Trade Openness and Wage Inequality: Evidence for ...

The Journal of Development Studies, 2013 Vol. 49, No. 8, 1118–1132, http://dx.doi.org/10.1080/00220388.2013.794263

Trade Openness and Wage Inequality: Evidence for Malaysia ROBERT MCNABB* & RUSMAWATI SAID** *Cardiff Business School, Cardiff University, Cardiff CF10 3EU, UK, **Faculty of Economics and Management, Universiti Putra Malaysia, 43400 Sedang, Selangor Malaysia

Final version received February 2013

ABSTRACT This article examines the impact of trade openness on wage inequality in Malaysia during the period 1984–1997. Malaysia has operated a very open trade regime since the 1960s and has pursued aggressive import substitution and export supporting policies. This development strategy is very different to that adopted in many other emerging economies where trade liberalisation has been associated with greater wage inequality. The aim of the present study is to examine whether Malaysia’s more open approach to international trade has had a similar effect on wage inequality. The results suggest, in fact, that this is not the case.

1. Introduction The impact of globalisation on wage inequality has attracted considerable attention (see, for example, Anderson, 2005; Desjonqueres, Machin, & Van Reenen, 1999; Haskel & Slaughter, 2001; Katz & Murphy, 1992).For the most part, these studies have focused on using changes in the pattern of world trade to explain increasing wage inequality in developed economies. In general, trade liberalisation is found to increase wage inequality, as basic trade theory would predict, though the impact is not especially strong. Those studies that have examined the consequences of globalisation for wage inequality in emerging economies have been generally limited in their regional coverage, with a focus primarily on Latin America (Arbache, Dickerson, & Green, 2004; Beyer, Rojas, & Vergara, 1999; Galiani & Sanguinetti, 2003; Gonzaga, Filho, & Terra, 2006; Pavcnik, Blom, Goldberg, & Schady, 2004). Moreover, the consistent finding that comes from these studies is that trade liberalisation is found to also increase wage inequality. This contradicts the tenet of basic trade theory according to which trade liberalisation reduces wage inequality in those countries with low-skilled labour-abundant economies (Stolper & Samuelson, 1941). Of course, globalisation is not one dimensional and can operate in other ways than through relative prices following the freeing up of trade flows (Anderson, 2005; Goldberg & Pavcnik, 2007). In particular, the role of skill-biased technology transfer between developed and developing countries associated with an increase in foreign direct investment has been proposed as a reason for the observed increase in wage inequality in the latter (Acosta and Gasparini 2007; Behrman, Birdsall, & Szekely, 2003; Feenstra and Hanson 1996). The focus on Malaysia is especially interesting in the context of the current literature. Malaysia has been described as one of East Asia’s “economic miracles” (UNDP, 2006) recording high economic growth rates for over 40 years. Importantly, Malaysia’s economic performance has been associated Correspondence Address: Dr Rusmawati Said, Faculty of Economics and Management, Universiti Putra Malaysia, 43400 Sedang, Selangor, Malaysia. E-mail: [email protected] © 2013 Taylor & Francis

Trade Openness and Wage Inequality 1119 with a more market-oriented industrialisation strategy and, in particular, a commitment to an open trade policy regime (Athukorala, 2005; Athukorala & Menon, 1999). Malaysia’s development strategy represents a very different approach to that followed by many other emerging economies, including those where more recent trade liberalisation has been found to increase wage inequality (Sachs & Warner, 1995). It is relevant, therefore, to consider whether this long-term commitment to openness in international trade has resulted in a similar consequence for wage inequality in Malaysia.

