Description
It has long been observed that the labour markets of developing countries have distinguishing structural features. This view for example is embodied most famously in the "Lewisian" model of the less developed economy, which stressed that poor countries typically possess a small "modern" sector and a large "traditional" sector in which employment and wages are determined by principles that accord with convention and that are at variance with those determining employment and wages in the modern sector.
GLOBALISATION, LABOUR MARKETS, AND SOCIAL
OUTCOMES IN DEVELOPING COUNTRIES
Sanjay G. Reddy
(I) The Problem:
In this paper we seek to examine the relationship between globalisation in its current
form and social outcomes (in particular, poverty and inequality) in developing countries
with special reference to channels of causation that involve the effects of globalisation on
labour markets.
1
In particular, we focus on the effect of the current form of globalisation
on employment, wages, and working conditions, and thereby on poverty and inequality.
For purposes of this study, we take the current form of globalisation to be defined by a set
of policy changes that has reduced barriers to the integration of national economies, and
thereby induced such integration. In practice, the most important policy modifications
fostering the integration of national economies are those that have reduced barriers to
trade and to capital flows. The context of the study is the well-documented observation
that in the last two decades a "worldwide wave" of market-oriented reforms featuring
policy modifications of these types has swept the developing countries
2
.
(II) Relevant Specificities of Developing Country Labour
Markets:
It has long been observed that the labour markets of developing countries have
distinguishing structural features. This view for example is embodied most famously in
the "Lewisian" model of the less developed economy, which stressed that poor countries
typically possess a small "modern" sector and a large "traditional" sector in which
employment and wages are determined by principles that accord with convention and that
are at variance with those determining employment and wages in the modern sector.
3
Another (comparatively recent) "dual economy" view centres on the distinction between
the "formal" and "informal" economy. This distinction, which may be traced to Hart
(1973), and ILO (1972) emphasizes that some economic activities and enterprises are
formal in the sense that they take place in the context of official legal structures and
recognitions that make them susceptible to regulation, whereas others “take place beyond
1
I would like to thank Martha Chen and Marco Vivarelli for their invaluable comments.
2
See for instance Cornia (in this volume).
3
See Lewis (1954)
effective state regulation” [Hart (2001)]. It has frequently been supposed that formal
sector enterprises are likely to be larger and more capital-intensive and to possess greater
access to credit and other resources than do informal sector enterprises. It has also been
supposed that workers in the formal sector are likely to be more skilled, better paid, and
more likely to be provided with non-wage benefits such as the protection offered by
formal pension and social insurance systems. It has frequently been emphasized that the
mass of workers (particularly in the poorer developing countries) are likely to belong to
the informal sector, because the most accessible and prevalent livelihoods involving
agriculture, petty commerce, manufacturing and services are likely to be outside of the
ambit of direct state regulation.
4
The concept of “informal sector” is of course
inadequately precise. An important distinction, for instance, is that between informality
of enterprise and informality of employment. Formal sector enterprises can, for instance,
employ workers informally. Workers who are informally employed are unlikely to
benefit from the protections of those who are employed formally, whether or not they are
employed in informal enterprises.
These distinctions have been powerfully employed in characterizing and analysing the
specificities of developing country labour markets. However, they have been qualified
from at least two standpoints. First, it has been noted that developed countries also
possess the "structural dualism" that developing countries are characterized by, if to a
smaller degree
5
. Second, it has been noted that the distinction between sectors is more
muted then typically presumed. For example, there are typically significant and vital
practical inter-linkages (involving, for example involving employment and commercial
ties) between formal and informal sectors. Moreover, the extent to which enterprises are
subject to state regulation is typically a matter of degree rather than kind. Further, it
cannot be supposed that formal sector enterprises and workers are always more
privileged, although they most often are.
6
The presence of a significant informal sector in developing countries may limit the ability
of the state to foster improved conditions for workers through direct intervention, and
may require more creative approaches to this goal. Institutional provisions such as
minimum wages may reach only a small share of workers who are “covered” by these
provisions, and changes to such provisions may have complex general equilibrium effects
as a result [see e.g. Harrison and Leamer (1997) and the discussion later in this paper].
4
For a compelling statistical portrait of the scale and nature of informal sector employment in developing
countries, see ILO (2002).
5
See e.g. Gordon (1972). Note, however, that much of this literature appears to emphasize the
segmentation of labour markets into two types without emphasizing the segmentation of production into
two forms.
6
Formal sector entrepreneurs and enterprises may at times be unprivileged in their access to capital and
social networks, where informal sector entrepreneurs and enterprises may be privileged in their access to
the same resources. Similarly, workers in formal sector enterprises may not always possess conditions of
employment or pay that are superior to those of comparable workers in informal sector enterprises,
although this is usually the case. Some, such as Maloney (1997), have gone so far as to state that in many
respects “the informal sector behaves as an unregulated entrepreneurial sector, rather than the
disadvantaged sector of a dual economy”. This claim appears, however, to be based on analysis of a narrow
segment of the informal sector (relatively privileged entrepreneurial small enterprises), and not on the
broader category of the self-employed and informal sector workers.
Forms of universal social protection that reach all workers, regardless of the nature of the
enterprises in which they work and their employment contracts, are attractive
alternatives in such contexts.
An important feature of labour markets in the poorer developing countries is that wage-
productivity relationships are likely to be important. The presence of a relationship
between nutrition and productivity (as identified for instance by Smith (1776) and
Leibenstein (1963)) is one such relationship that can have important labour market
consequences. As demonstrated by Dasgupta and Ray (1986) in the presence of such a
relationship, self-reinforcing involuntary unemployment equilibria may arise. Those who
were once shut out of employment opportunities may find that they remain shut out,
because of the impact of their past history on their current productivity. Other
mechanisms of this type are related to the role of social networks in facilitating access to
employment and the role of skills generated through employment in making workers
more likely to be employed, or more employable. When past employment makes a
worker more employable, then the chronically unemployed may find it difficult to gain
access to remunerative work
Much previous literature in development economics has emphasized the role of
interlinkages between the labour market and other important markets (for example, those
for land and credit) that result from asymmetries of information and lacunae in contract
enforcement. The emphasis of this literature has been on noting the widespread existence
of long-term labour contracts whose terms are linked to those governing the provision of
other resources. These long-term contracts may impede the mobility of labour as well
as of other factors of production and influence the way in which wages and employment
respond to changes in economic conditions.
It is important to note that internal labour migration may take complex forms in
developing countries. For instance, Breman (1991,1996) has documented the existence of
complex social-network based regional and inter-regional flows of migration on the part
of unskilled workers. These flows abide by seasonal patterns and tie rural to urban areas
in concrete but shifting relationships. In such a setting, the assessment of the
employment and distributional consequences of policies must be undertaken with
consideration to what is known about these labour market dynamics.
The gendered nature of responsibilities for work, within the labour market, and within the
larger world of production, also requires consideration. As noted by Cagatai
(1998,1998b,2001), the disproportionate presence of women in particular segments of the
developing country labour market (particularly those involving export-oriented
production) implies that policies such as trade liberalisation can have gender-specific
effects. Moreover, the recourse to household production as a substitute for market
incomes makes women’s labour an important absorber of shocks experienced in the
formal labour market. These facts require recognition in an adequate distributional
analysis.
Finally, it is important to note that the role that labour market outcomes play in
determining the distribution of income will depend on the importance of non-wage
incomes. The historical process of proletarianisation is one in which wage incomes gain
nearly exclusive significance as a source of livelihood for increasing numbers of people.
In some developing countries, in which self-employment in agriculture, home production
and petty commerce is common, this process has not as yet advanced far.
7
The relevant specificities of developing country labour markets pointed to here are
regrettably not adequately taken in to account in much of the survey which follows,
which focusses disproportionately, by necessity of the fact that much of the existing
economic literature does so, on evidence concerning the level and distribution of wages
in formal sector non-agricultural employment. This blindness of the recent literature is
one of the major lacunae that must be overcome by future studies. In the absence of such
studies, the tendency to draw broad conclusions concerning the effects of globalisation on
labour markets in developing countries must be firmly resisted.
(III) Globalization: Pathways and Consequences
We focus in this section on current theory and evidence concerning the impact that the
package of policy reforms that we have referred to as globalization may have on
employment, wages and working conditions and thereby on poverty and inequality. We
focus in succession on revisions to policies concerning trade, policies concerning capital
markets, and policies concerning labour markets (which are of concern insofar as they
have been adopted in order to complement other policies aimed at fostering international
integration).
