The Effect of Trade Liberalization on Wage Inequality in

Bangladesh (1989 to 2009)

To

Iftekharul Haque

Eco 324 (Bangladesh Economy)

Prepared by

Tahsin Hyder (09205006)

Sanchita Sarker (10221022)

Shabnaz Zubaid (11105010)

Sakib Rahman(11105015)

Nagla Bahar Prova (11105020)

Sanika Rahman (11105025)

Sheikh Shuchita Jahan Sneha (11105028)

 Abstract:

This paper discusses the relationship between trade liberalization and wage inequality in Bangladesh by

analyzing the trends of trade and wages of skilled and unskilled laborers of Bangladesh from 1989 to

2009. The paper first gives a brief overview of the literature regarding trade liberalization and wage

inequality and then moves onto the empirical analysis. The result found indicates that wage inequality

increased as trade increased from 1989 to 2009.

1. Introduction

The relationship between trade liberalization and wage inequality has grabbed extensive

attention of policy makers and researchers in recent years. Trade liberalization refers to removal

or reduction of barriers (tariff and non-tariff) on the free exchange of goods between nations

(Investopedia), and wage inequality refers to the wage differences between skilled and unskilled

laborers. The developing economies have started liberalization since the mid-1980s, so

researches are being done to see the relationship between trade liberalization and wage

inequality. The foremost impact of growing trade volume or trade liberation has been curiously

seen by measures trade balance or balance of payment. Developing countries that have hugged

liberalization from the seventies or afterwards not just have faced an increase in export but a far

wide increase in imports as well [Amelia et al., 2004]. Greater openness to trade increases

efficiency as well as reduces wage inequality in developing countries (Munshi, 2012). This is the

conventional knowledge we have about their relationship. When trade is liberalized, the relative

demand for unskilled workers increases and thereby reduces the gap in wages between unskilled

and skilled workers (Wood, 1997). However the results for impact of wage inequality due to

liberalization of trade in developing countries are not very clear as mixed results are obtained.

[(Goldberg and Pavcnik, 2004, Blom et al., 2004, Feliciano, 2001)].

 2. Literature Review

Our research focuses on the effect on wage inequality in Bangladesh due to trade liberalization.

In order to fully understand the impact on the wage inequality the Hecksher-Ohlin-Samuelson

prediction provides a clear relationship between wage inequality and trade. In this paper we will

analyze if the prediction holds true for Bangladesh. Our research will highlight the reasons and

form a concrete relationship between wage and trade liberalization.

Before we figure out the effect that trade liberalization had in the inequalities a few theorems

provided by famous economists which will help to draw a conclusion in our research are:-

StolperSamuelson theorem-

Relative changes in output goods prices will drive the relative prices of the factors used to

produce them. If the world price of capital-intensive goods increases, it will increase the relative

rental rate as well as decrease the relative wage rate (the return on capital as against the return to

labor). Also if the price of labor intensive goods increases, it will increase the relative wage rate

as well as decrease the relative rental rate. (Wikipedia)

The main focus of the theorem is that trade reduces wage inequality in unskilled-labor-abundant

countries, and vice versa in skilled-labor-abundant countries through changes in relative prices.

In the next few pages we will try to relate it with a regression model.

The main theory used to explain the effects of trade on wage inequality is that of Heckscher-

Ohlin-Samuelson (H-O-S). In this model, it is assumed that there are two factors of production

(skilled and low-skilled labor) and two traded manufactured goods, one that employs intensively

skilled labor and the other, low-skilled labor [Giliani et al. (2003)]. Under these assumptions, it
is predicted that trade liberalization reduces wage inequality via the StolperSamuelson effect

(Stolper and Samuelson, 1941). The H-O-S theory asserts that, under a liberalized regime of

international trade, a countrys production structure is determined by its relative factor

endowments (Munshi 2012).

It is observed that countries that are developing export more goods that are produced by their

larger population of unskilled workers whereas the developed countries make use of their greater

proportion of skilled workers to produce skilled labor incentive products. From this we can

derive that in developing countries the prices of the products yielded by the unskilled workers

will increase more than the products of skilled workers thus increasing the wages of the unskilled

workers whereas in developed countries the prices of the skilled labor incentive goods will have

a higher price thus skilled labors will have a higher wage; under such circumstance it is plausible

that the wage inequality will increase in developed countries and decrease in developing

countries. Thus we reach our null hypothesis that with increase in trade the wage inequality will

reduce.

Ho: Wage inequality reduces with increase in trade.

