Trade liberalisation with African socio-economic structures and imperfect markets

Recent research has demonstrated that the benefits of free trade tend go to better of countries that can produce more value added, while the poorest countries become producers of primary goods. Moreover, the poorest countries often suffer from distorted macroeconomic conditions as well as in many ways imperfectly functioning markets. It is suggested that factor markets represent a primary channel for trade policy transmission to social structures as well as poverty. The simulations show considerable changes in prices and use of primary factors following the implementation of new trade policy regimes in developing countries. Inside a country, even if the overall impact of trade liberalisation were positive, increased inequality results in little, if any, improvement to the poorest people. Dualism in the factor markets, characterised with large informal sector, combined with cruelly imperfect information can create structural rigidities that may prevent the gains from macro-policy interventions, such as trade liberalisation, to fully translate into poverty reduction. Unless the new trade policy regime is accompanied with other policy reforms, it can lead to aggravation of disequilibria. Thus, a central assumption in this paper is that the economic impact of a free trade agreement in a developing country greatly depends on its economic structures, in particular functioning of the labour market. The presence of dualism and the existence of an exogenous downward rigidity of the wage of some labour categories are peculiar characteristics to many developing countries. Typically, a substantial part of the population is in informal sector where the salaries are often infinitesimal. When the assumption of perfect functioning of labour market is relaxed, the gains from a macro-level policy change can be significantly reduced. The factor market effects are demonstrated by case studies, which include simulations of possible future trade liberalisation or regional integration regimes in three countries in Sub-Saharan Africa, using the GTAP model. Possible changes in production structure due to the new policy regimes can be anticipated by studying the industry specific simulation results. The paper then looks into the underlying structural phenomena and market imperfections in order to identify the eventual inadequacies in the simulation results on one hand, and possible policy alternatives to improve the poverty reduction impacts on the other hand. Simulations show that the relative demand for unskilled labour to skilled raises, and production shifts from industrial sectors towards agricultural goods and raw materials. While this can increase the share of formal sector in agricultural production as paid labour is required for production growth, it can also sharpen the inequalities as the number of workers in sectors with higher value-added decreases, thus creating a small group of rich people and a large working class earning very little. This is because the results tend to be driven by increased exports of processed goods from developed countries. If this increase is very big, it may effectively make Africa a destination of those commodities produced in developed world that cannot be sold elsewhere, which would deteriorate the Africa’s capacity to provide itself of the production of these commodities.