(a) Trade Policy Reforms
It has frequently been supposed that trade liberalization in developing countries would be
likely to reduce poverty and inequality. A variety of reasons have been adduced for this
conclusion. One reason is the belief, derived from the Stolper-Samuelson theorem of
Hecksher-Ohlin trade theory, that trade liberalization is likely to raise the real rate of
return to the factor of production that is relatively abundant in poor countries -- labour --
and lower the real rate of return to the factor of production that is relatively scarce in poor
countries -- capital. Insofar as the primary asset of the poor is labour, trade liberalization
is likely to raise the incomes of the poor and reduce poverty. Insofar as the primary asset
of the wealthy is capital, trade liberalization is also likely to lower inequality. This
conclusion has been extremely influential in the literature on international trade and
development, notwithstanding the fact that it is dependent on a number of premises of
questionable empirical validity (as noted for instance by Bhagwati and Dehejia (1994)).
For example, it has provided the basis of the belief (advocated for instance by Krueger et
al (1991)) that trade liberalization in poor countries possessing a significant agricultural
sector would be likely to benefit the mass of small farmers and landless labourers, as
7
See Unger (2002) for example, for the argument that proletarianisation is by no means a necessary
consequence of modernization.
trade barriers suppressed the prices of the agricultural goods that they produced and
raised the prices of the non-agricultural goods that they consumed. Another reason for
the belief that trade liberalization in developing countries would be likely to reduce
poverty and inequality has been the view that past protectionism has tended to benefit a
small and politically powerful "aristocracy of labour", present primarily in cities, and
representing those privileged enough to gain access to formal sector employment in
manufacturing enterprises. The costs of protecting this aristocracy of labour, it has been
argued, have fallen disproportionately on those consumers and workers (especially the
unskilled) who pay higher prices as a result of protection and face more limited
employment opportunities due to the bias that protectionism has created toward
employing resources in sectors that intensively employ capital and skilled labour. It has
been argued accordingly that trade liberalisation is likely to have raised the earnings of
the large mass of unskilled workers while lowering those of a small group of relatively
privileged workers in developing countries. Both of these arguments concern the static
distributional consequences of trade liberalisation. They identify a ‘one-time’ impact of
trade liberalisation on the pattern of earnings.
In addition to these static arguments, there exist dynamic arguments (see for example
Romer (1986), Romer and Rivera-Batiz (1991), and complementary empirical literature
by Sachs (1995), Frankel and Romer (1999)) that assert the role of trade liberalisation in
providing a basis for sustainable growth in aggregate incomes, and thereby in
employment and wages. Followers of these arguments emphasize that sustained
increases in aggregate income generated by trade are likely ultimately to cause a decrease
in poverty, although their impact on inequality is ambiguous. The focus of such
arguments is on the role of the enlarged markets and increased competitive pressures
created by trade in fostering ongoing technological improvements that facilitate sustained
growth. The tradition of making such arguments is lengthy (see for example Smith
(1776)). However, the mechanisms by which trade liberalisation can be expected to have
a sustained impact on growth remain surprisingly obscure.
These powerful arguments have provided the intellectual underpinning for trade
liberalization in developing countries. Are they right? The empirical record concerning
the impact of recent trade liberalization in developing countries appears to be mixed.
This paper will not consider further the general impact of trade liberalization on
aggregate income and growth, but rather will focus on the recent evidence concerning the
direct impact of trade liberalization on labour market outcomes. A number of careful
recent studies offer insights. Many of the studies, based on labour market surveys, focus
on the wage premium accorded to more skilled labour. Studies of this kind are
informative, but can offer only limited insight concerning the impact of trade
liberalization on the distribution of overall incomes, comprising non-wage as well as
wage income.
Harrison and Hanson (1999) note that wage inequality in Mexico (between skilled and
unskilled workers) has been increasing after trade liberalization, "which is puzzling in a
Hecksher-Ohlin context if Mexico has a comparative advantage in producing low skill-
intensive goods". Noting that Mexico “ experienced a substantial rise in the skill
premium and overall wage inequality following the trade reform of the mid-1980s",
Attanasio, Goldberg and Pavcnik (2002) go on to state that "while the causal link
between the Mexican trade liberalization and inequality was never established beyond
dispute, the chronological coincidence of the increase in wage dispersion with the trade
reforms was nevertheless a disappointment to those who hoped that globalization would
benefit the poor in developing countries". Indeed, Slaughter (2002) notes that in Mexico
the skill premium began “rising sharply the year of liberalization, after 20 years of steady
declines”. Attanasio, Goldberg and Pavcnik (2002) find that an increase in the wage
premium to skilled workers was also experienced in Colombia in the aftermath of
“drastic tariff reductions” in the 1980s and 1990s. Similarly, Pavcnik, Blom, Goldberg
and Schady (2002) find that increases in the wage premium to skilled workers have
accompanied trade liberalisation in Brazil. Building on the work of Robbins (1995,
1996), Slaughter (2002) reports that substantial increases in overall income-inequality
were experienced in a range of Latin American countries in the aftermath of trade
liberalization. This finding is consistent with the general observation of a pattern of
rising inequality in developing countries during the recent period of policy reforms.
There does not also appear to have been any substantial reduction in poverty in Latin
American countries in this period. The developing countries in which notable increases in
inequality have been experienced during periods of policy reform include India and
China (see Slaughter (2002)). Within both of these countries, differences in the extent to
which specific regions have gained from international trade appear to have played an
important role in widening inter-regional inequalities. The picture in regard to poverty
appears more promising. Substantial poverty reduction appears to have been experienced
over the past twenty years both in India and in China. However, in both cases the
increases in growth and poverty reduction experienced in the last two decades appear to
have preceded the onset of significant trade liberalization, suggesting that factors other
than trade may have played the central role.
The casual evidence seems to suggest that trade liberalization need not be linked (at least
over the time horizons studied) to reductions in either inequality or poverty. How can
this conclusion be satisfactorily reconciled with existing theory?
A first possibility is that the simplest version of the theory is wrong. The possibility that
the simplest "Stolper-Samuelson" picture of the consequences of trade liberalization may
be far too simple is suggested by the fact that many of the observed increases in skill
premia have taken place in middle-income developing countries, such as those in Latin
America. The Stolper-Samuelson conclusion emerges most unambiguously within a two-
commodity, two-good, two-factor model. In a real-world context, the presence of
multiple countries, factors and goods complicates the applicability of this conclusion. In
principle, the implications of trade liberalization for factor prices in middle-income
countries may be indeterminate in a more general setting. For instance, the impact of
trade liberalization on the wages of the unskilled in Mexico may be influenced by the
necessity to compete with (relatively more abundant) unskilled labour in China more than
it is by its ability to complete with (relatively less abundant) unskilled labour in the
United States. Furthermore, as Davis (1996) points out, if countries’ factor endowments
are sufficiently dissimilar that they do not inhabit a common “cone of diversification”
then the impact of trade liberalization on the return to a particular factor of production
may depend not on whether or not it is abundant in a global sense but rather on whether
or not it is abundant in a local sense. In particular, the effect of trade liberalization on the
rate of return to a factor of production may depend on whether or not that factor is
relatively more abundant in the country in question than it is in other countries whose
factor endowments belong within the same cone of diversification. This reasoning
implies that trade liberalization will have diverse and difficult to predict effects on
countries when there exist multiple cones of diversification and multiple countries
associated with each.
An important factor in middle-income developing countries and in the urban-industrial
sector in poor countries is that wage determination involves an element of rent-sharing.
Increased competition induced by international trade can lower firm-level rents and
increase firm-level elasticities of product demand, which in this case will cause a
lowering of bargained wages [see e.g. Reddy (2000)]. If tariffs fall most in those sectors
in which unskilled workers are disproportionately represented (as found in the case of
Mexico by Harrison and Hanson (1999)), then wage-bargaining associated reductions in
wage can lead to the increases in skill premia that have been widely observed.
Moreover, reductions in wages associated with trade liberalization [See Revenga (1997)
for evidence concerning the magnitude of such effects in Mexico] can be a major cause
of overall increases in income inequality.
A factor of considerable importance in certain poor countries is the presence of labour
surplus, along the lines specified by Lewis. In the context of labour surplus, unlike that
of full employment supposed in the standard theoretic setting, trade liberalization induced
increases in demand for unskilled labour need not give rise to significant increases in
wages of the unskilled, although they must give rise to increases in employment.