2.1 Effect of trade liberalization on different countries

The understanding that trade liberalization invites both positive and negative implications; is not

new but one of the breakthrough arguments put forward in the context of Bangladesh was in a

paper of eighties where empirical evidences reflected a worsening crisis with poverty and

inequality even when higher trade gains were expected [Islam et al., 1986]. When it comes to

the issue of wage inequality considerable amount of literature stand firm to claim greater
openness does contribute to the widening of the gap between the wages of skilled and unskilled

workers. [Williamson, 1997; Arbache et al., 2004; Goldberg et al,. 2004]

Many empirical studies have been carried out by many researchers, but mixed results are

obtained, regarding the StolperSamuelson effect in the context of developing countries. The

East Asian countries showed positive results following the H-O model, meaning that trade

liberalization reduced wage inequality during the 1960s and 1970s. (Wood, 1997). However,

studies on Latin American countries showed that openness increased in wage inequality in these

countries (Beyer et al., 1999, in Chile; Galiani and Sanguinetti, 2003, in Argentina;Attanasio et

al., 2004, in Colombia). Moreover, most recently studies on India (Mishra and Kumar, 2005) and

Kenya (Bigsten and Durevall, 2006) maintained the theoretical prediction. The variation in

results may be because of several reasons. According to Munshi (2012), some reasons maybe,

firstly, methodology and the time period studied may differ among the countries. Next, the two

most important factors that affect wage inequality, like, the primary level of inequality and the

abundance of factor may be different. As an example, we can say that the East Asian countries

have an abundance of unskilled labors compared to the Latin American countries. So this will

cause a difference in the impacts of openness between Latin American and East Asian countries.

Lastly, the H-O-S model assumptions may be too restrictive for developing countries. For

example, trade liberalization may affect wage inequality via changes in wages due to lack of

labor mobility across sectors. But if wages are not made flexible as the H-O-S model demands,

then transitional unemployment and informal sectors may rise with a change in labor demand.

Theoretical (Goldberg and Pavcnik, 2003) and empirical (Attanasio et al., 2004) evidences show

that trade liberalization often causes informal sectors to rise. This in turn raises the wage gap
between skilled and unskilled workers since workers associated with these sectors are paid less

than others.

2.2 Trade Policy and its effect in Bangladesh

Since we are focusing on Bangladesh, we would like to explore the trade history of the country.

After receiving independence in December 1971, Bangladesh followed an import substitution

industrialization strategy for a decade (Munshi 2012). According to the definition given by the

Investopedia website Import Substitution Industrialization is an economic theory which is

followed by developing or emerging market nations that wish to increase their self-sufficiency

and decrease their dependency on developed countries. This theory is implemented in order to

protect and incubate domestic infant industries, so that they may emerge to compete with

imported goods and make the local economy more self-sufficient. Trade policies were based on

high tariffs and quantitative restrictions on imports. Liberalization of the trade regime started in

the middle of the 1980s under structural adjustment reforms initiated by the World Bank and the

International Monetary Fund. This is why before 1980s higher tariffs must have led to lesser

trade thus having a large effect on wage inequality. However the key role that played in the trade

liberalization was the decision of privatizing state owned enterprises soon after the war of

liberation.

2.3 Labor market in Bangladesh

Bangladesh like any other developing country has a greater number of unskilled labor force

compared to the number of skilled labor force. Nearly 80% of the employed population over 15

years is in the informal sector (Mujeri and Khondker, 2002). Although the labor policy states that

the workers working in public sectors gets wages that is determined by the government whereas
the private sector labors obtain wages through a process of bargaining where the minimum wage

set was the government determined wage. However it has been observed that the minimum wage

has not increased since 1993 despite of presence of many active labor unions which is expected

to have an impact on the changing inequality of wages.

2.4 What we expect to find

Liberalization induced productivity changes at the firm level may also impact industry wages.

Most empirical work has established a positive link between liberalization and productivity (e.g.,

Harrison, 1994, for Cte DIvoire; Krishna and Mitra, 1998, for India, Pavcnik, 2000, for Chile,

etc.). The increased threat of foreign competition raises innovation incentives by domestic

producers. To the extent that productivity enhancements are passed through onto industry wages,

relative wages would be positively correlated with trade liberalization.

For this paper however, we have endorsed and adopted the methodology and conceptual

framework of a time-series data to find whether trade has resulted in widening of wage

inequality or otherwise resulted in a reduction. [Munshi, 2012] The level of wage inequality shall

therefore be our measure to behold as the determinant of the current wage inequality as current

wages is likely to depend on past wages and measure of trade liberalization and empirically it

shall show the relationship.