2. Economic Restructuring in Malaysia The emphasis of Malaysia’s industrialisation strategy during the decade or so following independence was on import substitution, though policies were less about encouraging the growth of indigenous industry but rather in attracting foreign inward investment (Athukorala, 2005; UNDP, 2006). The limited success of these policies in promoting a more diversified economy and in alleviating poverty and addressing the rising levels of urban unemployment was disappointing, prompting a major shift in government policy. The New Economic Policy (NEP) was introduced in 1971 and continued through to 1990. The important point about the NEP was that it was very much driven, initially at least, by ethnic considerations as much as economic ones. Thus, the NEP sought to establish national unity through the principal goals of eradicating poverty and restructuring Malaysian society to eliminate the association between ethnicity and the nature of economic activity which had been the root cause of widespread social unrest in the country (Torii, 1997). To meet the first of these, the Malaysian government moved towards introducing policies aimed at promoting export-led growth. However, the need to eliminate the divide between ethnicity and economic function led the government to also pursue affirmative action policies aimed at promoting ownership in the corporate sector amongst the Malay population and to expanding the Malay-dominated public sector. To strengthen the country’s manufacturing base, the government also created, in 1981, the Heavy Industries Corporation of Malaysia, a public holding company which, in partnership with foreign companies, was expected to be the basis for a strong capital goods sector in industries such as petrochemicals, car production, and iron and steel. These industries were, however, heavily subsidised, protected by high import duties and restrictions on imports of competing goods, and were, for the most part, uncompetitive internationally. The lack of success of the policy to develop a domestic heavy goods sector coupled with the growth of the public sector simply aggravated an already deteriorating position for the Malaysian economy. The downturn in the world economy during the mid-1980s had meant that both domestic and foreign private sector investment had stagnated and the Malaysian economy was in decline. The government’s response, as reflected in its National Development Policy (1990–2000), represented a major shift away from public sector expenditure towards incentives to promote private sector investment, including some privatisation of state-owned companies. The structure of the incentives available was generous and, again, very much aimed at promoting exports. The average nominal tariff rate fell from 26 per cent in 1984 to 9.1 per cent in 1997, and the reductions were especially significant on imports of intermediate and capital goods (Athukorala, 2005; Okamoto, 1994). This trend was also associated with the removal of many quantitative restrictions on imports, the introduction of favourable tax incentives and, more recently, with significant increases in investment in physical and human capital. Notwithstanding Malaysia’s long-term commitment to trade openness, this development strategy was especially evident in the more aggressive policies pursued after the 1985–1987 economic crisis (Athukorala 2005; Athukorala and Menon, 1999; Rasiah and Shari, 2001; UNDP, 2006). This is reflected both in the nature of the policies followed by the Malaysian government and in Malaysia’s export orientation (exports as a percentage of GDP), which increased from 25 per cent during 1970–1980 to 33 per cent during 1980–1990 and to around 100 per cent by 1995. The availability of strong financial incentives coupled with industrial labour relations legislation in a wider climate of trade and financial liberalisation proved very attractive to foreign investors and foreign ownership. The flow of foreign direct investment (FDI) into Malaysia increased during the

1120 R. McNabb & R. Said 1970s and 1980s, and accelerated sharply after 1987, reaching a peak of US$5741 million in 1996, a figure equivalent to nearly 10 per cent of total FDI flows worldwide (Mithani, Ahmad, & Saifudin, 2008). The annual flow of FDI into Malaysia between 1980 and 1987 was around US$2 billion and foreign companies accounted for 22.3 per cent of total fixed assets, increasing to US$18 billion by 1990, when foreign companies accounted for 40 per cent of total fixed assets (Okamoto, 1994). Of course, the adoption of a more aggressive export-oriented growth policy after 1987 was associated with a marked increase in trade liberalisation globally. These changes together brought not just an increase in Malaysia’s exports but also a significant change in their composition. In particular, the export of manufactured goods as a percentage of total exports increased from less than 15 per cent in 1970 to around 45 per cent by 1985 and to over 85 per cent by 1997. Within manufacturing, the growth in exports has been dominated by two industries, electrical and electronic products, and machinery manufacturing, which together account for around one half of all Malaysia’s total manufacturing exports (Devadason, 2002; UNDP, 2006). Kuruvilla (1996), amongst others, has shown that the market reforms associated with the country’s industrialisation strategy were very closely aligned with labour market reforms also introduced in the late-1980s. Initially, the export-oriented industrialisation strategy was characterised by low-cost, labour-intensive production. To establish a low-cost manufacturing base, labour market policies were introduced to ensure flexibility and hold down wage rates. These included banning trade unions from exporting sectors and not enacting minimum wage legislation. Moreover producers increasingly relied on foreign labour to meet their labour requirements, especially from ASEAN countries and from Bangladesh, a policy officially endorsed by the Malaysian government from the early 1980s. Between 1985 and 1995, foreign workers as a percentage of the total manufacturing workforce increased from 6 per cent to 14 per cent (Athukorala and Devadason, 2012). Foreign workers represented a readily available supply of, primarily, unskilled labour, which impacted upon the nature of the technologies adopted which have remained relatively labour intensive and focused on component production and assembly, with only a limited shift towards high-quality and value-added production (Devadason, 2011). Despite the major changes that have taken place in the volume and composition of Malaysia’s external trade, the direction of this trade has changed little since 1980 (UNDP, 2006). In particular, the USA, Singapore, Japan and the EU continue to account for some two-thirds of total exports.

