Volume 43 | Number 3

Making Trade Liberalization Work for the Poor: Trade Law and the Informal Economy in Colombia

by Kevin J. Fandl

Summary

1. Introduction
   1. Why This Study Was Undertaken
   2. Approach to This Study
2. The Informal Economy
   1. The Informal Economy in Colombia
3. International Trade Law in Colombia
   1. Historical Perspective
   2. Economic Openness in Colombia
   3. Existing Inequality in Latin America
4. Linkages Between Liberalization and Informality
   1. Trade Liberalization and the Informal Sector
5. Recommendations


6. Conclusions

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I. Introduction

The liberalization of domestic markets around the world to facilitate the transfer of goods and services across borders has been unprecedented in recent decades.  The vast majority of developed and developing countries have lowered trade barriers, reduced restrictions on investment, and taken other important steps toward the goal of full and open trade with their global partners.  Yet as the pace of this liberalization increases, it is imperative that we examine the effects this process has on the people living in the liberalizing countries.  Rather than associating trade liberalization with the movement of goods and services alone, we must also consider the effects of these economic changes on the population enduring such changes.

Linkages between trade liberalization and poverty are certainly not a new concern.  Development economists and policymakers, among others, have long considered the impact of trade policy on the everyday lives of citizens.  Theories abound regarding the potential benefits and negative externalities associated with liberalization such that one could just as easily produce a well-reasoned argument in support of liberalization as one against it.  In this Article, however, I will attempt to address a concern often overlooked by economists and policymakers alike, a concern that involves the potential collision of two speeding trains:  the continuing expansion of trade liberalization and the growing informal economy in developing countries.

I selected Colombia as the case in point for this Article based on its outward orientation in trade liberalization coupled with its large and growing informal economy.  Colombia has made substantial efforts in recent years to liberalize its economy and open its borders to international trade.  While aggregate income in Colombia has grown in conjunction with its trade expansion, this growth has not created a corresponding reduction in poverty.  The regional director of the United Nations Development Programme found that existing inequality is one of the reasons that increasing wealth is becoming less effective in fighting poverty in the region.¹ Conversely, poverty is associated with unemployment as well as with underemployment—that is, employment primarily in the informal economy.

This is a qualitative study of the working conditions and income of informal workers in Colombia examined through the lens of legal change in the area of trade liberalization.  I will begin by describing the informal economy in general and its composition in Colombia, and by showing the importance of this portion of the economy in fostering economic growth and development.  I will go on to describe the changes in Colombian laws that have facilitated trade liberalization and opened the country to international commerce.  Finally, I will illustrate the relationship between the opening of the Colombian economy to external trade and the size and income of the informal sector in Colombia.

All of the data used in this study was collected either from agencies and organizations working in Colombia, or directly as a result of my investigation while there as a Fulbright scholar.  Where possible, distinctions have been made between state-gathered statistics and international organization data.  My research team and I collected this data between August 2006 and June 2007.

A. Why This Study Was Undertaken

Trade liberalization has a positive role to play in raising the income of the poor in developing countries.  Open trade has, albeit with several important caveats, reduced poverty in many countries.  In Colombia, however, liberalization has not had the same positive effects on poverty reduction as anticipated.  This study begins from that point and asks why the outward orientation of the Colombian economy brought economic growth without equivalent reductions in poverty and inequality.

Many developing countries are at a relative disadvantage to industrialized countries in the process of liberalizing trade.  For instance, implementing changes in the law with the type of adherence evident in developed countries is often impossible in developing countries.  Failure to enforce existing laws and a lack of respect for the judiciary can make necessary legal changes a challenge to implement.  Additionally, internal structures which exist to facilitate increases in trade resulting from more open policies are less common in developing than in developed countries.  Such structures include effective ports and customs services, adequate highway and internal transportation systems, and streamlined administrative procedures.  Without such essential components in place, developing countries face hurdles to reach the anticipated benefits of their trade liberalization policies.

Despite these hurdles, developing countries push forward in opening their borders, reaching out for global economic growth of their own.  These countries make necessary changes in the law, strive to enforce such changes, and encourage their own domestic businesses to utilize these changes for their own benefit.  However, they fail to grow as expected.² While some incomes increase and absolute poverty declines by a negligible degree, the goal of realizing sufficient economic growth to reinvest in domestic infrastructure or eliminate the need for World Bank and International Monetary Fund assistance continues to be out of reach.  Why have the concerted efforts at liberalization not brought the requisite growth as expected?

One of the reasons is the existence of a large and growing informal economy.  Two markets exist in developing countries—the formal market, which functions much like markets we would see in a developed country, and the informal market, consisting of workers that could not find or chose not to take work in the formal economy.  The informal market also exists, albeit to a lesser extent, in developed countries, but generally with more sustainable incomes than that of developing countries.  This informal economy, which can occupy more than half of the working population in developing countries, plays an important role in economic development, and as such, plays an equally important role in trade liberalization.  In this Article, I contend that (1) trade liberalization policies can negatively impact the informal economy by failing to provide adequate domestic protection against foreign competition, and that (2) economic growth will remain below its full potential unless the informal economy is extended the same opportunities for global participation and technical assistance as those offered to the formal economy.