8
However, decreases in protection for the commodities produced by scarce skilled workers
ought still to give rise to decreases in the relative wages and employment of skilled
workers. However, as already noted, there is little evidence of this kind.
A second possibility is that the observed increases in inequality are due to factors other
than trade liberalization. After all, the theory predicts that trade liberalization will have
particular effects only when other features of the environment are unchanging. Needless
to say, in practice, other features of the environment change alongside changes in the
trade regime. Evidence that would permit the role of distinct factors to be identified
convincingly is scarce, but that which is available is suggestive. For example, Haouas,
Yagoubi and Heshmati (2002) find that in Tunisia increases in labour supply (especially
due to women’s entry in to the labour market) dampened increases in wages that would
otherwise have occurred due to trade liberalization. A causal factor that has been
extensively mentioned in the developed country literature on rising wage inequality is
“skill biased technological change”. Has technological change in developing countries
taken a form that has made skills more valuable and increased the wage premium
associated with them? It cannot be readily established that technological change rather
than trade is responsible for observed increases in wage inequalities, since as Slaughter
8
See Marglin (1976).
(2002) point out, it is quite possible that “liberalization induces technological change”.
9
Pavcnik et al (2002) find evidence of increasing use of skilled labour in the aftermath of
trade liberalization in Brazil. They interpret the evidence that "firms do not substitute
away from skilled labour given the higher relative price of hiring skilled workers" to
suggest that the ”economy wide skill premium cannot be attributed to Hecksher-Ohlin
adjustments to trade” (which would lower the demand for skilled labour), but rather that
“the evidence is however consistent with skill biased technological change". On the
other hand the authors state that "skill biased technological change... was concentrated in
sectors that experienced larger increase in import penetration. These results suggest
that skill-biased technological change could have been partially induced by changes in
foreign competition, so that trade liberalization may have had an indirect effect on the
rise of the skill premium". If skill biased technological change was merely accelerated by
trade liberalization, then the rise in inequalities associated with it may have been difficult
to avoid through alternative trade policies alone. Rising wage inequality is in principle
wholly consistent with rising wages for all. The impact of trade on the level of wages of
unskilled workers in developing countries is a subject that deserves further investigation.
Is trade liberalization a determinant of the level of informality in the labour market? This
hypothesis has gained currency as a result of the rise in informality in many developing
countries labour markets in the last two decades, contemporaneous with trade
liberalization. However, there seems to be little systematic data concerning the extent of
these relations.
10
However, anecdotal evidence suggests that subcontracting chains that
ultimately involve informal sector workers play an important role in North-South trade.
A fair conclusion is that the picture remains muddy, and that microeconomic evidence
concerning labour market outcomes does not suggest any grounds for complacency
concerning the effects of trade liberalization on either poverty or inequality in developing
countries.
(b) Capital Market Reforms
What are the effects of policies opening the way to increased foreign direct investment on
labour market conditions in developing countries? This question has been understudied
and is difficult definitively to address. At the macro-economic level, foreign direct
investment offers potential additional resources with which to undertake investment and
create employment. Moreover, to the extent that it brings about improvements in skills
and productivity, this may have a positive influence on wages. However, it is
controversial both to what extent foreign direct investment in fact provides net
investment resources, and to what extent it is associated with improvements in skills and
productivity [Singh (2003), Haddad and Harrison (1993)]. In any event, net foreign
9
“.Many .. researchers have argued that exports and imports transfer technology across countries; others
have argued that greater product-market competition spurs innovation in firms. That said, it has proved
difficult to find clear support for this liberalization-technology link”. [Slaughter, 2002]. See also Acemoglu
(2001), and Wood (1995).
10
Goldberg and Pavcnik (2002) report that they find no evidence of such a relationship in Brazil, and
limited evidence of such a relationship in Colombia.
direct investment inflows made up only one percent of GDP in low-income countries in
2000 (as compared with four percent in high-income countries and three percent in
middle-income countries). Similarly, net foreign direct investment flows made up only
two percent of gross capital formation in low-income countries in 2000 (as compared
with nineteen percent in high-income countries and thirteen percent in middle-income
countries).
11
Lall (in this volume) points out that the vast majority of foreign direct investment in
developing countries goes to a small number of recipients. There is also considerable
evidence that a large and increasing share of foreign direct investment is motivated by the
desire for cross-border mergers and acquisitions rather than fresh investment [Singh
(2003), Andersen and Hainaut (1998)]. For these reasons, the role of foreign direct
investment in generating employment in the developing countries should not be
exaggerated.
Conventional theory emphasizes that capital flows to poor countries are likely to raise
wages and increase employment (especially in the sectors employing capital intensively).
There is some evidence that higher wages are associated with foreign investment in
enterprises [see e.g. Aitken, Harrison and Lipsey (1995)]. On the other hand, it is likely
that the poorest and least skilled workers have limited access to such employment. The
work of Feenstra and Hanson (1996, 1997) emphasizes the role of FDI and trade
(outsourcing) in bringing about a worldwide relocation of marginal activities. The key
result is that this relocation "reduces the relative demand for unskilled labour, and this
result applies both to the more developed economy that is shedding production activities,
and to the developing economy that is receiving them. The reason is that the outsourced
activities are unskilled labour-intensive relative to those done in the developed economy,
but skilled labour-intensive relative to those done in the less developed economy.
Moving these activities from one country to the other raises the average skill-intensity of
production in both locations" [Feenstra, 1998]. As a result, FDI and trade can cause
increases in wage inequalities in developing countries, just as they may do in developed
countries.
Finally, when wages incorporate a rent sharing component, the possibility of relocating
production activities to lower wage locations can create opportunities for employers to
achieve reductions in the wages they bargain with their workers, even if they do not ever
actually take advantage of these opportunities for relocation. Reddy (2000)
demonstrates the possibility that such wage reductions through threat effects may arise,
and shows that they are likely to be concentrated in industries that have an intermediate
level of capital intensity. Reductions in bargained wages of this kind, associated with
outward capital mobility, may be of some importance in middle-income developing
countries, as they may be in developed countries.
It has been widely documented that in the last two decades, the share of inward capital
flows to developing countries that can be attributed to portfolio investment rather than to
foreign direct investment has substantially increased. As is widely known, various
11
World Development Indicators online, June 2003.
concerns have been attached to portfolio investment, especially relating to its volatility
and the potential macro-economic consequences of that volatility. Information
concerning the labour market consequences of financial crises generated by reversals of
capital flows is limited. We therefore confine ourselves to a brief account of recent
evidence concerning the distributional impact of financial crises.
Das and Mohapatra (2002) show that financial market liberalization (and in particular,
capital account liberalization) appears to be associated in a sample of developing
countries with increasing inequality in the distribution of income. In particular, they find
a pattern in which relative income gains are experienced by the top quintile of the income
distribution at the expense of the middle three quintiles of the income distribution. They
find that the share of income commanded by the lowest income quintile remained
unchanged. However, the small size of the sample makes it necessary to view these
conclusions as far from definitive. Diwan (2001) found, using a dataset incorporating 67
financial crises (51 of which took place outside the OECD) that financial crises are
associated with a "sharp" fall in the share of labour income in national income. Galbraith
and Lu (1999) find similarly, using a dataset involving 34 financial crises, that there is a
significant association between the occurrence of financial crisis and increases in
inequality in wage earnings, and that these increases are large and magnitude. A more
microeconomic view is provided by Levinsohn, Berry and Friedman (1999), who
demonstrate clearly on the basis of a study of differences in the detailed consumption
pattern of individuals inhabiting different income groups and regions, that in the
aftermath of financial crisis in Indonesia, the poor faced substantially higher increases in
cost-of-living than did others. The authors declare that "what is clear is that the notion
that the very poor are so poor as to be insulated from international shocks is simply
wrong. Rather, in the Indonesian case, the very poor appear the most vulnerable." This
conclusion is based simply on price effects, and does not incorporate the effect of the
financial crisis on employment and wages.
It may be concluded that the evidence concerning capital market reforms does not
suggest any grounds for complacency concerning their effects either on poverty or
inequality in developing countries.
(c) Labour Market Reforms
We address labour market reforms because of their connection to globalization in two
respects. First, many labour market reforms in developing countries have been
introduced as an element of a larger package of reforms that has included liberalization of
trade policies and capital markets. In many instances they have been introduced
specifically in order to support the success of those elements of the policy reform aimed
at greater external integration.
