Trading Up

New research suggests access to high-income export markets could raise productivity and profitability for businesses across the developing world

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Based on research by David Atkin, Amit Khandelwal, and Adam Osman

The Egyptian town of Fowa, long overshadowed by its more famous neighbor, Rosetta — site of the discovery of the Rosetta Stone — could soon emerge as an unlikely battleground for economists across the world. A new study centered on Fowa’s historic rug industry provides some of the first hard evidence of the benefits of foreign trade in developing countries. In a randomized control trial, Amit Khandelwal has documented a 20 percent rise in profits for rug manufacturers who gained access to export markets, along with substantial gains in quality and productivity.

Trade has been a centerpiece of global development policy for decades. International financial institutions, including the World Trade Organization (WTO) and International Monetary Fund (IMF), have long argued that by focusing on exports, firms in developing countries can improve profits, contribute to faster economic growth, and, consequently, reduce poverty. In 2010 alone, the WTO organized commitments of $48 billion globally for “aid-for-trade” initiatives, programs designed to reduce barriers to trade in developing countries and draw them into the global economy. These policies have further been widely embraced in the developing world, despite a lack of hard evidence for their efficacy.

In order to study the effects of such programs, Khandelwal and his collaborators settled on Fowa, a small semi-urban town in northern Egypt, as the setting for the experiment. With a per-capita income of just $3,600, roughly half that of the national average, and only 65,000 residents, Fowa resembles thousands of small towns across the developing world whose economies are dominated by small-scale, often home-based, industries.

Fowa became a center of the Egyptian wool trade in the nineteenth century, emerging as a major producer of rugs and carpets in the early twentieth century under the British, who introduced technological innovations like the foot-treadle loom, which continues to dominate the local industry. Of the several hundred carpet manufacturers in Fowa, Khandelwal and his colleagues selected a subset of firms at random, providing them with the opportunity to export their products to buyers in the high-income economies of Western Europe and North America. After they began producing for export, their performance was measured and contrasted with that of other local firms that lacked access to these high-income markets.

Surprisingly, over the course of the experiment, firms that manufactured for export decreased their output, making significantly fewer carpets than control firms. All of the carpets, however, were of substantially higher quality than those of their counterparts, allowing these firms to command higher prices and driving up net profits by 15 to 20 percent across manufacturers.

While it may seem counterintuitive, one part of the explanation is fairly straightforward. “These producers probably knew that they could make much higher-quality rugs anyway,” Khandelwal explains, “it’s just that it wasn’t rewarded in the market.” By exporting, he continues, they were “exposed to a different set of buyers, high-end buyers, for whom quality matters,” making it profitable for them to create higher-quality carpets, despite limited local demand for such products.

This passive quality upgrading only explains part of the study’s results, however. Through interactions with local intermediaries and foreign commercial buyers, manufacturers learned not only higher standards of quality, but also the techniques necessary to produce them. Ultimately, firms that engaged with international markets produced finer goods across 11 different measures of quality than manufacturers who lacked access to international markets, even when producing exclusively for the domestic market in a controlled setting.

For policymakers in emerging economies that have pushed export-oriented growth policies and aid-for-trade initiatives at the international level, Khandelwal’s experiment provides robust evidence to support their push for greater openness in the global economy. That trade is a tool for development may no longer be an ideologically driven position, but rather, as Fowa has shown, a simple truth.

About the researcher

Amit Khandelwal

Professor Khandelwal teaches an elective course on International Business. His research interests examine issues in international and development economics, including the strategic response of...

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