Trade Liberalisation In Developing Countries: What Impact On Wage Inequality?

02 Feb 2004

Does increased openness to international trade raise or lower wage inequality in developing countries? Research by Professor Francis Green, Dr Andy Dickerson and Dr Jorge Arbache, published in the February issue of the Economic Journal, suggests that an important effect of liberalising trade is to make labour markets more competitive, lowering wages for all workers.

Certainly, in Brazil, one of the biggest developing countries, there has been no fall in wage inequality following major trade liberalisation, and returns to a college education have increased significantly. There has been considerable debate as to whether the growth of international trade has led to greater wage inequality in the industrialised world. But there is another side to this story: the possibility that increased trade could be a vehicle for reducing inequality in developing countries. Opening up trade with low-income countries could, it is argued, allow higher rewards to less skilled labour in the developing country without necessarily boosting the wages of skilled labour.

So what is the evidence? The research by Green, Dickerson and Arbache suggests that trade liberalisation may not have the beneficial effects on wage inequality that are sometimes claimed. They have studied a ''natural experiment'' in Brazil: a four-year bout of substantive trade reform in the early 1990s, which was unaccompanied by other major structural policy changes.

Brazil is a large and important developing economy, which has traditionally had a very high level of wage inequality. This research analyses the country''s changing wage dispersion and employment allocation since 1981 to explore two key issues for low-skill developing countries:
· the impact of trade liberalisation on wages in the traded and non-traded sectors of the economy;
· and whether trade liberalisation raises or lowers the returns to skills. The findings indicate that trade liberalisation led to a 16% cut in wages for workers in traded sectors. This fall in wages can be explained as resulting from the increased competition that comes from the arrival of imported goods.

Only part of this wage cut spilled over into the rest of the economy. Trade liberalisation also led to a significant rise in the returns to acquiring a college education. The increased returns were not accompanied by any slowdown in the gradual upwards trend in the share of college-educated labour in the workforce: this means that the relative demand for collegeeducated labour increased during the 1990s.

This trend could be explained by an influx of skill-biased technology following trade liberalisation and the likelihood that the new technology demands a higher proportion of skilled workers than the old technology, even if the technology is itself not skill-biased.

An alternative explanation is that Brazil trades with both industrialised economies and very low-income economies like China. If trade liberalisation also opens up trade with China, Brazil''s comparative advantage may lie in more skilled-labour intensive sectors.

Despite these changes, wage inequality in Brazil remained at a very high level both before and after trade liberalisation.

''Trade Liberalisation and Wages in Developing Countries'' by Francis Green, Andy Dickerson and Jorge Arbache is published in the February 2004 issue of the Economic Journal. Professor Green is at the University of Kent; Dr Dickerson is at the University of Warwick; and Dr Arbache is at the University of Brasilia. The paper is part of a symposium on ''Trade Liberalisation and Economic Performance in Developing Countries'' organised by Amelia Santos-Paulino of the Institute of Development Studies at Sussex University and Tony Thirlwall at the University of Kent.

Professor Francis Green

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