B. Approach to This Study

The study that this Article is based on was carried out by a team of researchers that I organized at the Universidad de Los Andes in Bogotá, Colombia, where I was a visiting professor of law in 2006–2007.³ Extensive quantitative data was collected by the Colombian National Statistics Agency, the DANE, including comprehensive studies of the informal sector in Colombia.  In addition to these statistics, data was gathered from the World Bank, the Economist Intelligence Unit, and research conducted by the Center for the Study of Economic Development (CEDE) at the Universidad de los Andes.
Legal research was also conducted directly by the team through the investigation and sorting of laws and administrative changes made in furtherance of trade liberalization in Colombia.  Included in this survey is a collection of major laws, decrees and administrative actions that had an impact or intended impact on the role of international trade in Colombia between 1980 and 2006.  For clarity, the laws have been translated and summarized herein.
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II. The Informal Economy

The informal economy consists of workers who operate outside the constraints and benefits of legally sanctioned work.  This includes those workers who are unable—either due to lack of employment opportunities, lack of appropriate job skills, or geographic location away from formal employment—to secure work that provides stable income, state benefits, and some predictability for future work.  “The basic distinction between formal and informal activities relies entirely on the character of production and distribution processes, namely degree of compliance with the terms of the laws.”⁴ These workers generally do not pay taxes; however, they also do not benefit from job-related social services such as unemployment, social security, and pensions.⁵ Most importantly, these workers are often working with short-term “contracts” that can be terminated at-will by the employer, eliminating the possibility of financial planning for the worker.⁶

Informal work expands substantially during periods of economic adjustment, such as those that accompany political or legal reforms related to the economy.⁷ As workers lose opportunities in the formal sector due to increasing competition or technological advances that reduce the need for labor, they tend to move into informal employment to find the means to survive.  These informal workers tend to be poorer and earn less income than their equivalents in the formal economy.⁸

The informal economy is made up of people who—constituting as much as 80% of the developing world—live or work without meeting formal licensing requirements or maintaining any formal right to their property.⁹ Hernando de Soto has been the key author in analyzing this sector to identify pathways to economic growth.  De Soto first explored this concept in Peru in his book, The Other Path:  The Economic Answer to Terrorism, which looked at various economic reforms that would potentially reduce the possibility of violence by the Shining Path (Sendero Luminoso) in Peru in the 1980s and 1990s.¹⁰

Informal markets consist primarily of specialized activities, such as street vending, carried out by those who cannot meet their business needs through the formal legal system.¹¹ The majority of vendors, according to De Soto, are women.¹² In fact, this was confirmed by a recent case study carried out by the Colombian newspaper El Tiempo on the cellular phone minute vendor market in Colombia.¹³ The economic contribution of informal vendors is substantial in economic terms as they occupy a substantial portion of the national economy.¹⁴ Operating in the extralegal sector, informal market vendors meet a critical need in developing countries:  providing goods such as foodstuffs, crafts, textiles, and services such as phone calls and transportation.¹⁵ Because of their status (or lack thereof), they do not enjoy the benefits of formal businesses.  Moreover, without operating licenses and access to credit, their prospects for exporting goods and services are limited, and they are unable to contribute in a meaningful way to the global economy.

De Soto goes on to argue that property rights are the missing component in effective development strategies.¹⁶ Without the right to use, transfer, or sell it, property is a limited-value asset.  Yet the informal sector maintains informal ownership over substantial property in many developing countries.  Labeling this valueless property “hidden capital,” De Soto finds that the informal sector significantly impairs many developing countries’ ability to grow.  He pushes for property reform through a semi-redistributive scheme (for example, titling unused property to the benefit of those that would use it most productively).  To achieve this, De Soto turns his attention to legal reform.

De Soto argues that the legal and regulatory barriers to becoming formal in many developing countries result in costs that are indicative of bad law for economic development.¹⁷ While De Soto uses Peru in 1986 as an example of the difficulties in this process, more recent and applicable data is available from the World Bank, which shows that it takes roughly forty-four days to start a business in Colombia and costs 19.8% of annual income (estimated to be $2290 in GNI per capita).¹⁸ Beyond this initial registration, businesses in developing countries are further burdened with regulatory compliance, including recordkeeping, report filing, and federal compliance, which De Soto estimated to consume roughly 40% of employee time.¹⁹ In this sense, companies are judged by how well they comply with the law rather than on their business acumen.²⁰ Accordingly, entrepreneurial activity is severely restricted in both the formal and informal sectors, albeit for different reasons.

De Soto continued his research of informal economic development in his more famous book, The Mystery of Capital.  Utilizing his team of researchers as guinea pigs operating informal businesses in Peru, De Soto pursued the reasons for informality and how to move toward formality in developing countries.  He found that informal business operators do indeed avoid some formal costs, such as taxation and compliance with the law, but are “taxed” in other ways through a lack of property rights and the resulting need to constantly hide their business from authorities.²¹ “What determines whether you remain outside [the formal sector] is the relative cost of being legal.”²²

Continuing his earlier argument, De Soto contends that it is the law that gives property its value.²³ Formalizing property is necessary for economic growth.²⁴ De Soto concludes that without a “formal property system, a modern market economy is inconceivable.”²⁵ He contends that economies become informal primarily because of the legal system, or more precisely, the system of contract enforcement in developing countries.²⁶ He sees this system as the primary motivation to move from the legal to the extralegal sector.²⁷ Yet most informal communities have already developed their own systems of extralegal contract enforcement, providing an efficient means of temporary or interim contract management.²⁸ Thus, De Soto argues that a bridge must be built between the formal and the informal systems of contract enforcement.²⁹ In this regard, this Article is primarily concerned with the divide between formal and informal systems as they pertain to labor contracts.