12
As such, they are an integral part of the thrust toward
globalization. Second, the impact of globalization is greatly dependent on the specific
12
See for instance Zagha (2000) and Rama (2003) for typical examples of the appeal for labour market
reforms as a complement to external market liberalisation.
features of labour markets. For this reason, it is necessary to study the implications of
labour market reforms, when investigating the impact of globalization.
Policy reforms aimed at attracting foreign capital, and at enabling the domestic economy
to adjust maximally so as to take advantage of opportunities for trade, have often
included an element of labour market liberalization. In particular, it has often been
advocated that restrictions on hiring and firing and on plant closures should be removed
as an aspect of the thrust for external market integration
13
. Although there is plentiful
anecdotal information on the consequences of such reforms, there is less by way of
concrete documentation. The arguments in favor of "labour market flexibility" in the
context of international integration are well-known. However, labour market flexibility
may have had more complicated implications then generally foreseen. Some recent
studies show that those who have lost formal sector employment as a result of policy
reforms in developing countries have often faced extended unemployment or downward
mobility, rather than being rapidly absorbed into the expanding sectors of a dynamic
post-liberalization economy, as hoped. These findings raise questions concerning the
nature of the employment impact of conventionally recommended labour market reforms
in developing countries. McMillan, Rodrik and Welch (2002) demonstrate that workers
displaced as a result of privatization and reform in the cashew sector in Mozambique
were thrown into a large pool of the already unemployed, and largely remained so. They
also point out that a very large share of the displaced employees were women, and reject
the idea that employees in the factories in which dislocation took place where “politically
powerful urban constituents" belonging to an aristocracy of labour. Similarly, Breman
(2003) has demonstrated that workers displaced due to the closure of textile mills in
Ahmedabad, India over time often suffered severe downward mobility. They typically
replaced their moderately well-paid formal sector employment with low-income informal
sector labour possessing little security.
The role of minimum wages in developing countries is controversial. It has been widely
proposed that minimum wages act inadvertently to increase unemployment. Although
the logic of this conventional prediction is well-known, it may be less widely applicable
than generally thought. Further, even if present, the employment-reducing effect of
minimum wages may offer less cause for concern than at first appearance. Even within
the textbook model of wage determination, the damaging effect of minimum wages on
employment is accompanied by its effect on increasing the wage of those who find work.
In developing countries, where intra-family and intra-community transfers of income are
common, it may well be the case that the net income of individuals is increased by the
application of a minimum wage. A recent World Bank study on Indonesia for example
finds that a recent doubling of the real value of Indonesia’s minimum wage lead to a 10%
increase in average wages and at 2% decrease in wage employment [Rama, 1996. See
also Alatas and Cameron (2003)].
14
With even moderate redistribution from the
13
Ibid.
14
A study for Columbia suggests that a 10% rise in the real value of the minimum wage reduced
employment of low-skilled workers by between 2 percent and 12 percent. In Mexico, a 45 percent change
in the minimum wage was not associated with any change in the level of employment [Harrison and
Leamer, 1997].
employed to the unemployed within communities or kinship groups, these elasticities
would imply that a minimum wage would increase the value of workers’ individual as
well as collective income. Another finding of the study is that the minimum wage
appears to have actually caused an increase in employment in large firms. One
interpretation as to why this is so, which is in keeping with the developed country
literature on minimum wages [e.g. Card and Krueger (1994)], is that large firms behave
like monopsonists in the labour market, as a result of which increases in the minimum
wage cause increases in wages and increases in employment. This theory is consistent
with the perception that there is widespread job queuing in developing countries such as
Indonesia. The study also finds that the elasticity of investment with respect to the
minimum wage is negative. On the other hand, the presence of positive wage-
productivity relationships in developing countries may cause increases in wages to give
rise to increases in productivity and output. These wage-productivity relationships may
be related to effort extraction [as suggested by Leamer and Harrison (1997)], nutrition or
health.
15
A central factor that differentiates the developing country experience of minimum wages
from the developed country experience is that rates of compliance with minimum wage
requirements are typically very low. Leamer and Harrison (1997) asks the interesting
question of what is the implication of these low coverage rates on the effect of minimum
wages. They point out that the possibility for production to take place in the “uncovered”
segment of a production sector implies that increases in the minimum wage that displace
workers may cause a decrease in the wage in the uncovered segment and a corresponding
increase in employment and production in the production sector as a whole. Whether
increases in minimum wages are a desirable policy will then dependent on what weights
are attached to the loss in employment and gain in wages in the covered segment as
against the gain in employment and decrease in wages in the uncovered segment.
The role of institutional factors, such as the capacity to form in to workplace collectives
and engage in collective bargaining is of considerable importance in determining the
labour market impact of globalisation. Suggestions that these act as deterrents to foreign
direct investment, and as impediments to the competitiveness of international trade may
often be misplaced. International trade can be based on the capabilities of an enterprise
and its workers rather than on labour cost advantages [as suggested by Lall (1992) and
Lazonick (1990)]. Collective organization in the workplace may foster technological
learning and thereby competitive advantage in the global marketplace. Whether or not
collective organization plays this role is not determined by the presence of collective
organization as such, but rather by its nature. Cooperative forms of workplace
organization that facilitate problem-solving can aid in the acquisition of competitive
advantage. Similarly, in the presence of wage productivity relationships associated with
nutrition and health, individual employers may not find it in their interest to invest in the
productivity of workers due to the difficulty of ensuring that these investments are not be
lost to other employers. In such circumstances, widespread improvements in wages and
15
The existence of such relationships has long been a central tenet of development economics. See for
example, Leibenstein (1963) and Dasgupta and Ray (1986).
working conditions brought about by workers’ organizations may generate gains for
employers and workers alike.
As demonstrated by Reddy (2000) the extent of workplace organization can be a critical
factor in determining the response of bargained wages and employment conditions to
competitive pressures arising from trade liberalization and capital market liberalization.
Reductions in bargained wages arising as a result of such competitive pressure will
generally be lower when coordination between workers across firms is greater. The
literature on institutions and labour market outcomes in developed countries also
demonstrates that labour unions have been a key factor in dampening wage inequalities
[see e.g. Abowd and Lemieux (1993), Card, Lemieux and Riddell (2003), Fortin and
Lemieux (1998)]. They have also played a historically important role in shaping the
"democratic trajectories" that have given rise to egalitarian outcomes in specific
developed societies, including some that have been relatively open to trade (such as those
of Scandinavia). [See e.g. Wallerstein and Moene (2002)]. The question for the future
concerns to what extent forms of worker organization can be found that overcome a
prevalent ‘corporatist’ model in developing countries in which labour unions act as
representatives of a small and privileged segment of the workforce, and act as a sclerotic
force that can cement inequalities and generate resistance to technological change.
(IV) Future Research Priorities and Implications for Public
Action
The existing literature on globalization and its social consequences in developing
countries has been based on a paucity of information. The literature attempting to
correlate aggregate level social outcomes with macro-economic and trade policy choices
is much better developed then that concerning how particular policy choices have
influenced microeconomic dynamics in the labour market and thereby individual well-
being. A major reason for the over-reliance on aggregate level data has been the lack of
adequate micro-level data suitable for the tracing of the pathways by which the current
form of globalisation affects social outcomes. Investment in the collection of appropriate
data concerning the reaction of firms, and individuals to changes in the policy
environment is essential if the gap in understanding is to be addressed. It is reassuring
that even with the limited data currently available, there has been substantial progress in
understanding the relations between globalization and social outcomes, with a more
realistic and nuanced picture of these relationships having emerged in recent years. It has
become increasingly clear that ideological nostrums of any kind concerning the impact of
the current form of globalisation on social outcomes are unhelpful. Existing research has
demonstrated that the actual record has been mixed at best. Future research can lead to a
better understanding of the diverse pathways that have given rise to this mixed record,
and thereby make possible better collective choices.
Dogmas concerning the role of trade liberalization or capital market liberalization in
reducing inequality or poverty have little justification on the basis either of recent
microeconomic evidence, or of a priori reasoning. Detailed study of labour market
experience in developing countries suggests reason for worry that the thrust toward
external market integration may in certain instances have contributed to increases in
inequality, and failed to contribute to poverty reduction. The state of knowledge suggests
caution in pursuing any one prescription, and recommends attention to complementary
measures. In particular, there is considerable room to pursue the improvement of levels
of employment, conditions of work and wages, as goals to be directly promoted through
appropriate policies and institutions.