3. Globalisation and Wage Inequality in Emerging Economies A variety of approaches have been used in the literature to assess the impact of globalisation on wage inequality.1 This is not unexpected given the diverse nature of the trade, finance and labour market reforms that have taken place across the range of emerging economies considered. Most studies have focused on changes in trade policy and their impact on local labour markets within the context of the Heckscher–Ohlin model and the Samuelson–Stolper theorem (Goldberg and Pavcnik, 2007). According to the former, economies which are less-skilled labour-abundant will specialise in those products that are less-skilled labour-intensive following trade liberalisation. According to the Samuelson–Stolper theorem, this will be associated with an increase in the relative demand for lessskilled labour, thus promoting greater wage equality in labour-abundant developing countries as the wages of less-skilled labour are bid up (Goldberg and Pavcnik, 2007; Wood, 1995). However, as the findings of many of the studies for emerging economies demonstrate, wage inequality has increased with trade liberalisation and not fallen as predicted by standard trade theory.2 To explain why trade liberalisation has led to increased wage inequality in many developing countries, researchers have considered other features of the globalisation process, especially when looking at the period following the early and mid-1990s (Anderson, 2005; Goldberg and Pavcnik, 2007). In particular, the nature of new technology associated with foreign direct investment, labour market reforms and increased competition from low-wage economies such as China and India have attracted attention. Feenstra and Hansen (1997), for example, show that foreign capital inflows into

Trade Openness and Wage Inequality 1121 Mexico increased the wages of more skilled workers needed to work with the new technology – a relationship they label the “capital accumulation-outsourcing hypothesis”. A similar finding is also reported for Costa Rica (Robbins & Gindling, 1999), for Chile and Mexico (Alvarez & Robertson, 2004), Peru (Muzumdar & Quispe-Agnoli, 2002), Argentina (Acosta & Gasparini, 2007), and Chile (Pavcnik, 2003). Feenstra and Hansen further suggest that labour market policies in Mexico, especially those aimed at limiting the power of trade unions and weakening minimum wage legislation, may also have contributed to a widening wage gap between skilled and unskilled groups. An additional explanation for the positive correlation between wage inequality and globalisation has been proposed by Wood (1994, 1999). He argues that many emerging economies have faced increased competition from countries such as China and India in which there are significant supplies of lowwage unskilled labour. This has pushed down the wages of lower-skilled workers in those countries that previously had a comparative advantage in low-wage, unskilled production. The combination of skill-biased technological change and increased openness to competition in domestic and international markets working to increase wage inequality has been found for Brazil (Arbache et al., 2004), Chile (Beyer et al., 1999), Colombia, (Attanasio, Goldberg, & Pavcnik, 2003), and Argentina, (Galiani & Sangunetti, 2003), though the latter emphasise the impact of foreign competition and import penetration as the significant contributor to increasing wage inequality. Away from Latin America, Kim (2002) found that wage inequality in Korea rose with increasing trade with countries less developed than itself, but was negatively correlated with trade with relatively more advanced countries. This is consistent with Davies’ (1996) notion that relative factor abundance compared to economies with similar factor endowments is the important consideration rather than absolute comparative advantage as typically assumed in basic trade theory. It may also explain the increase in wage inequality in Latin America, noted above, where the relative supply of skilled labour has been above that of other emerging economies (Hanson & Harrison, 1999). Li and Xu (2003) find that wage inequality in China fell with the degree of export orientation of firms, but that this was also correlated with the introduction of new and more advanced technology which had an offsetting effect. Similar results are found for Taiwan by Tsou (2002). More recently, a number of studies have considered the impact of the gradualist approach to trade liberalisation that began in India in 1991. Kumar and Mishra (2008) report increased productivity associated with trade liberalisation resulting in higher wage premiums in those industries where the size of tariff reductions was greatest. These were, in general, less skill-intensive, which resulted in an improvement in wage equality for the country as a whole. These were sectors, moreover, that experienced large increases in imported inputs and a significant increase in the number of products manufactured (Goldberg, Khandelwal, Pavcnik, & Topalova, 2010). Evidence for a number of East Asian countries is reviewed by Wood (1999), who suggests that, in contrast to the findings for Latin America, increased openness has been associated with a fall in wage inequality as the relative demand for unskilled labour has increased. The studies include Robbins (1996) for Malaysia, which indicates a narrowing of the wage gap between the most educated and less educated workers over the period 1973–1989. In part, this reflects an increase in the demand for production workers (with limited education levels) employed in exporting sectors such as rubber, tin, machinery and textiles. This is consistent with the data presented in Berman and Machin (2000), which show that whilst there has been a shift in favour of non-production workers in manufacturing in most of the low and middle-income countries they studied, in Malaysia the shift has been in favour of production workers.