More recent research by Sugata Marjit and Dibyendu Maiti at the Center for Studies in Social Science (Calcutta) and the Center for Development Studies, respectively, shows that the informal sector comprises as much as 70–80% of the economy in many developing countries, and as much as 90% if agriculture is taken into consideration.³⁰ The goods and services produced in this sector are vertically linked to goods and services in the formal sector.³¹ This important finding corrects prior studies of this sector which showed a minimal relationship.³² Markets are either local, national, or export (international), according to Marjit and Maiti.³³ Informal workers generally cannot participate beyond the local market unless they utilize middlemen or traders to carry their goods to those broader markets.  When they do, the middlemen extract a portion of the profit from the good.³⁴ “If the artisans wish to avail themselves of the external markets, they become tied to master enterprises (the formal producers) and traders.” ³⁵ The authors contend that deregulation is the most effective approach to improve the conditions of informal workers.³⁶ Echoing these sentiments, Anne Trebilcock argues that “while some informal workers provide low-cost inputs to global production systems, the majority are excluded from the opportunities of globalization and confined to restricted markets.”³⁷

Pinelopi Goldberg and Nina Pavcnik wrote a particularly insightful paper discussing the effects of trade liberalization on the informal sector in Latin America.  They conclude that while there is no such linkage in Brazil, there was a linkage in Colombia before the completion of major labor market reforms in the 1990s.³⁸ They begin by pointing out the dearth of evidence supporting the relationship between informal employment and trade policy.³⁹ The authors question the traditional hypothesis that as competition increases, firms are more likely to resort to subcontractors and other informal workers to cut costs.⁴⁰ They contend that if this were true, firms would have done this long before the increase in competition (perhaps stringent labor laws prevented firing such workers).⁴¹

The authors focused on Colombia and Brazil due to their recent major labor market reforms and large informal sectors.⁴² Colombia reduced its trade barriers between 1984 and 1994, with the largest reforms taking place in 1990 and 1991.⁴³ Between 1984 and 1998, the average tariff in Colombia declined from 27% to 10% (an aggregate measure that does not accurately reflect the tariff on goods produced directly or indirectly by the informal sector).⁴⁴

Prior to 1990, Colombia maintained very strict labor laws that prevented the firing of workers for unjust reasons.⁴⁵ In 1990, Law 50 was passed, which significantly reduced the costs of firing workers and increased labor market flexibility.⁴⁶ Via statistical analysis, the authors conclude that a decline in the tariff for a certain industry resulted in a higher probability of informal employment prior to the 1990 reform than after the reform.⁴⁷ However, despite the loosening of labor restrictions on firing workers, formal employers were also required at this time to provide social services, savings accounts, and vacation time for workers.⁴⁸ Accordingly, many employers resorted to the use of service contracts to hire workers, thereby avoiding formality and the need to offer these benefits to their workers.

The authors found that informal workers in Colombia tend to be older, less educated males,⁴⁹ a finding that contradicts many of the reports on this economy.  Moreover, their definition of “inequality” as the difference between those with good and bad jobs seems inappropriate in light of existing studies that define inequality in terms of differences in income rather than quality of work.  Nonetheless, they find that work in the informal sector is less satisfying, yielding fewer benefits than work in the formal sector.⁵⁰ The primary industries in which these authors find informal workers employed in Colombia are in the “manufacture of wood and wood products, agriculture, restaurants and hotels, and household services.”⁵¹ Goldberg and Pavcnik conclude that labor market institutions are critical when analyzing the effects of trade policy on employment.⁵² When operating in rigid labor markets, firms are more likely to respond to increased foreign competition by reducing formal employment.

Anne Trebilcock, Deputy Director of Policy Integration at the International Labor Organisation (ILO), provided a comprehensive summary of the 2002 international labor conference in which the issue of informal work arose.  The ILO recognized at this session the important contributions that informal work makes to the global provision of goods and services.⁵³ Speaking about the informal workers, the ILO found that “although they are operating within the formal reach of the law, the law is not applied or not enforced; or the law discourages compliance because it is inappropriate, burdensome or imposes excessive costs.”⁵⁴ Because linkages exist between formal and informal work, the ILO set forth several recommendations for the betterment of the informal economy.

