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Written by Adrian Wood, the article Openness and Wage Inequality in Developing Countries: the Latin American Challenge to East Asian Conventional Wisdom, explores the effects of openness and wage inequality especially in developing countries.
The conventional wisdom theory of East Asian is analysed in relation to the experience of the Latin America countries in the mid 1980s.
As the author puts it, the conventional wisdom theory that was developed from the experience of the East Asian countries in the 1960s argues that increased openness to trade particularly in the developing countries increases efficiency and reduces inequality that exists in wages between unskilled and skilled workers.
According to this theory, increased openness to trade raises the demand for unskilled workers who form the largest proportion of workforce in the developing countries hence reducing the rate of unemployment.
Wood argues that, in developing countries, the number of unskilled workers far outweighs the number of skilled workers. This argument is supported by the well-known Heckscher-Ohlin theory.
On the other hand, the author argues that the experience of the Latin American countries in the mid 1980s contradicted the theory of the conventional wisdom.
The challenge faced by these countries showed that increased openness to trade made the wage gap to widen rather than to reduce as it is portrayed by the conventional wisdom theory. Increased openness to trade in the developing countries has continued to raise wage inequality in greater magnitude than expected.
The author attempts to bring the two views together by providing an explanation of what could have caused this increased wage differential in the Latin America countries.
As demonstrated in this article, the possible explanation for the difference between the two theories lies in the economic difference between the two regions and time difference between the experiences of the two regions.
The debate over the two schools of thought has been going on for many years. As the author in this article points out, increased openness to trade reduces wage differential in the developing countries (Wood, 1997, p.33).
An economic occurrence that contradicts this theory is not easy to explain for it goes against what is empirically tested and accepted. Openness to trade creates employment opportunities among skilled and unskilled workers in the developing countries.
As Heckscher-Ohlin theory explains, countries tend to produce goods, which will intensively use the resources that are available in abundance.
On the hand, countries import goods that require resources in scarce supply and this explains why countries in developed world produce goods that are capital intensive while developing countries tend to export goods that are labour intensive (Wood, 1997, p.34).
As Juozapaviciene and Eizenta argue, resources endowment may help to explain export and imports of different countries (2010, p.87). Thus, openness to trade will allow exchange of these factors of production between developed and developing countries.
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Increased demand for unskilled labour because of openness in trade will create more opportunities for unskilled labour thus reducing wage differential and as Pollan notes, “Reduced wage differential will increase income inequality” (2009, p.389).
The author of this article presents two possible explanation of why openness to trade led to wage inequality in the Latin American countries. First, there was economic difference between the two regions and secondly, the time difference between the experiences of the two countries (Wood, 1997, p.55).
These two explanations are possible since they are supported by empirical evidence, which is presented by the author of this article. The two regions are different in terms of endowment in natural resources.
The supply of skilled labour in the East Asian countries is growing at a faster speed, which is different from the Latin American countries where labour market is highly regulated.
The two regions are almost the same in resources endowment since both enjoy developed infrastructures and high literacy rate compared to other regions like south Asia and Africa.
In spite of this, Latin American countries have more natural resources compared to East Asian countries that make the former to prefer primary products production (Wood, 1997, p.46).
On the other hand, East Asian countries have a competitive advantage in manufactured products though with a narrow margin and this phenomenon explains why the export products of East Asian countries are mainly manufacturing products while those for Latin American countries are primary products.
Therefore, in Latin American countries, natural resources and skilled labour were used to complement each other (Wood, 1997, p.47). Expansion of the primary products industry because of openness to trade raised the demand for skilled labour thus increasing the wage of this type of labour.
However, the case is different for East Asian countries where expansion in the manufacturing industries provides more opportunities for unskilled workers. Increased employment for unskilled workers will reduce wage differential (Wood, 1997, p.47).
The author of this article brings out this point very well by providing an empirical analysis of both manufacturing and primary products industries in the two regions. The two regions also have different trade policies, which could have resulted to this contradiction (Wood, 1997, p.48).
As the article presents, the experiences of the two regions happened at different economic periods. The Latin America challenge happened at a time when several activities that had great impact to the world economy were happening.
First, there was entry of middle-level income generating countries such as China into the world economy, which affected global labour market in many ways.
Secondly, there was technological advancement and mobility of capital and labour globally, which affected operations of the labour market. These differences can help to explain why the two views are different (Wood, 1997, p.55).
For instance, Egger, Huber, and Pfaffermayr posit that, export openness in Eastern and Central Europe has also continued to increase wage disparity (2005, p.63) and this could explain the differences experienced in the aforementioned case.
However, the author of the article does not appreciate the fact that Heckscher-Ohlin theory is not universally accepted in international trade. As Thompson argues, “factor price equalisation does not hold for capital and labour” (2011, p.186).
This may make Heckscher-Ohlin theory not to hold when explaining the relationship between wage inequality and openness to trade in developing countries. Again, productivity differences as noted by Morrow (2010, p.139) may also help to explain the differences between the two outcomes.
The author of this article gives two explanations in his attempt to harmonise the two different views of openness to trade and wage inequality.
Economic and time differences between the two economic phenomena in Latin American countries’ challenges and East Asian countries’ conventional wisdom are strong explanation of the contradiction.
However, Heckscher-Ohlin theory may not fully explain this contradiction since it is not universally accepted in international trade. Differences in productivity between the two regions may also help to explain the contradiction between the two views.
Egger, P., Huber, P., & Pfaffermayr, M., 2005. A note on export openness and regional wage disparity in Central and Eastern Europe. Annals of Regional Science, 39 (1), pp. 63-71.
Juozapaviciene, A., & Eizentas, V., 2010. Lithuania exports in the framework of heckscher-ohlin international trade theory. Economics & Management, 86-92.
Morrow, P. M., 2010. Ricardian–Heckscher–Ohlin comparative advantage: Theory and evidence. Journal of International Economics, 82 (2), pp.137-151.
Pollan, W., 2009. How large are wage differentials in Austria?.Empirica, 36 (4), pp. 389-406.
Thompson, H., 2011. Estimating the Heckscher–Ohlin model: Inverting the inverse matrix. International Review of Economics & Finance, 20 (2), pp. 185-192.
Wood, A., 1997. Openness and wage inequality in developing countries: The Latin American challenge to East Asian conventional wisdom. The world bank economic review, 11 (1), pp. 1-26.