of the majority of tariffs for those Peruvian agricult ural and farming products considered sensitive, has offered concessions by diminishing import tariffs for American products. The treaty also  accepts that the United States will  maintain unaltere d non-tariff restrictions for Peruvian products and authorises the protection of test data for pharmaceutical and chemical products.

What is the probable  effect of this group of agreements on the agricult ural and farming sector and on poverty? Some analysts sustain that the FTA will  provoke a greater drop in prices of the basic products of the food basket, massively subsidised by the U.S., such as grains, milk, oil products, sugar and fibres and, as a result , will  depress the prices of goods produced in traditional agricult ure9. Furthermore, since the FTA requires the dismantlin g of the free price zone system, the prices of products such as rice, sugar, milk, and, to a lesser  degree, yello w corn, will  be reduced, aggravating the situation for agricult ural producers of these import goods. Because the non-tradable  agricult ural and farming goods are, in general, substitutions for tradable  goods, the prices of these non-tradable  products, widely produced in the South Sierra, such as potatoes, barle y, and white amilaceo  maize will  also  be reduced. In this way, the terms of trade for importable  and non-tradable  agricult ural goods would deteriorate. The new agreement will  li kely benefit agricult ural exporters, due to the opening of the American market for their products and the decrease in tariffs of some imported inputs. In a similar  vein, Escobal and Ponce (2006) affirm that the effects of the FTA in the short term could be fairly heterogeneous among geographic areas and population  groups with different characteristics. A simulation  exercise indicated that the FTA would produce profits of around US$ 575 million in urban Peru, but losses  of US$ 158 million in rural Peru.

The increase in rural poverty would have several collateral  effects. As the income of rural households drop, school attendance could be negatively impacted by the combined effect of a reduction in education spending and increased truancy, due to the need for children to generate income to help  support the family. The other effect of the reduction of income in rural areas is the impact that it will  have on health  in rural populations , by affecting the capacity of the poor to access health  services.

## 4. Conclusions And Implications For Economic Policy

What are the effects of trade polic y on economic growth? International trade favours economic growth when the emphasis is place d on exports, before the unilateral  reduction of tariffs.

And what is the relationship  between economic growth and poverty? In the literat ure reviewed here, the relationship  between economic growth and poverty is indeed soli d; all  economies that have managed to significantly reduce poverty have also exhibited sustained growth, through international trade or by other means. And what is the lin k between trade polic y and poverty? Given that the great majority of the poor in Peru depends directly or indirectly on agricult ural and farming activities for their survival, in order to understand the lin k between trade polic y and poverty in Peru, we must first analyse the relationship  between trade polic y and the agricult ural and farming sector. When trade polic y constitutes an opening for imports, rural poverty can be aggravated. What would be the effects of the FTA with the U.S. on poverty? The official government claim is that the FTA is essentiall y an opening of the North American market for Peruvian products. However, the FTA is not only an opening of the North American market for Peruvian products. The opening of the North American market was achieved with the ATPDEA. The number of additional items that were not present under the ATPDEA and that were consoli dated under the FTA is rather limite d. As a result , apart This document has been produced as part of "Trade and Poverty in Latin America" (COPLA), project implemented in Peru by the Economic and Social Research Consortium (CIES). COPLA is financed by the Department for International Development (DFID) through the Overseas Development Institute (ODI) and is also implemented in Bolivia and Nicaragua. COPLA aims at strengthening evidence-informed policy dialogue on trade, poverty and social exclusion in Latin America. For further information please visit: www.cop-la.net from the fact that the FTA soli dified the opening of the North American market, which was transitory with the ATPDEA, the FTA is, essentiall y, an opening for American imports, with negative consequences for the producers of non-tradable  agricult ural and farming goods. As a result , there should be special attention paid to the study of compensatory policies  for those who are conceptualise d as the "losers " of the FTA. The study of the Mexican and Chilean experiences could be very useful in this regard. As Grade cautions (2006) in a critique of the Mexican program to compensate producers of wheat, corn and cotton who could be affected by the FTA with the U.S., the fact that compensation was directed towards specific products, and not towards all the producers, generated an unforeseen and undesirable  consequence, because it provided incentives to produce less  profitable  agricult ural goods, despite having expanded markets for much more profitable  goods. Under these conditions, the recommended solution is for programs of conditional monetary transfers, in order to create a social support network for vulnera ble  populations  in the rural sector. Social protection programs such as JUNTOS could be expanded and should concentrate on promoting opportunities and economic capabilities  for those affected by the FTA. u

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