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Citation Information

Type Working Paper
Title Factor immobility and regional effects of trade liberalization: Evidence from India
Author(s)
Publication (Day/Month/Year) 2004
URL http://sticerd.lse.ac.uk/dps/03122004/topalova.pdf
Abstract
Although there is a general presumption that trade liberalization results in higher GDP, much less is known about its effects on poverty and inequality. This paper uses the sharp trade liberalization in India in 1991, spurred to a large extent by external factors, to measure the causal impact of trade liberalization on poverty and inequality in districts in India. Variation in pre-liberalization industrial composition across districts in India and the variation in the degree of liberalization across industries allow for a difference-in-difference approach, establishing whether certain areas benefited more from, or bore a disproportionate share of the burden of liberalization. In rural districts where industries more exposed to liberalization were concentrated, poverty incidence and depth increased as a result of trade liberalization, a setback of about 15 percent of India's progress in poverty reduction over the 1990s. The findings are related to the extremely limited mobility of factors across regions and industries in India. Indeed, in Indian states where inflexible labor laws impeded factor reallocation, the adverse impact of liberalization on poverty was more pronounced. Moreover, while inequality was unaffected in the sample of all Indian states, in places with flexible labor laws, trade liberalization led to a rise in inequality. The findings, consistent with a specific factors model of trade, suggest that to minimize the social costs of inequality, additional policies may be needed to redistribute some of the gains of liberalization from winners to losers. Creating a flexible institutional environment will likely minimize the need for additional interventions.

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