Industrial development and economic growth: Implications for poverty reduction and income

4. Impact of industrialization and trade on the poor
Industrialization is often essential for economic growth, and for long-run
poverty reduction. The pattern of industrialization, however, impacts
remarkably on how the poor benefit from growth. Pro-poor economic and
industrial policies focus on increasing the economic returns to the produc-
tive factors that the poor possess, e.g. raising returns to unskilled labour,
whereas policies promoting higher returns to capital and land tend to
increase inequality, unless they also include changes in existing patterns of
concentration of physical and human capital and of land ownership. Use of
capital-intensive methods instead of labour-intensive ones tends to increase
income disparities, as does the employment of skill-biased technologies, espe-
cially where the level of education is low and human capital concentrated.
Also, the location of industrial facilities has an impact on overall poverty
reduction and inequality. As enterprises are often concentrated in urban areas
– because of ready access to skilled labour force, better infrastructure, larger
markets and technological spillovers (e.g. Lanjouw and Lanjouw, 2001),
industrialization may increase inequality between urban and rural areas.
Promoting development of rural non-agricultural activities, like production
in small and medium-sized enterprises (SMEs), may decrease this disparity. 
The degree of economic openness of a country can have an important
influence on its pattern of specialization and industrialization. If countries
are open to trade they should, according to Heckscher-Ohlin theory, special-

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ize in the production of commodities in which they have a comparative
advantage. In labour-abundant countries, trade liberalization would tend to
shift production from capital-intensive import substitutes towards labour-
intensive exportables. Due to this change, domestic inequality in those coun-
tries is expected to decline because of the increased demand for labour,
whereas inequality would increase in countries with an abundant endow-
ment of capital. Liberalization of foreign direct investment can also decrease
inequality in capital-importing countries, but that depends in part on the
degree of skill-bias of technologies employed by foreign invested firms. 
In several countries, trade and investment liberalization has, indeed,
decreased absolute poverty and sometimes also inequality. Bourguignon and
Morrison (1990), for example, analyze the determinants of inequality in 35
developing countries and conclude that the phased removal of trade protec-
tion in manufacturing reduces the income of the richest 20 per cent of the
population and increases the income of the poorest 60 per cent. Dollar and
Kraay (2004), who examined impacts of increased trade on growth and
inequality, found changes in growth rates to be highly correlated with
changes in trade volumes. No systematic relationship between changes in
trade volumes and changes in household income inequality was found, and
they conclude that on average greater globalization is a force for poverty
reduction. Still, the impact of trade liberalization is likely to vary between
countries, depending for instance on factor endowments, and liberalization
creates both winners and losers. Similarly to international trade, the impact
of foreign direct investments on income inequality is likely to vary between
countries. Any foreign direct investment (FDI)-inequality relation depends
e.g. on the sectoral composition of FDI, its impact on demand for unskilled
workers, the skill bias of technical change induced through FDI, and the
regional distribution of FDI (see e.g. Cornia, 2005).