While an increasing number of developing economies are engaging in trade
liberalisation, its impact on wage inequality is not quite understood. Trade liberalisation is
defined as the removal or reduction of restrictions or barriers on the free exchange of goods
between nations. This includes the removal or reduction of both tariff (duties and surcharges)
and non-tariff obstacles (like licensing rules, quotas and other requirements) [Investopedia].
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This phenomenon is seen to impact wages for various skill levels differently and therefore, is
likely to have consequences on wage inequality as well. Even though various studies have
focused on how economic growth and various demographic factors affect wage inequality,
few studies examine the impact on it as a result of policy changes such as, trade liberalisation
[Kassa (2003)]. Given Pakistan’s slashing reforms towards liberalisation of trade in the 1990s
especially after its membership of the WTO in 1995, the impact of this policy on wage
inequality is equally important as other determinants.
The Heckscher-Ohlin model and the Stolper-Sameulson Theorem provide the
necessary theoretical underpinning to explain how free-trade impacts wages in different
sectors of the economy. According to the H-O model, countries specialise in the
production of those goods which intensively use the factors of production in which they
are abundantly endowed. Consequently, this model predicts that while developed
countries specialise in the production of goods that intensively use skilled labour,
developing countries like Pakistan, specialise in goods that intensively use unskilled
labour [Giliani, et al. (2003)]. Under this approach, international competition in
developed countries will only increase wages of high-skilled labour, if and only if there
is an increase in the relative prices of goods they specialise in. This result is presented by
the Stolper-Sameulson Theorem. This theorem, in the developing country context, would
imply that trade liberalisation increases the relative prices of industries that employ
unskilled labour, and therefore, increasing their wages would consequently reduce wage
inequality within the country.