Importantly, the ILO recognized that the elimination of the informal economy is not a reasonable or desirable goal.  Rather, it suggested removing the negative aspects of the informal economy while ensuring the protection of the opportunities for entrepreneurialism and livelihood that informal work provides.⁵⁵ This protection specifically includes the right to decent work and social security coverage.  While not directly linked with poverty, working informally does indicate income variability and instability.⁵⁶

According to the report, bad macroeconomic and social policies are often at the root of expanding informal economies.⁵⁷ These factors include the lack of a good legal and institutional framework, good governance, and the proper implementation of laws and policies.  In particular, the report suggests enacting legislation governing employment relationships, enforcement of rights and protections, easy access to legal dispute resolution mechanisms, lower costs of establishing new businesses, and laws that protect property rights and title assets.⁵⁸ To promote these interests, the ILO suggests the protection of freedom of association, including the proliferation of business associations to protect the rights of informal workers.⁵⁹

The report finds that labor laws have not kept pace with the changing nature of labor markets.  With regard to informality, an interdisciplinary approach, such as the one incorporated in this Article, is the best mechanism to seek adequate solutions.⁶⁰

A. The Informal Economy in Colombia

Colombia maintains one of the largest informal economies in the developing world, with roughly 60% of its population working outside the bounds of the law.⁶¹ This suggests half of the population works without job security, without reasonable livable wages, with little or no public service benefits such as social security or medical coverage, and is likely on the road to worsening poverty.  According to some authors, this fact represents one of the greatest challenges to the development of the country.⁶²

The growth of the informal sector in Colombia may be partially linked to the rapid growth of the nation’s urban areas, a result of mass migration and displacement of workers in rural areas by the guerillas.⁶³ Conditions which contribute to increased migration “ha[ve] a large impact on the probability of being employed in the informal sector.”⁶⁴ Additionally, the informal economy grew due to a decline in the demand for labor during the economic downturn of the 1990s.⁶⁵

Moreover, according to Francisco Thoumi, the former chief of the International Economics and Infrastructure section of the Inter-American Development Bank, the rise in the informal economy, which he posits began in the 1970s, is one of the main reasons for a weakening rule of law in Colombia.⁶⁶ Thoumi finds that the expanding informal economy has “made respect for the law more costly and . . . has made engaging in illegal activity more acceptable.”⁶⁷

While some authors have drawn linkages between informal work and the formal global economy,⁶⁸ the majority of informal workers are excluded from global opportunities and are “confined to restricted markets.”⁶⁹ Thoumi argues that the growth of the informal economy has made it more difficult for Colombia to compete internationally in markets where economic growth has the potential to increase income and well-being.  His conclusion is largely founded on the substantial drug trade, where many Colombian youths work in place of gaining an education or seeking more skills-intensive industry training.⁷⁰

International trade reforms can have a substantial, negative impact on the labor market in a developing country.  Dani Rodrik finds that global trade favors capital-intensive as opposed to labor-intensive industries, placing most developing countries with their labor-intensive economies at a significant disadvantage.⁷¹ Additionally, trade liberalization often has the effect of increasing competition in the domestic marketplace.  As demand for labor decreases, informal workers proliferate and the number of workers with unstable and generally lower-paying positions increases:

[G]lobal competition tends to encourage formal firms to shift formal wage workers to informal employment arrangements without minimum wages, assured work, or benefits and to encourage informal units to shift workers from semi-permanent contracts without minimum wages or benefits to piece-rate or casual work arrangements without either assured work, minimum wages, or benefits.⁷²

Informal workers in Colombia primarily occupy service industries, such as hotels and restaurants, as well as the transportation sector—operating buses, taxis, and other public transit.  Thus, taking a bus or eating out in Colombia more likely than not means your service provider is underpaid and working without the knowledge that they will have a job the next day.  These dynamics result in a highly competitive marketplace in which scarce jobs are fought over by the workers and maintained only at the demand of the employer.

Until recently, labor laws in Colombia made it difficult to relieve formal, salaried employees from their position without good cause.⁷³ To increase their flexibility and control over the employment relationship, employers routinely hired informal workers as day laborers or non-permanent subcontractors without benefits.  However, major labor reforms in 1990–1991, in conjunction with the development of a new Constitution, changed these laws to make it easier to release employees.⁷⁴ Accordingly, the reliance upon informal workers has decreased in some sectors.

Yet despite this change, the informal sector in Colombia is expanding rather than contracting.⁷⁵ Less work available due to increases in technology and increasing foreign competition, combined with a growing labor force, lead many workers to seek alternative employment opportunities.  In Colombia, this is evident in gratuity-oriented positions, such as parking lot attendants guiding your car into and out of spaces for a few coins, entertainers and window washers at every stoplight looking for monedas, and supermarket grocery baggers that will pack your food and walk it to your car (or all the way to your house if you like), all earning nothing more than you are willing to give.  These informal workers cost nothing to the owner of the parking lot or grocery store, yet they provide a service that some people find useful and for which they are willing to tip.  What is increasingly apparent, however, is that these informal positions are themselves in high demand.  Using the supermarket grocery bagger example once again, you will rarely find less than two workers bagging your groceries at the same time, and in some cases as many as four or five.  Demand for the change in your pocket is growing.

