Distributional Effects of Trade Liberalisation on Wages in India
| Published date | 01 February 2025 |
| DOI | http://doi.org/10.1177/00157325221126588 |
| Author | Nidhi Dhamija |
| Date | 01 February 2025 |
Distributional Effects of
Trade Liberalisation on
Wages in India
Nidhi Dhamija1
Abstract
There is a high level of policy interest on the effect of trade liberalisation on
inequality, especially in developing countries, because of their large vulnerable
populations. India also initiated the process of liberalisation as a response to
the severe balance of payments crisis of 1991. However, both rural and urban
inequality has been increasing since the period 1993–1994, with urban inequality
increasing at a higher rate. This study empirically examines the impact of trade
openness on wage inequality using panel data for Indian states (separately for
rural and urban areas). The results of this study indicate that trade openness
does not lead to decrease in the wage inequality in the states and their rural
areas. However, urban wage inequality is found to be increasing due to trade
openness. These results are analysed and explained by various factors present in
the Indian economy such as, skill biased technological changes; trade in interme-
diate goods; barriers to domestic labour mobility; and pattern and composition
of India’s exports. An interesting aspect emerging is that higher education levels
lead to increase in wage inequality as returns to education and inequality are
increasing and the increase is also attributed to liberalisation.
JEL Codes: F16, O18, C23
Keywords
Trade, wage inequality, Gini coefficient, panel regression
Introduction
The relationship between trade liberalisation and factor markets was historically
studied using the Hecksher–Ohlin (HO) and Stolper Samuelson (SS) theorems.
These trade theories predict that openness would push up the relative demand for
Original Article
Foreign Trade Review
60(1) 54–82, 2025
© 2022 Indian Institute of
Foreign Trade
Article reuse guidelines:
in.sagepub.com/journals-permissions-india
DOI: 10.1177/00157325221126588
journals.sagepub.com/home/ftr
1 Economics Department, Hindu College, University of Delhi, New Delhi, Delhi, India.
Corresponding author:
Nidhi Dhamija, Economics Department, Hindu College, University of Delhi, New Delhi, Delhi
110007, India.
Emails: dhamijanidhi@yahoo.com; nidhidhamija@hinducollege.ac.in
Dhamija 55
unskilled labour and their wages, thus reducing the wage inequality in unskilled
labour abundant developing countries and increasing it in skilled labour abundant
developed countries. However, the inequality (especially within-country inequal-
ity) in both developed and developing countries experienced an increasing trend
over the past two to three decades (Harrison et al., 2010). There is also enough
evidence showing increase in income inequality between developed and develop-
ing countries due to transfer of resources from developing to developed countries
as a consequence of trade (Chishti, 2002).
Most of the empirical studies have found trade liberalisation to be associated
with higher wage inequality and other broader measures of inequality (Golberg &
Pavcnik, 2004; 2007). In the liberalised world, increased wage inequality and in
a broader sense income inequality is appearing as a common phenomenon across
countries. Various attempts have been also been made to explain this trend by
developments in the theoretical literature.
This study attempts to analyse the relationship between trade openness and wage
inequality in India. The empirical analysis is carried out using data for 21 major
states and also separately for its rural and urban sectors. The data for the period
after trade liberalisation, that is, after the year 1991 is considered from the five
thick rounds for the years 1993–1994, 1999–2000, 2004–2005, 2009–2010 and
2011–2012 of Employment and Unemployment surveys of NSSO. The analysis
covers the entire economy (agriculture, organised and unorganised manufacturing
and services) by looking at wage inequality in rural and urban sectors of the states.
The results indicate no evidence of wage inequality in the rural sector and the
state as a whole to be impacted significantly by the trade openness. A significant
and positive impact is observed for the urban sector. This impact is also not affected
by the presence of more flexible labour market institutions in the states. There are
other important determinants found to be impacting wage inequality in India such as
growth rate, literacy rate and higher education levels of the population.
The study is structured as follows: the second section gives a brief review of both
theoretical and empirical studies and provides the descriptive statistics of wage ine-
quality in India. The third section presents model and methodology adopted along
with definitions of variables and sources used to collect data. The fourth section
discusses results and their robustness; and the fifth section concludes.
Theoretical and Empirical Evidences
Theoretical Literature on the Impact of Trade on Wage Inequality
In terms of the impact on wage inequality, Factor Price Equalisation theorem implies
that as a result of openness, wage inequality would fall in a unskilled labour abun-
dant developing country and would increase in a skilled labour abundant developed
country. However, contrary to these traditional theories of international trade, the
inequality (especially within-country inequality) in both developed and developing
countries have experienced an increasing trend over the past two to three decades
(Harrison et al., 2010). There have been widespread theoretical developments trying
to explain this trend, which can be classified into three categories:
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