International trade has been a big driver of economic development and regional integration in East Asia.  But we still have a long way to achieve meaningful "inclusive growth".

The past two decades have seen a dramatic rise in trade between the dynamic, emerging economies of Asia, and the advanced OECD countries.  This trade has contributed to prosperity for all the nations involved.  But the richer, higher-skilled members of most of our societies have gained much more than the poorer, lower skilled members.  The social and political strains of this inequality are starting to show in many countries.

"Inclusive growth" is an important goal as highlighted by the Asian Development Bank.  It is all about the creation of and equal access to opportunities for our citizens.  An inclusive growth strategy should have two pillars, that is, high and sustainable growth to create productive and decent employment opportunities, and social inclusion to ensure equal access to opportunities

One way to look at trade and inclusive growth is through the lens of Professor Richard Baldwin's theory of the “Great Unbundlings”

As Baldwin argues, until mid-18th century, with exception of few cities, every region in every nation was quite similar, namely poor and agrarian.  Trade costs were prohibitive, both within and between nations.  In other words, each village’s consumption was “bundled” with its production, with very little leakage outside the village.

And then came the first unbundling.

Rapidly falling transportation costs (thanks to steamships, railways and the telegraph) enabled geographical separation (“unbundling”) of production and consumption.  Goods could then be produced in the most efficient place (a factory), then transported to consumers.  This meant that there was much greater trade both within countries, and between countries.

These factories could now achieve economies of scale and economies of agglomeration.  Innovation could take place thanks to mutual learning from the clustering of people together.  Each factory undertook all phases of production -- product design, component manufacture, assembly and marketing.

This first unbundling initially took place in Western Europe and the US in 19th century.  A second phase then occurred in East Asia from 1950s to 1980s with the rise of Japan and the Newly Industrialising Economies (NIEs) of Hong Kong, Korea, Singapore and Taiwan.

Massive migration from the countryside to urban centres was a characteristic of this first unbundling.  In the first phase, there was also large scale migration from the Old World to New World.  During the East Asian phase, international migration was much lower.

And next came the second unbundling.

From mid-1980s, rapidly falling transport, communication and coordination costs enabled the factory to be unbundled.  The different tasks like product design, component manufacture, assembly and marketing could now be undertaken in different factories, towns or even countries according to where it was cheapest and most efficient.

In this phase, countries no longer specialize in certain products or sector.  Rather, they specialized in "tasks", based on comparative advantage.  For example, broadly speaking, China specializes in many low value added, labour intensive assembly operations.  Japan specializes in high technology component manufacture and product design.  International trade and competition now takes place at level of tasks or workers, not firms or sectors.

The initial example of this first example was the production network between US and Mexico, and the so-called Maquiladora twin plants on either side of the border.  The second example is the establishment of manufacturing supply chains East Asia.

But it was not only the factory that was unbundled, the office was also unbundled.  Many back office functions could be outsourced to countries like India or the Philippines.  Offshorable jobs have four features:  IT intensity; output that is IT transmittable; tasks that are code-fiable; and little face-to-face interaction.  May be 20% of the US workforce is offshore-able.

And some research and development functions are also outsourced to other countries.  It sometimes pays to undertake R&D close to your market, where you can respond to local markets.  And many developing countries like China and India have highly qualified research capacities, with large numbers of engineers and scientists.

This means that many tasks or functions that were not previously exposed to international competition ("non-tradable") were suddenly exposed to international competitive pressures.  This meant that individual workers in different countries increasingly compete head-to-head, rather than firms or sectors.

Who are the winners and losers of these "great unbundlings"?

Imagine the case of China and the US, with China specializing in low-skill T-shirts and the US specializing in high-skill computers following the first unbundling.  Economic theory would tell us that American high-skill workers would benefit from the US's specialization in computers, whereas American low-skill workers might suffer in relative terms.  In China, theory would suggest the reverse.  As it specializes in low-skilled T-shorts, Chinese low-skilled workers would benefit, while high-skill workers would lose in relative terms.