This problem is not unique to Colombia, but Colombia stands out as an example of a failure to reduce the reliance on informal work despite overall economic growth.  Colombia is a middle-income country, an active member of the GATT and WTO, and the fifth-largest recipient of U.S. foreign assistance monies.⁷⁶ All of this indicates that Colombia should be able to invest in its population in order to prevent more workers from falling into the poverty trap of working in unsustainable positions.  Yet as the informal sector grows, it becomes apparent that increased aggregate economic growth is failing to alleviate a substantial economic development problem.
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III. International Trade Law in Colombia

A. Historical Perspective

Colombia has not always been open to trade.  Like many other Latin American countries during the 1960s and 1970s, Colombia relied on a policy of import substitution whereby it followed the logic of economists of the day who suggested positive economic growth would result if the country reduced imports and facilitated domestic production of those previously imported items.  Colombia carried out this policy via Decree 1345 of 1959 and Law 81 of 1960, which offered tax-free treatment to domestic producers.⁷⁷ This policy contradicted David Ricardo’s theory of comparative advantage, which suggested that countries should focus on producing what they can produce most efficiently, allowing other items to be imported from countries that can produce them more efficiently.⁷⁸

In 1966, under the presidency of Carlos Lleras Restrepo, Colombia conducted national budget planning, implemented administrative innovation, and began to emphasize exports.⁷⁹ Between 1970 and 1974, under Misael Pastrana Borrero, Colombia enjoyed its greatest economic growth in the last half century, averaging 5.8% annually.⁸⁰ During this period, Pastrana focused on enhancing the internal urban industrial sector, which grew from 21.3% to 23%.⁸¹ However, inflation also grew from 7.2% in 1970 to 25.2% in 1974, along with a rise in urban unemployment from 9.7% to 11.6% by 1974.⁸² Lopez Michelsen took the presidency in 1974 and focused his national development plan on decentralization, emphasizing city collaboration and restricting foreign direct investment.⁸³ This process was continued by Turbay Ayala between 1978 and 1982.⁸⁴ Law 38 of 1979 forged a permanent linkage between regional and national development plans, offering significantly more influence of regional bodies on national development goals.⁸⁵

Developing new industries to produce products that could be imported cheaply became exceedingly difficult and costly and dragged Colombia into debt.  Accordingly, Colombia followed many of its neighbors and began to open its borders to free trade.  At the time, the favored policy in Latin America for trade was based on the Washington Consensus, a policy initiative put forth by the United States that encouraged rapid reduction of all barriers to international trade and legal reform to conform with developed country standards.⁸⁶ Colombia chose to embrace this initiative and began the substantial reduction of its barriers to trade.  Infant industries were abandoned in place of more competitive imports, and subsidies and state-owned industries were all but eliminated.

In 1981, Colombia approved Law 45, which instituted the Treaty of Montevideo, creating the Latin American Integration Association.⁸⁷ This association replaced the Latin American Free Trade Association, established in 1980 with the intention of facilitating a common market in Latin America.  The agreement set forth a regional tariff preference scheme in 1984, offering a range of reductions in import tariffs depending on the developmental status of member states.⁸⁸

Table 1. Colombian GDP per Capita (1980–2005)⁸⁹

[for the table, download the .pdf]

B. Economic Openness in Colombia

In the 1990s, Colombia began to open its economy to external trade via a series of changes in the law and policy of foreign commerce.  In Latin America during this period, the ten recommendations of the Washington Consensus were promoted and, to a large extent, implemented.⁹⁰ The following is a general overview of the major changes that took place between 1991 and 2003 resulting in liberalized trade in Colombia.

La Apertura (the opening of the Colombian economy to international trade), began around 1990, after dissatisfaction with the economic growth of the 1980s.⁹¹

In 1990, Colombia started an intense process of structural adjustment policies, which included most of the recommendations of the Washington Consensus.  Economic and institutional modernization, internationalization of the economy, flexibilization of the labor market and incorporation of private enterprises for the provision of social security services were the main objectives of this political agenda.⁹²

These reforms included fiscal decentralization, which resulted in increased government spending, thereby steadily increasing the central deficit during the 1990s.⁹³

Colombia instituted a new constitution in 1991, and with it, came many changes to the administrative organization of the political structure.⁹⁴ Of specific interest to this study, Article 225 established the Advisory Commission of Foreign Relations to advise the president;⁹⁵ Article 226 instructed the state to promote internationalization of political, economic, social, and ecological matters on the basis of fairness, reciprocity, and national convenience;⁹⁶ Article 227 instructed the state to promote economic, social, and political integration with other countries in Latin America and the Caribbean on the basis of fairness, reciprocity, and equality, including the establishment of a supranational governing structure;⁹⁷ and Article 334 placed the state in charge of the direction of economic development through the control of production, distribution, and consumption of goods and services to improve the quality of life and attain equitable distribution of the opportunities and benefits of development.⁹⁸

Also in 1991, Colombia approved Law 7, which set the foundation for international trade.⁹⁹ This law established the general rules that the Colombian government would have to follow in its foreign commerce.¹⁰⁰ It created the Ministry of Foreign Trade¹⁰¹ and established the functions and structure of the Foreign Trade Council.¹⁰² The law also created the Bank of Foreign Trade¹⁰³ and the Economic Modernization Fund.¹⁰⁴ In effect, this law established structure and guidelines for the government to follow in all future attempts to regulate foreign commerce, including (1) the enhancement of international integration with the goal of growth and sustainable development,¹⁰⁵ (2) promotion of exports,¹⁰⁶ (3) stimulation of bilateral and multilateral trade agreements,¹⁰⁷ (4) modernization and increased efficiency of domestic production to improve international competitiveness,¹⁰⁸ and (5) protection for domestic industry when facing unfair foreign competition.¹⁰⁹

The Foreign Trade Council was established in 1991 to, among other things, set tariff levels, advise the government on trade policy, instruct the delegations that represent Colombia in foreign trade negotiations, determine the best approach to export promotion, and advise the government on the protection of domestic industry against unfair foreign practices.¹¹⁰

In accordance with Law 7, Colombia took two major steps toward international integration in 1994 when it joined the Marrakesh Agreement establishing the WTO,¹¹¹ and when it established a free trade agreement with Mexico and Venezuela.¹¹² The latter treaty’s goals included reducing trade barriers between the parties, diversifying their exports, and promoting fair competition.

