Trade Liberalization and Wage Inequality: Empirical Evidence from Bangladesh

Abstract

The prediction of standard economic theory that trade liberalization reduces income inequality in developing countries has been challenged by several studies during recent decades. This paper explores this issue by analyzing the relationship between trade liberalization and skilled-unskilled wage inequality in the Bangladesh cotton textile industry. First cointegration analysis is used to test for long-run relationships between real wages and trade liberalization over the period 1971- 2010, and then a two-equation error correction model is estimated for wages of skilled and unskilled workers. Trade liberalization, proxied by the evolution of Bangladesh’s international trade, is associated with increased real wages for both skilled and unskilled workers. The relative skilled-unskilled workers’ wage fluctuates over the study period, but it has no trend and is not related to increased openness. Trade liberalization thus seems to have increased labor productivity in the cotton textile industry without any noticeable effects on wage inequality.