So, there would be some convergence in the wages of low skilled workers in the US and China.  But low-skilled American workers would not see their wages fall to Chinese levels, as they would remain more productive than Chinese workers, thanks to high levels of capital investment and technology.

What is the evidence of the effects of the unbundlings in developing Asia?

One indicator of the first unbundling is the state of the rural-urban transition.  This has advanced in East Asia, but it still has a long way to go compared with the advanced countries.  Despite Asia’s mega-cities, it is least urbanized continent, except Africa.

Advanced countries are very highly urbanized, with Japan's urban population at 67% of total, Korea's at 82% and Australia's 89%.  In developing Asia, urban populations represent a much smaller share of total.  For example, China’s urban population 44% of the total, India's is 30%, Lao's is 32% in 2009, Pakistan's is 37%, Philippines' is 66%, and Thailand's is 36%.

So, there is still a long way to go for the first unbundling in terms of urbanization and rural-urban migration.

How far has East Asia advanced in the process of the second unbundling?

East Asia has advanced very much through the establishment of supply chains based on trade in tasks.  After 1985 Plaza Agreement to increase the value of the yen, Japan outsourced much of its labour intensive production stages to other East Asian countries.  A triangular trade pattern was established, as Japanese headquarters produced hi-tech parts, factories in East Asia undertook labour intensive production and assembly, and then shipped the products back to Western markets or Japan.

And as the NIEs climbed the development ladder, and experienced rising costs, they also offshored labour intensive production and assembly to countries like Indonesia, Malaysia, Thailand and then China.  The effect of this can be seen on WTO's list of world’s leading exporters.  China is world’s biggest exporter.  Overall, 10 Asian countries now in world top 30 exporters:  China, Japan, Korea, Hong Kong, Singapore, Taiwan, Malaysia, Thailand, India and Indonesia.

Trade in tasks has offered new developmental opportunities for poor “bottom billion” countries.  They can now integrate into the global economy by specializing in niche tasks.  For example, twenty years ago, Qiaotou in China was a village.  Today it produces two-thirds of the world’s buttons.

Have East Asia's citizens been benefiting from these great unbundlings?

Developing Asia has experienced massive income growth and poverty reduction.  For developing Asia as a whole, per capita GDP at 2000 constant prices increased from $424 to $1030 between 1990 and 2005, growing at an annual rate of 6%.

Absolute poverty reduction is dramatic:

In East Asia and the Pacific, the % living below $1.25 a day fell from 77.7% in 1981 to 16.8% in 2005.  [China – 84.0% to 15.9%]

In South Asia, the % living below $1.25 a day fallen from 59.4% in 1981 to 40.3% in 2005.  [India – 59.8% to 41.6%]

Overall, Asia is on track to meet the MDG target of reducing by half the proportion of people living on less than $1 a day.  But, it is unlikely to meet the goals of reducing non-income poverty, like the level of primary school age children and child mortality rates.

And in reality, large proportions of population still poor, based on $2.50 measure.

In East Asia and the Pacific, the % living below $2.50 a day fell from 95.4% in 1981 to 50.7% in 2005.  [China – 99.4% to 49.5%]

In South Asia, the % living below $2.50 a day fallen from 92.6% in 1981 to 84.4% in 2005.  [India – 92.5% to 85.7%]

And further, while rural poverty has declined significantly, urban poverty has been rising and growing slum populations.

And scratching further below the surface shows that inequality has been increasing in most developing Asia countries over the past decade, and that it is also set to continue.

There are many dimensions to this inequality, like regional inequality (coastal areas versus inland) and sectoral inequality (agriculture versus manufacturing).  And this is not just inequality in terms of income or expenditure, but also in terms of health status, and distribution of land.