Colombia also entered into a trade framework agreement with the European Economic Community (EEC).¹¹³ This agreement was established between the EEC and the Andean Community, comprised of Colombia, Bolivia, Ecuador, Venezuela, and Peru.¹¹⁴ The agreement set out to foster commerce, investment, and technological advances.  It gave special regard to the Andean Community as a group of developing states,¹¹⁵ and sought to stimulate diversification of exports, the opening of new markets, the protection of foreign investments, and the exchange of statistical information.¹¹⁶ The agreement focused in particular on the following sectors:  industrial, agrarian and mining, agriculture and fishing, energy, environmental protection, technology transfer, intellectual property, quality certification, services, monetary information, sanitary and phytosanitary regulations, and regional economic development.¹¹⁷ The agreement aimed to promote trade fairs and conferences the exchange of experts, and the creation of joint ventures.¹¹⁸

The Ministry of Commerce, Industry, and Tourism was created by Law 790 in 2002 and implemented by Decree 210 in February 2003.¹¹⁹ This Ministry combined the functions of the former Ministry of Economic Development and the Ministry of Foreign Trade.¹²⁰

In 2004, Colombian president Alvaro Uribe instituted his National Development Plan.¹²¹ The plan was formulated around the idea of sustainable economic growth, macroeconomic price stability, sustainable debt, and access to Colombian markets.  Taking into account the concerns of the international community surrounding the drug trade and related crimes, terrorism, corruption, and environmental and human rights concerns, the plan’s primary focal point was export promotion.  The plan also alluded to the consolidation of the Andean Community with its Latin American neighbors as well as the facilitation of the Andean Trade Promotion and Drug Eradication Act (“ATPDEA”) with the United States.¹²² Additionally, the plan sought to conclude the Free Trade Area of the Americas, a goal that will not likely be achieved by the end of the Uribe Administration.¹²³

Two Decrees in 2005 and 2006 were issued to modify the functions of the Ministry of Commerce, Industry, and Tourism.¹²⁴ The Ministry’s role is to adopt and coordinate the economic and social policies of the country pertaining to competitiveness, integration, and development of the productive economic sectors comprised of small and medium businesses, foreign trade of goods and technology transfer, promotion of foreign investment, and internal commerce and tourism.¹²⁵ Thus, these extensive decrees gave the Ministry responsibility for promoting exports, facilitating foreign investment, negotiating trade agreements, promoting small and medium enterprises, and establishing import tariffs.

It would be incorrect to presume that the expansive laws in Colombia relating to trade are rigorously adhered to in every instance.  Generally speaking, the rule of law in Colombia is very weak due to weak enforcement and a lack of meaningful constraints on the elite.¹²⁶ Yet this is not unique to Colombia.  “After more than ten years and hundreds of millions of dollars in aid, many judicial systems in Latin America still function poorly.”¹²⁷ Lack of funding for effective police forces—and in Colombia’s case, significant emphasis on military actions against the guerillas rather than on civil law enforcement—yields an environment in which laws are often ineffective.  Accordingly, many of the aforementioned laws appear prima facie to be effective developmental solutions, yet they have yet to be successfully implemented.

C. Existing Inequality in Latin America

Inequality is measured by the differences in wealth distribution between economic groups within or between countries.  As people perceive “widening disparities in distributions of income” among their population, tension between economic groups is likely to increase.¹²⁸ In other words, as income inequality worsens, the risk for social conflict grows.  This dynamic is especially important in considering trade reforms that increase the overall income of a country but yield further divergence between the rich and poor.  While not the focus of this Article, this section briefly explains how trade liberalization via the informal sector can worsen inequality.

Inequality in Latin America has long been a significant economic and developmental problem for the region.  According to the World Bank, the poorest 10% of the population in Latin America has typically held less than 2% of total wealth whereas the richest 10% has enjoyed more than 30%.¹²⁹ Recently, this disparity has worsened.¹³⁰ As a result of increased inequality during the 1980s, the distributions today are more unequal than those of the 1970s.¹³¹ Notably, this trend is generally consistent among countries in the region, as changes in inequality have occurred within, rather than between, countries.¹³²

Measuring income changes across a country can yield highly diverse results depending on how such data is collected and interpreted.  Several authors have judged the increases in overall or aggregate income to be indicative of positive, sustainable economic growth.¹³³ However, aggregate economic growth does not take into consideration changes in individual income or income distribution.  “Average income may rise but inequality may also increase in such a way that some people suffer reductions in their real incomes, which may then translate into a negative assessment of the overall performance of the economy, according to some value judgments.”¹³⁴

Table 2.  Income Distribution in Colombia (1980–2003)¹³⁵

[for the table, download the .pdf]

The potential for social crisis arising from the growing, or at least steady, inequality in Latin America is evident in the attitudes of the population.  According to Latinobarometer, nearly 75% of the population considers the current income distributions to be “unfair” or “very unfair.”¹³⁶ Increasing national wealth from trade could worsen this situation if the majority of the population perceives the gains from liberalization to be centralized among only a small portion of the population.