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doc_628615466.pdf
It has long been observed that the labour markets of developing countries have distinguishing structural features. This view for example is embodied most famously in the "Lewisian" model of the less developed economy, which stressed that poor countries typically possess a small "modern" sector and a large "traditional" sector in which employment and wages are determined by principles that accord with convention and that are at variance with those determining employment and wages in the modern sector.
GLOBALISATION, LABOUR MARKETS, AND SOCIAL
OUTCOMES IN DEVELOPING COUNTRIES
Sanjay G. Reddy
(I) The Problem:
In this paper we seek to examine the relationship between globalisation in its current
form and social outcomes (in particular, poverty and inequality) in developing countries
with special reference to channels of causation that involve the effects of globalisation on
labour markets.
1
In particular, we focus on the effect of the current form of globalisation
on employment, wages, and working conditions, and thereby on poverty and inequality.
For purposes of this study, we take the current form of globalisation to be defined by a set
of policy changes that has reduced barriers to the integration of national economies, and
thereby induced such integration. In practice, the most important policy modifications
fostering the integration of national economies are those that have reduced barriers to
trade and to capital flows. The context of the study is the well-documented observation
that in the last two decades a "worldwide wave" of market-oriented reforms featuring
policy modifications of these types has swept the developing countries
2
.
(II) Relevant Specificities of Developing Country Labour
Markets:
It has long been observed that the labour markets of developing countries have
distinguishing structural features. This view for example is embodied most famously in
the "Lewisian" model of the less developed economy, which stressed that poor countries
typically possess a small "modern" sector and a large "traditional" sector in which
employment and wages are determined by principles that accord with convention and that
are at variance with those determining employment and wages in the modern sector.
3
Another (comparatively recent) "dual economy" view centres on the distinction between
the "formal" and "informal" economy. This distinction, which may be traced to Hart
(1973), and ILO (1972) emphasizes that some economic activities and enterprises are
formal in the sense that they take place in the context of official legal structures and
recognitions that make them susceptible to regulation, whereas others “take place beyond
1
I would like to thank Martha Chen and Marco Vivarelli for their invaluable comments.
2
See for instance Cornia (in this volume).
3
See Lewis (1954)
effective state regulation” [Hart (2001)]. It has frequently been supposed that formal
sector enterprises are likely to be larger and more capital-intensive and to possess greater
access to credit and other resources than do informal sector enterprises. It has also been
supposed that workers in the formal sector are likely to be more skilled, better paid, and
more likely to be provided with non-wage benefits such as the protection offered by
formal pension and social insurance systems. It has frequently been emphasized that the
mass of workers (particularly in the poorer developing countries) are likely to belong to
the informal sector, because the most accessible and prevalent livelihoods involving
agriculture, petty commerce, manufacturing and services are likely to be outside of the
ambit of direct state regulation.
4
The concept of “informal sector” is of course
inadequately precise. An important distinction, for instance, is that between informality
of enterprise and informality of employment. Formal sector enterprises can, for instance,
employ workers informally. Workers who are informally employed are unlikely to
benefit from the protections of those who are employed formally, whether or not they are
employed in informal enterprises.
These distinctions have been powerfully employed in characterizing and analysing the
specificities of developing country labour markets. However, they have been qualified
from at least two standpoints. First, it has been noted that developed countries also
possess the "structural dualism" that developing countries are characterized by, if to a
smaller degree
5
. Second, it has been noted that the distinction between sectors is more
muted then typically presumed. For example, there are typically significant and vital
practical inter-linkages (involving, for example involving employment and commercial
ties) between formal and informal sectors. Moreover, the extent to which enterprises are
subject to state regulation is typically a matter of degree rather than kind. Further, it
cannot be supposed that formal sector enterprises and workers are always more
privileged, although they most often are.
6
The presence of a significant informal sector in developing countries may limit the ability
of the state to foster improved conditions for workers through direct intervention, and
may require more creative approaches to this goal. Institutional provisions such as
minimum wages may reach only a small share of workers who are “covered” by these
provisions, and changes to such provisions may have complex general equilibrium effects
as a result [see e.g. Harrison and Leamer (1997) and the discussion later in this paper].
4
For a compelling statistical portrait of the scale and nature of informal sector employment in developing
countries, see ILO (2002).
5
See e.g. Gordon (1972). Note, however, that much of this literature appears to emphasize the
segmentation of labour markets into two types without emphasizing the segmentation of production into
two forms.
6
Formal sector entrepreneurs and enterprises may at times be unprivileged in their access to capital and
social networks, where informal sector entrepreneurs and enterprises may be privileged in their access to
the same resources. Similarly, workers in formal sector enterprises may not always possess conditions of
employment or pay that are superior to those of comparable workers in informal sector enterprises,
although this is usually the case. Some, such as Maloney (1997), have gone so far as to state that in many
respects “the informal sector behaves as an unregulated entrepreneurial sector, rather than the
disadvantaged sector of a dual economy”. This claim appears, however, to be based on analysis of a narrow
segment of the informal sector (relatively privileged entrepreneurial small enterprises), and not on the
broader category of the self-employed and informal sector workers.
Forms of universal social protection that reach all workers, regardless of the nature of the
enterprises in which they work and their employment contracts, are attractive
alternatives in such contexts.
An important feature of labour markets in the poorer developing countries is that wage-
productivity relationships are likely to be important. The presence of a relationship
between nutrition and productivity (as identified for instance by Smith (1776) and
Leibenstein (1963)) is one such relationship that can have important labour market
consequences. As demonstrated by Dasgupta and Ray (1986) in the presence of such a
relationship, self-reinforcing involuntary unemployment equilibria may arise. Those who
were once shut out of employment opportunities may find that they remain shut out,
because of the impact of their past history on their current productivity. Other
mechanisms of this type are related to the role of social networks in facilitating access to
employment and the role of skills generated through employment in making workers
more likely to be employed, or more employable. When past employment makes a
worker more employable, then the chronically unemployed may find it difficult to gain
access to remunerative work
Much previous literature in development economics has emphasized the role of
interlinkages between the labour market and other important markets (for example, those
for land and credit) that result from asymmetries of information and lacunae in contract
enforcement. The emphasis of this literature has been on noting the widespread existence
of long-term labour contracts whose terms are linked to those governing the provision of
other resources. These long-term contracts may impede the mobility of labour as well
as of other factors of production and influence the way in which wages and employment
respond to changes in economic conditions.
It is important to note that internal labour migration may take complex forms in
developing countries. For instance, Breman (1991,1996) has documented the existence of
complex social-network based regional and inter-regional flows of migration on the part
of unskilled workers. These flows abide by seasonal patterns and tie rural to urban areas
in concrete but shifting relationships. In such a setting, the assessment of the
employment and distributional consequences of policies must be undertaken with
consideration to what is known about these labour market dynamics.
The gendered nature of responsibilities for work, within the labour market, and within the
larger world of production, also requires consideration. As noted by Cagatai
(1998,1998b,2001), the disproportionate presence of women in particular segments of the
developing country labour market (particularly those involving export-oriented
production) implies that policies such as trade liberalisation can have gender-specific
effects. Moreover, the recourse to household production as a substitute for market
incomes makes women’s labour an important absorber of shocks experienced in the
formal labour market. These facts require recognition in an adequate distributional
analysis.
Finally, it is important to note that the role that labour market outcomes play in
determining the distribution of income will depend on the importance of non-wage
incomes. The historical process of proletarianisation is one in which wage incomes gain
nearly exclusive significance as a source of livelihood for increasing numbers of people.
In some developing countries, in which self-employment in agriculture, home production
and petty commerce is common, this process has not as yet advanced far.
7
The relevant specificities of developing country labour markets pointed to here are
regrettably not adequately taken in to account in much of the survey which follows,
which focusses disproportionately, by necessity of the fact that much of the existing
economic literature does so, on evidence concerning the level and distribution of wages
in formal sector non-agricultural employment. This blindness of the recent literature is
one of the major lacunae that must be overcome by future studies. In the absence of such
studies, the tendency to draw broad conclusions concerning the effects of globalisation on
labour markets in developing countries must be firmly resisted.
(III) Globalization: Pathways and Consequences
We focus in this section on current theory and evidence concerning the impact that the
package of policy reforms that we have referred to as globalization may have on
employment, wages and working conditions and thereby on poverty and inequality. We
focus in succession on revisions to policies concerning trade, policies concerning capital
markets, and policies concerning labour markets (which are of concern insofar as they
have been adopted in order to complement other policies aimed at fostering international
integration).