According to the ADB, the following countries seen increased inequality over the past decade – Nepal, China, Cambodia, Sri Lanka, Bangladesh, Lao, India, Korea, Taiwan, Viet Nam, Turkmenistan, Azerbaijan, Tajikistan, Philippines, Pakistan.  There have been positive trends in Thailand, Armenia, Kazakhstan, Malaysia, Mongolia and Indonesia.

What has been the cause of this inequality?

Trade itself has not been a cause of inequality in developing Asia.  On the contrary, specializing in lower skilled manufactured exports should benefit low-skilled workers.  Technological change has tended to bias the demand for labour towards higher skilled workers in all of our countries.

But on top of that, in many countries government policies of promoting manufactured exports has favoured certain groups, sectors and regions, and contributed to inequality.  In China, for example, policies promoting manufactured export activities in the coastal areas, including through export processing zones, have left the inland, agricultural provinces at a disadvantage.

However, this is not a case of the rich getting richer and poor getting poorer.  Everyone is doing better, but rich are doing even better.  But increases in income gaps and very visible changes in consumption patterns and lifestyles of the rich are leading to a perceptible increase in social and political tensions, undermining social cohesion.

Inequalities can be socially and politically explosive.  Witness the recent political violence in Thailand, the suicides at the Foxconn factory in China and strike at Honda in China.

The working poor

Another way of looking at this issue is to examine the phenomenon of "working poor", notwithstanding developing Asia’s very high rate of employment and very low rate of unemployment.

Unemployment is very low, although youth unemployment is much higher – 4 1/2% in East Asia (youth 9%), 5 1/2% in South East Asia and the Pacific (youth 15%), and 5% in South Asia (youth 10%).  The proportion of the population with a job is also very high -- East Asia 70%, South East Asia and the Pacific 65%, and South Asia 55% (the world average is 60%).

But in reality, a major is underemployment and disguised unemployment.  People have to work (to do something) to survive, so they work.  According to the ILO, large numbers of Asians are " working poor".  Based on a poverty line of $1.25 a day, 16% of East Asian are working poor (34% based on a poverty line of $2 a day).  For South East Asia and the Pacific, the figures are 33% and 63%, while for South Asia the figures are 61% and 86%.

Another characteristic of developing Asian labour markets is the high degree of informal workers.  Close to 80% of workers in informal sector, and this figure has not declined over the last 15 years.  Informal enterprises do not follow regulations, do not pay taxes, do not obey social security regulations or pay minimum wages.  People work in the informal sector because no opportunities in formal sector.

The informal sector is also characterized by weak respect of the ILO's core labour rights, namely:

--                Freedom of association: workers are able to join trade unions that are independent of government and employer influence;

--                The right to collective bargaining: workers may negotiate with employers collectively, as opposed to individually;

--                The prohibition of all forms of forced labor: includes security from prison labor and slavery, and prevents workers from being forced to work under duress;

--                Elimination of the worst forms of child labor: implementing a minimum working age and certain working condition requirements for children;

--                Non-discrimination in employment : equal pay for equal work.

Overall, despite its rapid growth, developing Asia’s income gap with the developed world remains very wide.  Much noise is made today about the fact that China’s GDP is now overtaking Japan’s.  But China’s population is 10 times that of Japan, and its GDP per capita is 10%!

Another issue is human trafficking, the dark side of migration.  According to the United Nations, human trafficking involves an act of recruiting, transporting, transfering, harbouring or receiving a person through a use of force, coercion or other means, for the purpose of exploiting them.  Human trafficking can take many forms – forced labour, bonded labour, debt bondage among migrant labourers, involuntary domestic servitude, forced child labour, child soldiers, sex trafficking and child sex trafficking and related abuses.

Asia is a global hot spot for human trafficking.  Many Asian developing countries are classified by the US state department as major problem cases as either sending or destination countries – Bangladesh, Burma, Cambodia, China, India, Malaysia, Pakistan, Philippines.

Policy implications -- what should developing Asia governments do?