According to one author,

[t]he combination of slow growth and persistent inequality is yielding chronic poverty and social disarray in spite of the fact that the dominant concern (voiced by international financial institutions) in the recent decade was poverty reduction, with real income becoming the key metric for defining the welfare levels of low income groups.  Other social objectives such as lower inequality of income and wealth, empowerment, popular participation in decision-making and public policy have not been, on the whole, important policy priorities.¹³⁷

The effects of low-cost imports, expanded exports, and growing foreign direct investment in Colombia can be positive for the overall economy.  Both aggregate and per capita GDP have grown since the end of the import substitution policies of the 1960s and 1970s.  Yet this growth has been uneven, yielding significant economic gains to the already wealthy, and preventing economic gains where they are most needed.  The third and final section of this Article addresses the potential link between more liberalization and a wider informal sector, which could also lead to increased poverty and inequality.
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IV. Linkages Between Liberalization and Informality

A. Trade Liberalization and the Informal Sector

The expansion of trade liberalization in Colombia is associated with an increase in the size of the informal economy.  “[I]ncreasing informal employment is inherent to the current global economic restructuring.”¹³⁸ Table 3 (below) represents the scope of the informal economy in Colombia as a percentage of GDP between 1981 and 2006.  Despite the gaps in data due to the only recent implementation of annual statistics of Colombia’s informal economy, it is evident that this sector was close to 50% during the 1980s and early 1990s, and that the sector has grown substantially, to above 60%, since that time.  The expansion of the informal sector might readily be linked to the implementation of the trade-opening policies of the 1990s, including the Washington Consensus.
It should be noted that some authors have found weak linkages between the implementation of the Washington Consensus and slowed economic growth.  Mauricio Cardenas, for instance, found that Colombian growth slowed in the 1980s, before the reforms of the Washington Consensus were instituted.¹³⁹ Many of these authors do not consider, however, the effect of labor market and trade-oriented reforms on the informal economy, which substantially expanded in the 1990s and which is linked to growing inequality and poverty.  Because more than half of the Colombian economy operates in an illegal, unregulated marketplace, reforms that open opportunities for foreign imports and increased competition in the formal sector also exert downward pressure on wages and curb formal employment opportunities.  Thus, while the economy may have been on a downward swing when the Washington Consensus reforms were implemented, it was the reforms that opened the door to the expanding gap between rich and poor, causing more lasting damage than the economic downswing itself.

Table 3.  Size of the Colombian Informal Economy (as a percentage of GDP)¹⁴⁰

[for the table, download the .pdf]

The laws passed in Colombia in the early 1990s that liberalized trade also increased competition, lowered the cost of factor inputs, and improved technology.  All of these secondary effects are consistent with a decline in formal employment and a growing informal sector due to a decrease in demand for labor.
The size of the informal economy can be linked both to the level of unemployment and to the pace of trade liberalization in Colombia, as seen in Tables 3 (above) and 4 (below).  As reforms that opened the Colombian economy to foreign trade were implemented, primarily during the 1990s, unemployment increased sharply; the informal sector grew upwards of 60%; and poverty reduction, while on the decline prior to 1991, began climbing steadily until 1998, when it again began to decline.

Table 4.  Unemployment in Colombia (1980–2004).¹⁴¹

[for the table, download the .pdf]

In their study, Goldberg and Pavcnik contend that there are no clear linkages between trade liberalization and the scope of the informal sector.¹⁴² They find that the Brazilian informal sector was reduced in size during the period of trade liberalization identified by Goldberg and Pavcnik, whereas that of Colombia remained stable.¹⁴³ While their study is comprehensive and interesting, the results are ultimately unconvincing.  Goldberg and Pavcnik base their definition of trade liberalization on tariff reduction alone rather than examining, as I have done here, the level of imports (which is the actual effect of tariff reductions).¹⁴⁴ Yet even when considering tariff reductions, they find a growing informal sector in Colombia prior to the 1990 labor law reform that eased the firing of workers,¹⁴⁵ and a smaller increase post-1990 reform.¹⁴⁶ Thus, even using a measure that may not accurately reflect the amount of increased trade Colombia experienced in the survey period, Colombia’s informal sector was still found to have expanded between 1984 and 1994.

Despite the aggregate growth of the Colombian economy, poverty reduction has slowed, inequality has not improved, and the informal sector has grown.  A recent issue of the Colombian weekly news periodical Semana featured several articles on the state of poverty in Colombia.  One such article highlighted the fact that poverty had been steadily reduced between 1978 and 1995, when the Colombian economy was growing at a rate of 4% annually and unemployment remained below 10%.  During this period, the number of Colombians in poverty dropped from 45% to 21% of the total population.¹⁴⁷ As the economy slowed after 1998, poverty increased in Colombia, reaching 57.5%.¹⁴⁸

Consider the linkage between trade liberalization and poverty the Semana article above suggests.  World Bank statistics support this perspective, showing that while trade liberalization has expanded, the fight against poverty has weakened substantially (see Table 5 below).