(a) Trade Policy Reforms
It has frequently been supposed that trade liberalization in developing countries would be
likely to reduce poverty and inequality. A variety of reasons have been adduced for this
conclusion. One reason is the belief, derived from the Stolper-Samuelson theorem of
Hecksher-Ohlin trade theory, that trade liberalization is likely to raise the real rate of
return to the factor of production that is relatively abundant in poor countries -- labour --
and lower the real rate of return to the factor of production that is relatively scarce in poor
countries -- capital. Insofar as the primary asset of the poor is labour, trade liberalization
is likely to raise the incomes of the poor and reduce poverty. Insofar as the primary asset
of the wealthy is capital, trade liberalization is also likely to lower inequality. This
conclusion has been extremely influential in the literature on international trade and
development, notwithstanding the fact that it is dependent on a number of premises of
questionable empirical validity (as noted for instance by Bhagwati and Dehejia (1994)).
For example, it has provided the basis of the belief (advocated for instance by Krueger et
al (1991)) that trade liberalization in poor countries possessing a significant agricultural
sector would be likely to benefit the mass of small farmers and landless labourers, as
7
See Unger (2002) for example, for the argument that proletarianisation is by no means a necessary
consequence of modernization.
trade barriers suppressed the prices of the agricultural goods that they produced and
raised the prices of the non-agricultural goods that they consumed. Another reason for
the belief that trade liberalization in developing countries would be likely to reduce
poverty and inequality has been the view that past protectionism has tended to benefit a
small and politically powerful "aristocracy of labour", present primarily in cities, and
representing those privileged enough to gain access to formal sector employment in
manufacturing enterprises. The costs of protecting this aristocracy of labour, it has been
argued, have fallen disproportionately on those consumers and workers (especially the
unskilled) who pay higher prices as a result of protection and face more limited
employment opportunities due to the bias that protectionism has created toward
employing resources in sectors that intensively employ capital and skilled labour. It has
been argued accordingly that trade liberalisation is likely to have raised the earnings of
the large mass of unskilled workers while lowering those of a small group of relatively
privileged workers in developing countries. Both of these arguments concern the static
distributional consequences of trade liberalisation. They identify a ‘one-time’ impact of
trade liberalisation on the pattern of earnings.
In addition to these static arguments, there exist dynamic arguments (see for example
Romer (1986), Romer and Rivera-Batiz (1991), and complementary empirical literature
by Sachs (1995), Frankel and Romer (1999)) that assert the role of trade liberalisation in
providing a basis for sustainable growth in aggregate incomes, and thereby in
employment and wages. Followers of these arguments emphasize that sustained
increases in aggregate income generated by trade are likely ultimately to cause a decrease
in poverty, although their impact on inequality is ambiguous. The focus of such
arguments is on the role of the enlarged markets and increased competitive pressures
created by trade in fostering ongoing technological improvements that facilitate sustained
growth. The tradition of making such arguments is lengthy (see for example Smith
(1776)). However, the mechanisms by which trade liberalisation can be expected to have
a sustained impact on growth remain surprisingly obscure.
These powerful arguments have provided the intellectual underpinning for trade
liberalization in developing countries. Are they right? The empirical record concerning
the impact of recent trade liberalization in developing countries appears to be mixed.
This paper will not consider further the general impact of trade liberalization on
aggregate income and growth, but rather will focus on the recent evidence concerning the
direct impact of trade liberalization on labour market outcomes. A number of careful
recent studies offer insights. Many of the studies, based on labour market surveys, focus
on the wage premium accorded to more skilled labour. Studies of this kind are
informative, but can offer only limited insight concerning the impact of trade
liberalization on the distribution of overall incomes, comprising non-wage as well as
wage income.
Harrison and Hanson (1999) note that wage inequality in Mexico (between skilled and
unskilled workers) has been increasing after trade liberalization, "which is puzzling in a
Hecksher-Ohlin context if Mexico has a comparative advantage in producing low skill-
intensive goods". Noting that Mexico “ experienced a substantial rise in the skill
premium and overall wage inequality following the trade reform of the mid-1980s",
Attanasio, Goldberg and Pavcnik (2002) go on to state that "while the causal link
between the Mexican trade liberalization and inequality was never established beyond
dispute, the chronological coincidence of the increase in wage dispersion with the trade
reforms was nevertheless a disappointment to those who hoped that globalization would
benefit the poor in developing countries". Indeed, Slaughter (2002) notes that in Mexico
the skill premium began “rising sharply the year of liberalization, after 20 years of steady
declines”. Attanasio, Goldberg and Pavcnik (2002) find that an increase in the wage
premium to skilled workers was also experienced in Colombia in the aftermath of
“drastic tariff reductions” in the 1980s and 1990s. Similarly, Pavcnik, Blom, Goldberg
and Schady (2002) find that increases in the wage premium to skilled workers have
accompanied trade liberalisation in Brazil. Building on the work of Robbins (1995,
1996), Slaughter (2002) reports that substantial increases in overall income-inequality
were experienced in a range of Latin American countries in the aftermath of trade
liberalization. This finding is consistent with the general observation of a pattern of
rising inequality in developing countries during the recent period of policy reforms.
There does not also appear to have been any substantial reduction in poverty in Latin
American countries in this period. The developing countries in which notable increases in
inequality have been experienced during periods of policy reform include India and
China (see Slaughter (2002)). Within both of these countries, differences in the extent to
which specific regions have gained from international trade appear to have played an
important role in widening inter-regional inequalities. The picture in regard to poverty
appears more promising. Substantial poverty reduction appears to have been experienced
over the past twenty years both in India and in China. However, in both cases the
increases in growth and poverty reduction experienced in the last two decades appear to
have preceded the onset of significant trade liberalization, suggesting that factors other
than trade may have played the central role.
The casual evidence seems to suggest that trade liberalization need not be linked (at least
over the time horizons studied) to reductions in either inequality or poverty. How can
this conclusion be satisfactorily reconciled with existing theory?
A first possibility is that the simplest version of the theory is wrong. The possibility that
the simplest "Stolper-Samuelson" picture of the consequences of trade liberalization may
be far too simple is suggested by the fact that many of the observed increases in skill
premia have taken place in middle-income developing countries, such as those in Latin
America. The Stolper-Samuelson conclusion emerges most unambiguously within a two-
commodity, two-good, two-factor model. In a real-world context, the presence of
multiple countries, factors and goods complicates the applicability of this conclusion. In
principle, the implications of trade liberalization for factor prices in middle-income
countries may be indeterminate in a more general setting. For instance, the impact of
trade liberalization on the wages of the unskilled in Mexico may be influenced by the
necessity to compete with (relatively more abundant) unskilled labour in China more than
it is by its ability to complete with (relatively less abundant) unskilled labour in the
United States. Furthermore, as Davis (1996) points out, if countries’ factor endowments
are sufficiently dissimilar that they do not inhabit a common “cone of diversification”
then the impact of trade liberalization on the return to a particular factor of production
may depend not on whether or not it is abundant in a global sense but rather on whether
or not it is abundant in a local sense. In particular, the effect of trade liberalization on the
rate of return to a factor of production may depend on whether or not that factor is
relatively more abundant in the country in question than it is in other countries whose
factor endowments belong within the same cone of diversification. This reasoning
implies that trade liberalization will have diverse and difficult to predict effects on
countries when there exist multiple cones of diversification and multiple countries
associated with each.
An important factor in middle-income developing countries and in the urban-industrial
sector in poor countries is that wage determination involves an element of rent-sharing.
Increased competition induced by international trade can lower firm-level rents and
increase firm-level elasticities of product demand, which in this case will cause a
lowering of bargained wages [see e.g. Reddy (2000)]. If tariffs fall most in those sectors
in which unskilled workers are disproportionately represented (as found in the case of
Mexico by Harrison and Hanson (1999)), then wage-bargaining associated reductions in
wage can lead to the increases in skill premia that have been widely observed.
Moreover, reductions in wages associated with trade liberalization [See Revenga (1997)
for evidence concerning the magnitude of such effects in Mexico] can be a major cause
of overall increases in income inequality.
A factor of considerable importance in certain poor countries is the presence of labour
surplus, along the lines specified by Lewis. In the context of labour surplus, unlike that
of full employment supposed in the standard theoretic setting, trade liberalization induced
increases in demand for unskilled labour need not give rise to significant increases in
wages of the unskilled, although they must give rise to increases in employment.