According to their capacities, governments should:

--                expand human capabilities to participate in new opportunities by investing in education, health and other social services like water and sanitation.

--                promote good policy and sound institutions to advance social and economic justice and level playing fields.

--                create social safety nets to prevent extreme deprivation.

How have developed country workers been affected by these great unbundlings?

As suggested by theory, growing international trade with developing Asia has seen a decline in the relative demand for lower skilled workers.  In Anglo-Saxon countries and Japan, their wages have stagnated or even declined in real terms, while in continental Europe they have borne the brunt of unemployment.  By contrast, higher income workers have seen their earnings grow.  Thus most advanced countries have also seen a widening in the gap between rich and poor.

Empirical analysis indicates however that the main cause these widening income gaps is not international trade, but rather technological change which has increased the demand for high skill workers who are necessary to work with such technology.  In addition, tax policy changes is some countries have clearly favoured rich people more than poor people.

But while skills matter, some highly skilled previously non-tradable tasks (like IT) can now be offshored.  And some lower skill tasks (taxi driver) can not be offshored.

Overall, we see the progressive emergence of a global labour market whereby workers, skilled and unskilled are competing head-to-head.

But this is not a race to the bottom.  As China and India continue to develop, the growing demand for their labour will see wages rise and exchange rates appreciate.

Policy implications for advanced countries

In the short term, the most effective way of dealing with income disparities is by providing tax relief to poorer people, and by strengthening social safety nets.  Over the longer term, education is the most effective means ensuring that workers will enjoy demand for their services.

Overall, the history of economic development has been one of climbing a development ladder.  The only way to not fall back or be overtaken by others, is to keep climbing that ladder by continual investments in human, social, technological and physical capital.

References:

Asian Development Bank.  “Inclusive Growth toward a Prosperous Asia: Policy Implications”,

Ifzal Ali and Juzhong Zhuang.  July 2007

http://www.adb.org/Documents/ERD/Working_Papers/WP097.pdf

Asian Development Bank.  Key Indicators 2007.

Special Chapter, “Inequality in Asia”.

http://www.adb.org/Documents/books/key_indicators/2007/pdf/Inequality-in-Asia-Highlights.pdf

Baldwin, Richard, Graduate Institute of International Studies, Geneva Globalisation: the great unbundling(s),

http://hei.unige.ch/~baldwin/PapersBooks/Unbundling_Baldwin_06-09-20.pdf

International Labour Office.

Global Employment Trends.  January 2010.

http://www.ilo.org/wcmsp5/groups/public/---ed_emp/---emp_elm/---trends/documents/publication/wcms_120471.pdf

International Labour Office.

Realising Decent Work in Asia.

http://www.oit.org/wcmsp5/groups/public/---dgreports/---dcomm/---webdev/documents/publication/wcms_071313.pdf

Urban Poverty and the Working Poor, UNESCAP

http://www.unescap.org/pdd/CPR/CPR2007/English/CPR4_4E.pdf

UNESCAP 2009 Population Data Sheet

http://www.unescap.org/esid/psis/population/

United Nations Industrial Development Organisation.

Industrial Development Report 2009.

Breaking In And Moving Up: New Industrial Challenges for the Bottom Billion and the Middle Income Countries

http://www.unido.org/fileadmin/user_media/Publications/IDR/2009/IDR_2009_print.PDF

World Bank.  World Development Report 2009 : Reshaping Economic Geography.

http://econ.worldbank.org/external

World Bank.  Global Economic Prospects 2007,

Managing the Next Wave of Globalization.

http://econ.worldbank.org

World Bank, Migration and Development Brief 12.

Outlook for Remittance Flows 2010-11

http://siteresources.worldbank.org

World Bank Policy Research Working Paper 4703, August 2008

The Developing World Is Poorer Than We Thought, But No Less Successful in the Fight Against Poverty,

Shaohua Chen and Martin Ravallion.

http://econ.worldbank.org