3. Methodology, Data and Findings

The econometric analyses that have been done here use our knowledge mostly from our basic

econometrics course and guidelines attained from a Princeton training manual from the website

http://dss.princeton.edu/training/. In addition to what we have done more complicated analysis

could have been done, like for example panel data analysis, but we lacked the sufficient data and
knowledge to carry out such an analysis. Moreover, 2 stage least square method and fixed effect

method could have been done for regression but we only used one stage least square method for

a linear regression. All research has flaws and as beginners to the researching world our analysis

may also have flaws and any advice and comment to improve our research would be gladly

appreciated.

3.1 Empirical Model:

Regression Equation: Ieqt = 0 + 1 (Ieq t-1) + 2 (Tr.Opent) + u

Ieqt is the dependent variable which is the measure of inequality in year t. We used Log of

(Ratio of Average Daily Wage of Skilled Workers to Average Daily Wage of Unskilled Workers

from five sectors) to calculate the data for inequality.

Ieq t-1 - is the one period lag used as an independent variable or in other words this is the last

years inequality and consideration of this lagged variable makes our model dynamic.

Tr.Opent is the independent variable and it is a measure of the openness of trade or measure of

trade liberalization in year t. We calculate this data by taking the Log of Trade (as a % of GDP).

u is the error term. This considers the other factors that we did not consider and which might

affect our model.

The purpose of using log was to minimize the effect of any low quality data. Moreover, average

wage of workers from 5 sectors have been used. There might be huge differences between the

data of the wages of the 5 sectors which is very much likely to affect our data and analysis. To

minimize this effect log is also used. According to stats.stackexchange.com log is used to make

"bad" data (perhaps of low quality) appear well behaved.

 3.2 Data

Time series data (secondary data) from the year 1989 to 2009 have been used for the analysis.

The data for wages of skilled and unskilled workers was obtained from Chapter Price and

Wage of the Statistical Year Book of Bangladesh. Similarly the data for trade (as a % of GDP),

which is used as a measure of trade liberalization have been obtained from the World

Development Indicator of Bangladesh published by the World Bank. We took the log value of

all the data and carried out our research and the reason for the usage of log was mentioned

above. Graphs were plotted using the data and they are shown below

Figure 1 Figure - 2

Trend of Trade Scatter Plot

Openness 0.18
Log of Trade( as a % of GDP)

0.16
2 0.14
Inequality

1.5 0.12
0.1
1 0.08
0.06
0.5 0.04
0.02
0
0
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009

0 0.5 1 1.5 2
Year Trade
 The Gap Between Wages of Skilled and Unskilled
Workers
3
Log of Daily Average Wage of both Skilled and

2.5

2
Unskilled Workers

1.5 Skilled Worker Daily Average

Wage
1 Unskilled Workers Daily
Average Wage
0.5

0
1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009
Year

Figure 3

If a best fit line is drawn in the scatter plot in figure -2 then it would be an upward sloping line

showing us a positive relation between inequality and trade. Graphical interpretation of our data

shows that trade increased as years passed (figure -1) and this represents that we became more

open to all forms of trade, both exports and imports. The volume of both our exports and imports

increased over the years. From the graph of wages against year (figure -3) we can see that there has

been a gap between the wage of skilled workers and unskilled workers in the years 1989 to 2009.

The gap in the wage of the two classes seemed to narrow and widen at some period and more of

this would be discussed when we talk about the unit root test that has been performed here.
 3.3 Method of Analysis:

Since time series data have been used we declared the data as time series in STATA so we could

use the necessary time series operators. Often the usage of time series data means that the

dependent variable is influenced by its last periods data. As a result we considered that this years

inequality would be affected by last years inequality and thus generated a data of one period lag in

STATA using the L operator. Before generating the lag we carried out VARSOC command in

order to find the optimal lag for our model.

Result from the VARSOC command: Table 1

. varsoc Inequality

Selection-order criteria
Sample: 1993 - 2009 Number of obs = 17

lag LL LR df p FPE AIC HQIC SBIC

0 36.0252 .000951 -4.12061 -4.11574 -4.0716

1 38.6159 5.1815* 1 0.023 .000789* -4.30775* -4.29801* -4.20973*
2 38.7991 .36646 1 0.545 .000871 -4.21166 -4.19705 -4.06463
3 38.8115 .02461 1 0.875 .000984 -4.09547 -4.07598 -3.89941
4 39.3698 1.1166 1 0.291 .001045 -4.0435 -4.01914 -3.79844

Endogenous: Inequality
Exogenous: _cons

From the table we see that all the criteria AIC, HQIC, SBIC along with FPE suggests that we

should take one period of lag for the data used in our analysis. With these result we generated a

lag of one period for our measure of inequality variable (Ieq t-1).