4. Data and Methodology The main focus of the empirical analysis of the present study, as noted earlier, is on whether changes in relative labour demand between different skill groups in Malaysia have come about either because of trade liberalisation which changes the pattern of trade, and thus the industrial structure of employment, or as a result of technical change which means that the final demand for goods and services shifts over

1122 R. McNabb & R. Said time either in favour of more- or less skill-intensive sectors, causing aggregate demand for labour to shift in favour of a particular group of workers. To this end, we draw upon a methodology employed in a number of previous studies (for example, Arbache et al., 2004; Attanasio et al., 2003; Galiani & Sanguinetti, 2003). This approach basically involves estimating wage functions, which include some measure of the level of trade-related competitiveness and/or technology in addition to the standard measures of human capital and other personal attributes. Although this is a common approach in the literature, it does mean, as Goldberg and Pavcnik (2007) note, that the focus is on one specific but very important aspect of globalisation. Data limitations on other ways in which globalisation may have affected the Malaysian economy dictate this focus of our analysis. The individual data used is taken from the Household Income Survey (HIS) for the years 1984, 1989, 1992, 1995 and 1997.3 The HIS is a household-based survey carried out by the Economic Planning Unit of the Malaysian Government and made available by the Department of Statistics, Malaysia. It provides data on earnings and various labour market and individual characteristics, and thus enables a detailed analysis of the changing nature of wage inequality over time. Although the surveys have been carried out as far back as 1973 and as recently as 2009, the study focuses on the period 1984–1997, which includes the period during which trade liberalisation policies were most aggressively pursued and would have impacted upon wage inequality. In addition, the survey questionnaire, variable definitions and measurements were different outside the period we are considering. Information compiled from the survey covers earnings (total monthly labour earnings from employment which have been deflated by the consumer price index to obtain a measure of real wages), age, economic activity, regional location, status of employment, three-digit occupation and three-digit industry data, and the highest education qualification achieved. The latter variable has six categories with two at tertiary level (degree and diploma), three intermediate-level qualifications (the High School Certificate, the Middle Certificate of Education [MCE/SPM] and the Middle Certificate of Education for vocational training [MCE/SPMV]), and one lower-level educational qualification (the Lower Certificate of Education [LCE/SRP/PMR]). In addition, there is a “Not Applicable” category covering those people who have received a traditional Islamic education or those, mainly migrant workers, who have qualifications which are not recognised within the Malaysian education system by the Ministry of Education. Finally, there are those workers who have no formal educational qualifications. The 1984, 1989 and 1992 surveys each covered around 250,000 people, but coverage fell to less than 200,000 in 1995 and 1997 due to a decision that statistical accuracy could be maintained with a smaller, and thus less costly, survey. The sample used in the present study focuses on employees aged between 16 and 65. Because of the problems associated with the measurement of self-employment income, people classified as self-employed are excluded from the analysis as are those in the agriculture and fishing sectors for the same reason. In addition, extreme earnings values have been excluded by dropping 0.1 per cent of the sample at the top and bottom of the income distribution, mirroring Arbache et al. (2004). The empirical work is conducted in two stages. First, we consider the changes that have taken place in rates of return to different skill levels as measured by highest educational qualification achieved. This analysis is undertaken across all industry sectors other than agriculture and fishing (it thus includes construction, utilities and services sector industries – ISIC 101 through 930). The second analysis focuses more directly on the impact of trade openness on wage inequality and is undertaken for manufacturing only, reflecting both data availability and the fact that manufacturing has been the key sector in Malaysian economic development and the one most affected by trade liberalisation. Descriptive statistics for each of the survey years are reported in Table 1. Although there has been an increase in employees with tertiary qualifications, this increase is from a low base. As a result, the percentage of people with tertiary qualifications in 1997 still represented less than 14 per cent of total employees. In contrast, there has been a sharp rise in the percentage of people with intermediate level qualifications. This is especially evident amongst those with MCE-level qualifications, which rose from 21.2 per cent of employees in 1984 to 31.3 per cent by 1997. The percentage of employees with

