Aid for trade, labor market flexibility with implication for Korea

Abstract

Purpose

The existing literature on aid for trade (AfT) tends to support the effectiveness of AfT in improving trade capacities and enhancing the export performance of recipient countries. While aid directed at trade-related infrastructure (e.g. ports and roads) is reported to drive the overall effect of AfT, the increasing importance of labor market flexibility and informal labor in export environment has been largely overlooked. The purpose of this paper is to test two hypotheses regarding the relationship between labor market flexibility, exports and AfT. First, flexible labor regulation promotes exports by reducing adjustment costs related to the export process. Second, for informal labor-intensive export sectors, AfT effectiveness may be compromised by the contraction of the informal sector due to labor deregulation as it deteriorates comparative advantage that supports recipients’ export competitiveness.

Design/methodology/approach

Since first introduced by Tinbergen (1962), the gravity model has been widely used to analyze bilateral trade, and its usefulness has been verified in several prominent empirical studies (e.g. Anderson and van Wincoop, 2003; Helpman et al., 2008). However, despite the empirically successful framework of the gravity model, the standard gravity equation may not be appropriate for estimating the effect of AfT in the paper. The main interest lies in whether aggregate AfT flows enhance the export “performance” of individual recipients, that is, whether they improve the recipients’ total exports rather than their bilateral exports. For this purpose, the authors took aggregated approach to the gravity model from Anderson and van Wincoop (2003).

Findings

The findings suggest that while both AfT and labor market flexibility are positively associated with higher export levels, the export-promoting effect of AfT is marginally reduced by the contraction of informal workforce. These findings, however, only hold for export sectors that heavily rely on informal labor force, that is, primary commodities and resource/labor-intensive goods. The authors also find that these effects are stronger in low-income countries, indicating that the AfT initiative has been effective where it is needed the most.

Originality/value

This paper is the first attempt to analyze the relationship between AfT and exports with consideration of labor market flexibility. Using the data for 85 recipient countries, the authors test the following hypotheses. First, labor market flexibility promotes exports by reducing adjustment costs related to the exporting process. Second, the contraction of the informal sector due to labor deregulation deteriorates developing countries’ comparative advantage in certain export sectors. Hence, while both AfT and labor market flexibility are expected to enhance the export volume of developing countries, the loss from weaker comparative advantage in a form of smaller informal labor force can exceed the gains from AfT in certain sectors.

Citation

Lee, H. and Park, M. (2018), "Aid for trade, labor market flexibility with implication for Korea", Journal of Korea Trade, Vol. 22 No. 2, pp. 121-142. https://doi.org/10.1108/JKT-01-2018-0002