A regression analysis was done with the aforementioned dependent and independent variables,

and the outcome of the regression is presented in Table -2.

. regress Inequality InequalityL1 Trade

Source SS df MS Number of obs = 20

F( 2, 17) = 5.27
Model .005784594 2 .002892297 Prob > F = 0.0165
Residual .009322011 17 .000548354 R-squared = 0.3829
Adj R-squared = 0.3103
Total .015106605 19 .000795084 Root MSE = .02342

Inequality Coef. Std. Err. t P>|t| [95% Conf. Interval]

InequalityL1 .5829564 .2005811 2.91 0.010 .1597672 1.006146

Trade .0650061 .0423015 1.54 0.143 -.0242422 .1542544
_cons -.0559128 .0670757 -0.83 0.416 -.1974301 .0856045

Table 2

We find, both lagged variable (Ieq t-1) and trade liberalization (Tr.Opent) are significant at 5%

level. This implies, inequality is affected by both the independent variables and the null

hypothesis that the coefficients 1=0 and 2=0 can be rejected.

So the sample regression line now is -

Ieqt = -0.0559128 +0.5829564 (Ieq t-1) + 0.0650061(Tr.Opent)

This equation tell us if last years inequality rise by 1 unit then this years inequality would also

rise by 0.5829564 units and if this years trade liberalization rise by 1 unit then the inequality

would also rise by 0.0650061 units. In addition to this the Value of R2 = 38% and this suggests

that the relation between the variables is moderately weak.

Time series data often have multiple trends and these trends might change the way a data is

interpreted. In order to test for these trends or in other words in order to test for the stationarity of

inequality over 1989 to 2009 we conducted a very popular test known as the Augmented Dickey

Fuller Test with a lag of one period.

 . dfuller Inequality, lags(1)

Augmented Dickey-Fuller test for unit root Number of obs = 19

Interpolated Dickey-Fuller
Test 1% Critical 5% Critical 10% Critical
Statistic Value Value Value

Z(t) -1.820 -3.750 -3.000 -2.630

MacKinnon approximate p-value for Z(t) = 0.3705

Table 3

The test statistic shows that inequality series have a unit root since it lies within the acceptance

range. It suggests there are multiple trends present and the graph (figure - 4) below would

confirm to this notion.

Wage Inequality
Log(Ratiof Wages of

Unskilled Workers)

0.2
Skilled Workers to

0.15

0.1

0.05

0
2000
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999

2001
2002
2003
2004
2005
2006
2007
2008
2009

Year

Figure 4
The graph shows several regions of shocks and these shocks to a unit root may have a long

lasting effect which may persist further throughout the years, unlike stationary variable whose

effects decay soon (Wikipedia, 2013).

3.4 Results

Our finding that inequality rise due to an increase in trade openness may be because the wages of

skilled workers appreciated more than that of the wages of unskilled workers. From Figure 3 it

is vivid that both the wages had an increasing pattern but since the skilled wages appreciated

more than the unskilled wages the gap between the wages or the inequality existing also

increased. So why did the wages of skilled workers rise more than that of unskilled workers?

One logical explanation can be because as years passed we became more developed compared to

the past periods and we looked forward to use technology to decrease our cost and increase our

productivity. This resulted in the increase in demand of skilled workers who would be hired to

operate the technologies but the supply of these types of skilled workers in Bangladesh is not

abundant as a result due to the increased pressure put on the demand their wages amplified.

Moreover, the demand for skilled labor intensive goods also increased and this also lead to the

higher increase in wages of skilled compared to unskilled.

We can see that the wages of the unskilled workers increased but not proportionate to the rise of

the skilled wages. Our major source of unskilled workers are actively present in the Ready Made

Garments sector and in those sectors the custom unions and minimum wages over the period was

successful in increasing the wages over some periods but the increase was not equal to the

increase of skilled workers wage. In addition to this the minimum wage did not increase by any

significant amount after 1993. Furthermore, many unskilled workers were employed in the Jute
Industries and the closing down of many jute mills along with other industries who largely hire

unskilled labor have also affected the wages of unskilled workers.