Table 5.  Trade as a percentage of GDP in Colombia; Colombians living on less than $2 per day.¹⁴⁹

[for the table, download the .pdf]

It is also clear that aggregate economic growth in Colombia has been declining since its peak of over 8% in the late 1970s (see Table 6 below).  Accordingly, while trade has expanded and GDP per capita has risen slightly, the Colombian economy’s growth has been slowing, and has even been negative for some periods over the last twenty years.

Table 6.  GDP Growth Rate in Colombia (1971–2005) (in 1990 U.S. dollars).¹⁵⁰

[for the table, download the .pdf]

V. Recommendations

What is most urgently needed to address rising informality, inequality, and poverty in Colombia, and likely in other developing countries as well, is a strategy that permits the equitable distribution of income from trade, as well as a program that reduces the reasons for informal employment and strengthens the opportunities available in the formal sector.  The first prong of this strategy requires more direct links between the Ministry of Trade, Commerce, and Tourism and the domestic agencies responsible for poverty reduction and sustainable economic development.  Through a carefully designed system of taxation, a portion of all incoming proceeds from trade, including foreign direct investment, capital transfers, and imports and exports, should be dedicated to low-income loans, small business development grants, poverty eradication programs, low-income healthcare, education, property titling, and judicial reform.  An example of an organization that could be funded via these trade taxes is the Banca de las Oportunidades (Bank of Opportunities),¹⁵¹ a new Colombian government organization that provides loans for starting small businesses.  Organizations such as this have the knowledge and ability to bring the economic gains from trade liberalization to the majority of the population, making the process not only more productive, but also more equitable.

The second part of this strategy involves working to eliminate the causes of informality.  “Specific laws, policies and programmes to deal with the factors responsible for informality, to extend protection to all workers and to remove the barriers to entry into the mainstream economy will vary by country and circumstance.”¹⁵² High unemployment in the formal sector caused by increasing competition and technology has reduced labor demand and pushed more workers into informal work.  In addition, rigid Colombian labor laws have discouraged employers from seeking long-term formal workers for fear of losing the ability to hire and fire workers in times of economic volatility.  The labor law reform passed in 1990 has eased this concern to some extent.  However, it is still costly to fire workers in Colombian businesses.¹⁵³

[T]o promote decent work, it is necessary to eliminate the negative aspects of informality while at the same time ensuring that opportunities for livelihood and entrepreneurship are not destroyed, and promoting the protection and incorporation of workers and economic units in the informal economy into the mainstream economy.¹⁵⁴

Part-time and at-will employment are uncommon in Colombia, yet these two solutions offer employers the ability to engage more formal workers with less fear of long-term contractual obligations, such as unemployment payments and health benefits.  Rather than relying upon a small staff of full-time employees and a number of day laborers, employers would be able to adjust workers’ hours based on current economic conditions.  This solution offers employees greater access to the benefits of a formal economy, including documentability of income, potentially more reliability in their income, and more ability to seek loans and make purchases backed by a regular job.  As an incentive, the state could offer employers tax benefits if they maintain workers previously employed outside the formal sector for a minimum of twenty hours per week.

These avenues for improving the economic condition of the majority of the Colombian population are only two of many potential solutions to the growing inequality and dismay caused by the distribution of benefits from liberalization.  Yet they are both aimed at two general goals—reallocating the income obtained through foreign trade, and creating laws and incentives to slow, and hopefully reverse, the growing informal sector.  With these goals in mind, trade liberalization can work as a productive tool for development and yield the much-praised results seen in the developed world.

VI. Conclusions

From the data presented in this Article, it is apparent that trade liberalization occurred at roughly the same time as an expansion of the informal sector and growth in unemployment and poverty.  This does not mean that it was the liberalization policies and laws that directly caused these negative residual effects on the population.  However, it does lead to the conclusions that the economic growth and development that arguably coincide with liberalization, at least in the case of Colombia, have been inequitably allocated, and that liberalization is associated with some negative economic effects on the majority of the population.

It must be noted that this Article is not intended to encourage the blind rejection of trade liberalization.  Expanding markets and increasing competition can also have positive effects, such as the creation of new opportunities for self-employed workers and small, informal businesses to manufacture products in demand on global markets.¹⁵⁵ For example, many informal workers occupy sectors such as the textile and garment industries, where global demand is high and the potential for income growth is undeniable.  Put simply, this Article suggests that the mechanisms to facilitate this potential growth are not currently in place, and should include legal and regulatory structures that would permit informal enterprises to negotiate fair wages, social benefits such as health care and unemployment insurance, and training and education programs.  With proper protective structures in place, some informal workers could yield significant benefits from trade liberalization efforts.

Unlike the developed world, it is improbable that a day will pass in Colombia, or most other developing countries, without interacting in some way with the informal economy.  Whether it is buying a pack of gum or cigarettes on the street corner, bagging your groceries at the local supermarket, or purchasing a handmade garment at a street market, you are briefly departing from the ordered formal market that we in the developed world take for granted.  Yet it is these informal workers who sustain much of the labor power in the world economy, keeping costs down for our clothes, food, and nearly every good that we purchase.  Appreciating how this market functions and how the push for trade liberalization affects these workers is critical to understanding how poverty persists, how inequality expands, and how these hardships can be avoided.

Footnotes

For complete footnote citations, download the PDF.