Trade Openness and Wage Inequality 1123 Table 1. Descriptive statistics

90/10 decile ratio SD (earnings) 90/10 decile ratio – trade sector SD (earnings) – trade sector 90/10 decile ratio – non-trade sector SD (earnings) – non-trade sector Education (% with qualification) Degree Diploma MCE/SPM MCE/SPMV High school cert LCE/SRP/PMR NA-qual No formal qualification Education – trade-sector (%) Degree Diploma MCE/SPM MCE/SPMV High school cert LCE/SRP/PMR NA-qual No formal qualification Education – non-trade-sector (%) Degree Diploma MCE/SPM MCE/SPMV High school cert LCE/SRP/PMR NA-qual No formal qualification Male (% of total employees) Married (% of total employees) Age (average) Employed in trade sector (% total employees)

1984

1989

1992

1995

1997

6.43 8160 6.31 7980 6.27 8190

6.17 8025 5.61 8076 6.08 7989

6.00 8011 5.01 7579 6.36 8125

5.74 8256 4.94 7700 5.97 8421

5.94 7687 5.32 6961 6.16 7911

3.2 3.7 20.6 1.9 12.6 7.5 50.5

3.7 4.5 24.8 3.1 10.8 5.2 47.9

3.9 4.6 27.5 4.0 14.3 5.1 40.7

4.1 5.3 31.0 4.3 15.1 4.4 35.8

4.9 6.7 31.9 4.0 14.2 3.5 34.9

1.8 0.9 18.0 1.2 13.6 5.5 58.9

1.8 1.2 24.5 2.4 11.4 4.0 54.7

1.7 1.6 29.1 3.1 18.0 3.5 43.0

2.2 2.4 32.4 2.9 17.6 3.9 38.2

2.6 3.6 33.4 2.4 16.2 3.2 38.6

3.5 4.3 21.2 2.0 12.4 7.9 48.6 68.2 57.8 31.4 19.1

4.3 5.5 24.8 3.3 10.6 5.5 46.0 66.9 60.5 32.3 21.9

4.7 5.7 36.9 4.4 13.2 5.7 39.8 66.2 59.1 32.2 26.4

4.8 6.4 30.5 4.8 14.1 4.6 34.8 66.3 60.7 32.7 27.7

5.8 7.8 31.3 4.5 13.5 3.6 33.4 64.7 61.5 33.0 27.0

no formal educational qualifications has fallen from around half of the employee population in 1984 to 33.4 per cent in 1997. There is, therefore, a clear trend in Malaysia towards a more educated workforce, though this is predominantly at the intermediate level rather than amongst employees with higher-level skills. The indicators of trade liberalisation used in the study are measures of the degree of import and export penetration, namely the ratios of imports to output and exports to output by industry sector. As in many previous studies, limited data availability means that other measures, such as the effective rate of tariff protection, are not an option. The trade data used are drawn from Malaysia’s official external trade database compiled by the Department of Statistics, Malaysia. These data are published at the two-digit Standard International Trade Classification level in, inter alia, the Department of Statistics’ publication, Malaysia External Trade Statistics. Unpublished data at a more disaggregated level was made available by the Department of Statistics. These data, which are classified according to the threedigit Standard International Trade Classification level, have then been matched to the three-digit Malaysian Industrial Classification, 1972. The latter was the standard classification for industry sectors used in all economic and household censuses and surveys conducted by the Department of Statistics until 2000. Industry output data are compiled from the Department of Statistics’ Annual Survey of Manufacturing Industries.

1124 R. McNabb & R. Said The trade data were also used to define a dichotomous variable to indicate whether an employee is employed in those industry sectors most open to international trade. This follows the approach adopted by Arbache et al. (2004) in which each industry sector is classified to either the trade or non-trade sector depending upon the extent to which it is open to international trade, defined here in terms of the sum of (import penetration + export orientation), a measure used by the Malaysian Ministry of International Trade and Industry. The classification of industry sectors is shown in Table 2. The overall impact of trade liberalisation on employment can be seen in Table 1, which shows that employment in the trade sector increased from 19.1 per cent in 1984 to 27.0 per cent in 1997. Ideally, the analysis should also consider the impact of technological change on relative