8
However, decreases in protection for the commodities produced by scarce skilled workers
ought still to give rise to decreases in the relative wages and employment of skilled
workers. However, as already noted, there is little evidence of this kind.
A second possibility is that the observed increases in inequality are due to factors other
than trade liberalization. After all, the theory predicts that trade liberalization will have
particular effects only when other features of the environment are unchanging. Needless
to say, in practice, other features of the environment change alongside changes in the
trade regime. Evidence that would permit the role of distinct factors to be identified
convincingly is scarce, but that which is available is suggestive. For example, Haouas,
Yagoubi and Heshmati (2002) find that in Tunisia increases in labour supply (especially
due to women’s entry in to the labour market) dampened increases in wages that would
otherwise have occurred due to trade liberalization. A causal factor that has been
extensively mentioned in the developed country literature on rising wage inequality is
“skill biased technological change”. Has technological change in developing countries
taken a form that has made skills more valuable and increased the wage premium
associated with them? It cannot be readily established that technological change rather
than trade is responsible for observed increases in wage inequalities, since as Slaughter
8
See Marglin (1976).
(2002) point out, it is quite possible that “liberalization induces technological change”.
9
Pavcnik et al (2002) find evidence of increasing use of skilled labour in the aftermath of
trade liberalization in Brazil. They interpret the evidence that "firms do not substitute
away from skilled labour given the higher relative price of hiring skilled workers" to
suggest that the ”economy wide skill premium cannot be attributed to Hecksher-Ohlin
adjustments to trade” (which would lower the demand for skilled labour), but rather that
“the evidence is however consistent with skill biased technological change". On the
other hand the authors state that "skill biased technological change... was concentrated in
sectors that experienced larger increase
that skill-biased technological change could have been partially induced by changes in
foreign competition, so that trade liberalization may have had an indirect effect on the
rise of the skill premium". If skill biased technological change was merely accelerated by
trade liberalization, then the rise in inequalities associated with it may have been difficult
to avoid through alternative trade policies alone. Rising wage inequality is in principle
wholly consistent with rising wages for all. The impact of trade on the level of wages of
unskilled workers in developing countries is a subject that deserves further investigation.
Is trade liberalization a determinant of the level of informality in the labour market? This
hypothesis has gained currency as a result of the rise in informality in many developing
countries labour markets in the last two decades, contemporaneous with trade
liberalization. However, there seems to be little systematic data concerning the extent of
these relations.
10
However, anecdotal evidence suggests that subcontracting chains that
ultimately involve informal sector workers play an important role in North-South trade.
A fair conclusion is that the picture remains muddy, and that microeconomic evidence
concerning labour market outcomes does not suggest any grounds for complacency
concerning the effects of trade liberalization on either poverty or inequality in developing
countries.
(b) Capital Market Reforms
What are the effects of policies opening the way to increased foreign direct investment on
labour market conditions in developing countries? This question has been understudied
and is difficult definitively to address. At the macro-economic level, foreign direct
investment offers potential additional resources with which to undertake investment and
create employment. Moreover, to the extent that it brings about improvements in skills
and productivity, this may have a positive influence on wages. However, it is
controversial both to what extent foreign direct investment in fact provides net
investment resources, and to what extent it is associated with improvements in skills and
productivity [Singh (2003), Haddad and Harrison (1993)]. In any event, net foreign
9
“.Many .. researchers have argued that exports and imports transfer technology across countries; others
have argued that greater product-market competition spurs innovation in firms. That said, it has proved
difficult to find clear support for this liberalization-technology link”. [Slaughter, 2002]. See also Acemoglu
(2001), and Wood (1995).
10
Goldberg and Pavcnik (2002) report that they find no evidence of such a relationship in Brazil, and
limited evidence of such a relationship in Colombia.
direct investment inflows made up only one percent of GDP in low-income countries in
2000 (as compared with four percent in high-income countries and three percent in
middle-income countries). Similarly, net foreign direct investment flows made up only
two percent of gross capital formation in low-income countries in 2000 (as compared
with nineteen percent in high-income countries and thirteen percent in middle-income
countries).
11
Lall (in this volume) points out that the vast majority of foreign direct investment in
developing countries goes to a small number of recipients. There is also considerable
evidence that a large and increasing share of foreign direct investment is motivated by the
desire for cross-border mergers and acquisitions rather than fresh investment [Singh
(2003), Andersen and Hainaut (1998)]. For these reasons, the role of foreign direct
investment in generating employment in the developing countries should not be
exaggerated.
Conventional theory emphasizes that capital flows to poor countries are likely to raise
wages and increase employment (especially in the sectors employing capital intensively).
There is some evidence that higher wages are associated with foreign investment in
enterprises [see e.g. Aitken, Harrison and Lipsey (1995)]. On the other hand, it is likely
that the poorest and least skilled workers have limited access to such employment. The
work of Feenstra and Hanson (1996, 1997) emphasizes the role of FDI and trade
(outsourcing) in bringing about a worldwide relocation of marginal activities. The key
result is that this relocation "reduces the relative demand for unskilled labour, and this
result applies both to the more developed economy that is shedding production activities,
and to the developing economy that is receiving them. The reason is that the outsourced
activities are unskilled labour-intensive relative to those done in the developed economy,
but skilled labour-intensive relative to those done in the less developed economy.
Moving these activities from one country to the other raises the average skill-intensity of
production in both locations" [Feenstra, 1998]. As a result, FDI and trade can cause
increases in wage inequalities in developing countries, just as they may do in developed
countries.
Finally, when wages incorporate a rent sharing component, the possibility of relocating
production activities to lower wage locations can create opportunities for employers to
achieve reductions in the wages they bargain with their workers, even if they do not ever
actually take advantage of these opportunities for relocation. Reddy (2000)
demonstrates the possibility that such wage reductions through threat effects may arise,
and shows that they are likely to be concentrated in industries that have an intermediate
level of capital intensity. Reductions in bargained wages of this kind, associated with
outward capital mobility, may be of some importance in middle-income developing
countries, as they may be in developed countries.
It has been widely documented that in the last two decades, the share of inward capital
flows to developing countries that can be attributed to portfolio investment rather than to
foreign direct investment has substantially increased. As is widely known, various
11
World Development Indicators online, June 2003.
concerns have been attached to portfolio investment, especially relating to its volatility
and the potential macro-economic consequences of that volatility. Information
concerning the labour market consequences of financial crises generated by reversals of
capital flows is limited. We therefore confine ourselves to a brief account of recent
evidence concerning the distributional impact of financial crises.
Das and Mohapatra (2002) show that financial market liberalization (and in particular,
capital account liberalization) appears to be associated in a sample of developing
countries with increasing inequality in the distribution of income. In particular, they find
a pattern in which relative income gains are experienced by the top quintile of the income
distribution at the expense of the middle three quintiles of the income distribution. They
find that the share of income commanded by the lowest income quintile remained
unchanged. However, the small size of the sample makes it necessary to view these
conclusions as far from definitive. Diwan (2001) found, using a dataset incorporating 67
financial crises (51 of which took place outside the OECD) that financial crises are
associated with a "sharp" fall in the share of labour income in national income. Galbraith
and Lu (1999) find similarly, using a dataset involving 34 financial crises, that there is a
significant association between the occurrence of financial crisis and increases in
inequality in wage earnings, and that these increases are large and magnitude. A more
microeconomic view is provided by Levinsohn, Berry and Friedman (1999), who
demonstrate clearly on the basis of a study of differences in the detailed consumption
pattern of individuals inhabiting different income groups and regions, that in the
aftermath of financial crisis in Indonesia, the poor faced substantially higher increases in
cost-of-living than did others. The authors declare that "what is clear is that the notion
that the very poor are so poor as to be insulated from international shocks is simply
wrong. Rather, in the Indonesian case, the very poor appear the most vulnerable." This
conclusion is based simply on price effects, and does not incorporate the effect of the
financial crisis on employment and wages.
It may be concluded that the evidence concerning capital market reforms does not
suggest any grounds for complacency concerning their effects either on poverty or
inequality in developing countries.
(c) Labour Market Reforms
We address labour market reforms because of their connection to globalization in two
respects. First, many labour market reforms in developing countries have been
introduced as an element of a larger package of reforms that has included liberalization of
trade policies and capital markets. In many instances they have been introduced
specifically in order to support the success of those elements of the policy reform aimed
at greater external integration.