4. Conclusion

The findings states that due to trade liberalization both the wages of skilled and unskilled

workers increased from 1989 to 2009 but the rise in skilled workers wages were more compared

to the wages of unskilled and this unbalanced appreciation of the wages resulted in an increasing

wage inequality. Trade liberalization created more competition for the industries and as an

attempt to survive in the market they had to shift to improved technology. This caused the

demand for skilled workers to rise in many sectors. Along with this the rise in the demand for

skilled labor intensive goods also helped to raise the wages. For the part of the unskilled workers

we found that most of this labor force has moved on to the Ready Made Garments sector and we

are all familiar with the unrest regarding the wages of this sector. This might be the reason for

them having a lower wage and another reason might be due to the close down of many Jute mills

along with other industries which used to hire a huge proportion of unskilled workers. Since we

found that trade liberalization increases wage inequality we can now reject our initial null

hypothesis: Wage inequality reduces with increase in trade, which in turn means the opposite is

true. Finally, as mentioned earlier this paper only employs the basic econometric tools for the

analysis and there is infinite potential to do extensive research and construct a more rigid and

robust model.
Acknowledgements

We are most grateful our course teacher, Iftekharul Haque, for helping us with our econometric

analyses and instantly replying to all our queries. We would also like to thank Mustak Hassan

Md. Iftekhar, Additional Secretary of the Ministry of Establishment. Without his help it would

have been impossible for us to manage the Statistical Year Books of Bangladesh in the middle of

all this political unrest.

References

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(2000) 51-71

Salman, Z., & Javed, M. (2011). The impact of Trade Liberalization on Wage Inequality: Case of

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(2013,February 27). Retrieved March 26, 2013, from Wikipedia:
http://en.wikipedia.org/wiki/Unit_root

(2013, February 28). Retrieved March 26, 2013, from Wikipedia:

http://en.wikipedia.org/wiki/Import_substitution_industrialization
Appendix
Table 1 ( Varsoc Command in order to find the optimal Lag)

. varsoc Inequality

Selection-order criteria
Sample: 1993 - 2009 Number of obs = 17

lag LL LR df p FPE AIC HQIC SBIC

0 36.0252 .000951 -4.12061 -4.11574 -4.0716

1 38.6159 5.1815* 1 0.023 .000789* -4.30775* -4.29801* -4.20973*
2 38.7991 .36646 1 0.545 .000871 -4.21166 -4.19705 -4.06463
3 38.8115 .02461 1 0.875 .000984 -4.09547 -4.07598 -3.89941
4 39.3698 1.1166 1 0.291 .001045 -4.0435 -4.01914 -3.79844

Endogenous: Inequality
Exogenous: _cons

Table 2 (Linear Regression Result using the OLS method)

. regress Inequality InequalityL1 Trade

Source SS df MS Number of obs = 20

F( 2, 17) = 5.27
Model .005784594 2 .002892297 Prob > F = 0.0165
Residual .009322011 17 .000548354 R-squared = 0.3829
Adj R-squared = 0.3103
Total .015106605 19 .000795084 Root MSE = .02342

Inequality Coef. Std. Err. t P>|t| [95% Conf. Interval]

InequalityL1 .5829564 .2005811 2.91 0.010 .1597672 1.006146

Trade .0650061 .0423015 1.54 0.143 -.0242422 .1542544
_cons -.0559128 .0670757 -0.83 0.416 -.1974301 .0856045
Table 3 (Results from the Augmented Dickey Fuller Test)

. dfuller Inequality, lags(1)

Augmented Dickey-Fuller test for unit root Number of obs = 19

Interpolated Dickey-Fuller
Test 1% Critical 5% Critical 10% Critical
Statistic Value Value Value

Z(t) -1.820 -3.750 -3.000 -2.630

MacKinnon approximate p-value for Z(t) = 0.3705

Figure 1 (Trend of Trade Openness over the Years)

Trend of Trade Openness

1.8
Log of Trade( as a % of GDP)

1.6

1.4

1.2

0.8

0.6

0.4

0.2

Year
Figure 2 (Scatter Plot, Inequality against Trade Openness)

Scatter Plot
0.18

0.16

0.14

0.12

0.1
Inequality

0.08

0.06

0.04

0.02

0
0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8
Trade
Figure 3 (Average Wages of Skilled and Unskilled Workers from 5 sectors over the years)

The Gap Between Wages of Skilled and Unskilled

Workers
3
Log of Daily Average Wage of both Skilled and Unskilled Workers

2.5

1.5 Skilled Worker Daily Average

Wage
Unskilled Workers Daily
Average Wage
1

0.5

0
1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009
Year
Figure 4 (Trend of Wage Inequality)

Wage Inequality
0.18
Log(Ratiof Wages of Skilled Workers to Unskilled Workers)

0.16

0.14

0.12

0.1

0.08

0.06

0.04

0.02

Year