wages. However, it is well documented that technological change is notoriously difficult to measure (Chennells & Van Reenen, 2002). One approach has been to include a measure of total factor productivity (TFP) as a proxy (for example, Dejonqueres, et al. 1999). Indeed, there is some evidence to suggest that a measure of technological change derived from TFP performs as well as some other proxies, such as the share of R&D personnel (Tsou, 2002). However, we are mindful that productivity change, as measured by TFP, can come about for reasons other than changes in technology. Moreover, the relationship between TFP and technological change for Malaysia is far from straightforward. Mahadevan (2002) has examined TFP in the Malaysian manufacturing sector over the period 1981–1996 using data envelopment analysis to calculate the Malmquist index, which can be used to decompose overall productivity gains into that part arising from technological change and that due to changes in technical efficiency. Mahadevan’s findings suggest that changes in TFP during the 1980s primarily reflected improved technical efficiency rather

Table 2. Industrial composition of trade and non-trade sectors Trade sector Forestry Mining and quarrying Manufacture of food products Manufacture of tobacco products Manufacture of textiles Manufacture of wearing apparel Tanning and dressing of leather Manufacture of wood products Manufacture of paper and paper products Manufacture of coke, refined petroleum products Manufacture of chemicals and chemical products Manufacture of rubber and plastic products Manufacture of other non-metallic mineral products Manufacture of basic metals Manufacture of fabricated metal products Manufacture of machinery and equipment n.e.c Manufacture of office, accounting and computing machinery Manufacture of electrical machinery Manufacture of radio, television and communication equipment Manufacture of medical, precision and optical instruments Manufacture of motor vehicles Manufacture of other transport equipment Manufacture of furniture

Non-trade sector Publishing, printing and reproduction media Construction Sale, maintenance and repair of motor vehicles Wholesale trade and commission trade Retail trade Hotels and restaurants Land transport Water transport Air transport Supporting and auxiliary transport activities Post and telecommunications Finance except insurance and pension funding Insurance and pension funding Activities auxiliary to finance Real estate activities Renting of machinery and equipment Computer and related activities Research and development Other business activities Public administration and defence: compulsory social security Education Health and social work Sewage and refuse disposal Activities of membership organisations n.e.c Recreational, cultural and sporting activities Other service activities Extra-territorial organisations and bodies

Trade Openness and Wage Inequality 1125 than technological change. However, productivity gains during the 1990s were the result of technological change associated with foreign direct investment. Similar results are reported by Jajri (2007). We consider the impact of changes in TFP on wage inequality which may, at least during the latter part of our study period, also capture the effects of technological change. To measure TFP, we have employed the same data and methodology as Mahadevan (2002), namely data on fixed capital stock, employment and value added were compiled from the Annual Survey of Manufacturing Industries published by the Department of Statistics, Malaysia, and data envelopment analysis used to calculate the Malmquist index of TFP. In view of the shortcomings of TFP as a measure of technological change and because changes in TFP are only very weakly associated with technological change during the early part of the study period, we also consider the robustness of our findings regarding the impact of trade on wage inequality excluding TFP.