12
As such, they are an integral part of the thrust toward
globalization. Second, the impact of globalization is greatly dependent on the specific
12
See for instance Zagha (2000) and Rama (2003) for typical examples of the appeal for labour market
reforms as a complement to external market liberalisation.
features of labour markets. For this reason, it is necessary to study the implications of
labour market reforms, when investigating the impact of globalization.
Policy reforms aimed at attracting foreign capital, and at enabling the domestic economy
to adjust maximally so as to take advantage of opportunities for trade, have often
included an element of labour market liberalization. In particular, it has often been
advocated that restrictions on hiring and firing and on plant closures should be removed
as an aspect of the thrust for external market integration
13
. Although there is plentiful
anecdotal information on the consequences of such reforms, there is less by way of
concrete documentation. The arguments in favor of "labour market flexibility" in the
context of international integration are well-known. However, labour market flexibility
may have had more complicated implications then generally foreseen. Some recent
studies show that those who have lost formal sector employment as a result of policy
reforms in developing countries have often faced extended unemployment or downward
mobility, rather than being rapidly absorbed into the expanding sectors of a dynamic
post-liberalization economy, as hoped. These findings raise questions concerning the
nature of the employment impact of conventionally recommended labour market reforms
in developing countries. McMillan, Rodrik and Welch (2002) demonstrate that workers
displaced as a result of privatization and reform in the cashew sector in Mozambique
were thrown into a large pool of the already unemployed, and largely remained so. They
also point out that a very large share of the displaced employees were women, and reject
the idea that employees in the factories in which dislocation took place where “politically
powerful urban constituents" belonging to an aristocracy of labour. Similarly, Breman
(2003) has demonstrated that workers displaced due to the closure of textile mills in
Ahmedabad, India over time often suffered severe downward mobility. They typically
replaced their moderately well-paid formal sector employment with low-income informal
sector labour possessing little security.
The role of minimum wages in developing countries is controversial. It has been widely
proposed that minimum wages act inadvertently to increase unemployment. Although
the logic of this conventional prediction is well-known, it may be less widely applicable
than generally thought. Further, even if present, the employment-reducing effect of
minimum wages may offer less cause for concern than at first appearance. Even within
the textbook model of wage determination, the damaging effect of minimum wages on
employment is accompanied by its effect on increasing the wage of those who find work.
In developing countries, where intra-family and intra-community transfers of income are
common, it may well be the case that the net income of individuals is increased by the
application of a minimum wage. A recent World Bank study on Indonesia for example
finds that a recent doubling of the real value of Indonesia’s minimum wage lead to a 10%
increase in average wages and at 2% decrease in wage employment [Rama, 1996. See
also Alatas and Cameron (2003)].
14
With even moderate redistribution from the
13
Ibid.
14
A study for Columbia suggests that a 10% rise in the real value of the minimum wage reduced
employment of low-skilled workers by between 2 percent and 12 percent. In Mexico, a 45 percent change
in the minimum wage was not associated with any change in the level of employment [Harrison and
Leamer, 1997].
employed to the unemployed within communities or kinship groups, these elasticities
would imply that a minimum wage would increase the value of workers’ individual as
well as collective income. Another finding of the study is that the minimum wage
appears to have actually caused an increase in employment in large firms. One
interpretation as to why this is so, which is in keeping with the developed country
literature on minimum wages [e.g. Card and Krueger (1994)], is that large firms behave
like monopsonists in the labour market, as a result of which increases in the minimum
wage cause increases in wages and increases in employment. This theory is consistent
with the perception that there is widespread job queuing in developing countries such as
Indonesia. The study also finds that the elasticity of investment with respect to the
minimum wage is negative. On the other hand, the presence of positive wage-
productivity relationships in developing countries may cause increases in wages to give
rise to increases in productivity and output. These wage-productivity relationships may
be related to effort extraction [as suggested by Leamer and Harrison (1997)], nutrition or
health.
15
A central factor that differentiates the developing country experience of minimum wages
from the developed country experience is that rates of compliance with minimum wage
requirements are typically very low. Leamer and Harrison (1997) asks the interesting
question of what is the implication of these low coverage rates on the effect of minimum
wages. They point out that the possibility for production to take place in the “uncovered”
segment of a production sector implies that increases in the minimum wage that displace
workers may cause a decrease in the wage in the uncovered segment and a corresponding
increase in employment and production in the production sector as a whole. Whether
increases in minimum wages are a desirable policy will then dependent on what weights
are attached to the loss in employment and gain in wages in the covered segment as
against the gain in employment and decrease in wages in the uncovered segment.
The role of institutional factors, such as the capacity to form in to workplace collectives
and engage in collective bargaining is of considerable importance in determining the
labour market impact of globalisation. Suggestions that these act as deterrents to foreign
direct investment, and as impediments to the competitiveness of international trade may
often be misplaced. International trade can be based on the capabilities of an enterprise
and its workers rather than on labour cost advantages [as suggested by Lall (1992) and
Lazonick (1990)]. Collective organization in the workplace may foster technological
learning and thereby competitive advantage in the global marketplace. Whether or not
collective organization plays this role is not determined by the presence of collective
organization as such, but rather by its nature. Cooperative forms of workplace
organization that facilitate problem-solving can aid in the acquisition of competitive
advantage. Similarly, in the presence of wage productivity relationships associated with
nutrition and health, individual employers may not find it in their interest to invest in the
productivity of workers due to the difficulty of ensuring that these investments are not be
lost to other employers. In such circumstances, widespread improvements in wages and
15
The existence of such relationships has long been a central tenet of development economics. See for
example, Leibenstein (1963) and Dasgupta and Ray (1986).
working conditions brought about by workers’ organizations may generate gains for
employers and workers alike.
As demonstrated by Reddy (2000) the extent of workplace organization can be a critical
factor in determining the response of bargained wages and employment conditions to
competitive pressures arising from trade liberalization and capital market liberalization.
Reductions in bargained wages arising as a result of such competitive pressure will
generally be lower when coordination between workers across firms is greater. The
literature on institutions and labour market outcomes in developed countries also
demonstrates that labour unions have been a key factor in dampening wage inequalities
[see e.g. Abowd and Lemieux (1993), Card, Lemieux and Riddell (2003), Fortin and
Lemieux (1998)]. They have also played a historically important role in shaping the
"democratic trajectories" that have given rise to egalitarian outcomes in specific
developed societies, including some that have been relatively open to trade (such as those
of Scandinavia). [See e.g. Wallerstein and Moene (2002)]. The question for the future
concerns to what extent forms of worker organization can be found that overcome a
prevalent ‘corporatist’ model in developing countries in which labour unions act as
representatives of a small and privileged segment of the workforce, and act as a sclerotic
force that can cement inequalities and generate resistance to technological change.
(IV) Future Research Priorities and Implications for Public
Action
The existing literature on globalization and its social consequences in developing
countries has been based on a paucity of information. The literature attempting to
correlate aggregate level social outcomes with macro-economic and trade policy choices
is much better developed then that concerning how particular policy choices have
influenced microeconomic dynamics in the labour market and thereby individual well-
being. A major reason for the over-reliance on aggregate level data has been the lack of
adequate micro-level data suitable for the tracing of the pathways by which the current
form of globalisation affects social outcomes. Investment in the collection of appropriate
data concerning the reaction of firms, and individuals to changes in the policy
environment is essential if the gap in understanding is to be addressed. It is reassuring
that even with the limited data currently available, there has been substantial progress in
understanding the relations between globalization and social outcomes, with a more
realistic and nuanced picture of these relationships having emerged in recent years. It has
become increasingly clear that ideological nostrums of any kind concerning the impact of
the current form of globalisation on social outcomes are unhelpful. Existing research has
demonstrated that the actual record has been mixed at best. Future research can lead to a
better understanding of the diverse pathways that have given rise to this mixed record,
and thereby make possible better collective choices.
Dogmas concerning the role of trade liberalization or capital market liberalization in
reducing inequality or poverty have little justification on the basis either of recent
microeconomic evidence, or of a priori reasoning. Detailed study of labour market
experience in developing countries suggests reason for worry that the thrust toward
external market integration may in certain instances have contributed to increases in
inequality, and failed to contribute to poverty reduction. The state of knowledge suggests
caution in pursuing any one prescription, and recommends attention to complementary
measures. In particular, there is considerable room to pursue the improvement of levels
of employment, conditions of work and wages, as goals to be directly promoted through
appropriate policies and institutions.
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