The education bias of 'trade liberalization' and wage inequality in developing countries

The aim of this paper is to examine the impact of increased trade on wage inequality in developing countries, and whether a higher human capital stock moderates this effect. We look at the skilled-unskilled wage differential. High initial endowments of human capital imply a more egalitarian society. When more equal societies open up their economies further, increased trade is likely to induce less inequality on impact because the supply of skills better matches demand. But greater international exposure also brings about technological diffusion, further raising skilled labour demand. This may raise wage inequality, in contrast to the initial egalitarian level effect of human capital. We attempt to measure these two opposing forces. We also employ a broad set of openness indicators to measure trade liberalization policies as well as general openness, which is an outcome, and not a policy variable. We further examine what type of education most reduces inequality. Our findings suggest that countries with a higher level of initial human capital do well on the inequality front, but human capital which accrues through the trade liberalization channel has inegalitarian effects. One explanation could be that governments in developing countries invest more in higher education at the expense of primary education in order to gain immediate benefits from globalization; thus becoming prone to wage inequality after increased international trade. Our results also have implications for the speed at which trade policies are liberalized, the implication being that better educated nations should liberalize faster.