5. Trade Liberalisation and Wage Inequality in Malaysia In order to provide some context for the analysis, two measures of wage inequality are reported in Table 1: the standard deviation of the wage distribution; and the ratio of the 90 to 10 per cent deciles. Both measures indicate that wage inequality has decreased over the period, in contrast to the findings reported for many other emerging economies. Also shown in Table 1 are the same two measures of inequality presented separately for the trade and non-trade sectors. Interestingly, wage inequality is both lower and has declined more in the trade sector. In addition, Table 1 also reports the distribution of education qualifications by trade sector/non-trade sector. As is evident, there has been an increase in the overall level of education in both sectors, though qualifications are more prevalent and, on average, higher in the non-trade sector. In order to provide a more formal analysis of the way trade liberalisation has impacted upon wage inequality, we first present earnings equations estimated across all survey years (Table 3). In the first column we include just the trade-sector dichotomous variable without any of the other standard regressors. As Table 3 shows, real earnings are about 14 per cent lower, on average, in the trade sector than in the non-trade sector, which is about half that found for Latin America (Arbache et al. 2004). In column 2, two additional variables are added measuring the situation post-1990. As noted earlier, although Malaysia’s economy and development strategy has been characterised by a high level of openness to international markets, trade liberalisation was most evident following the economic crisis during 1985–1987. To reflect this we have used two interaction variables (trade sector/post-1990 and non-trade sector/post-1990). It is, of course, important to recognise that the use of pre- and postmeasures of trade liberalisation is far from straightforward (Goldberg & Pavcnik, 2007; Topalova, 2010). Trade liberalisation has taken place alongside other aspects of globalisation as well as being against a background of economy-wide changes such as labour market reform. Disentangling the impact of increased trade openness from these other changes is problematic, given data limitations. In addition, this difference-in-difference approach (Topalova, 2010), measures the relative effect of trade openness on wage inequality across industries as opposed to the overall level effect. Notwithstanding this limitation, the results indicate that both variables are positive and statistically significant, indicating that real wages increased across the economy as a whole during the post-1990 period and that the increase was marginally higher in the trade sector. This is in contrast to the results reported for many other countries which indicate falling wages in the trade sector during a period of greater trade openness. Finally, the educational qualifications, sex, marital status and age variables are included in the wage equation. The results, not unexpectedly, confirm the previous findings regarding the positive impact of education on earnings. In addition, they also indicate a significant gender pay gap of around 35 per cent, that married employees earn over 10 per cent more than those who are not currently married, and that there is a quadratic relationship between earnings and age, and that earnings peak at 43 years of age.

1126 R. McNabb & R. Said Table 3. Trade liberalisation and wages 1984–1997 1 Constant Education Degree Diploma MCE/SPM MCE/SPMV High school cert LCE/SRP/PMR NA-qual Male Married Age Age squared Trade Trade sector Trade sector x post-1990 Non-trade sector x post-1990 R-Squared F N

8.777 (0.0017)*

2 8.693 (0.0025)*

3 6.381 (0.0139)* 1.423 0.932 0.532 0.725 0.288 –0.391 0.301 0.096 0.096 –0.001

–0.149 (0.0033)* 0.0067 2026.73 289337

–0.171 (0.0054)* 0.172 (0.0059)* 0.158 (0.0033)* 0.0174 1689.85 289337

(0.0064)* (0.0049)* (0.0064)* (0.0028)* (0.0035)* (0.0058)* (0.0025)* (0.0028)* (0.0008)* (0.00001)*

0.0282 (0.0042)* 0.064 (0.0047)* 0.043 (0.0026)* 0.3998 13995.43 289337

Note: Standard errors shown in parentheses; *denotes significance at 1 per cent.

However, the inclusion of these additional variables produces a rather different result concerning employment in the trade sector, namely that earnings are actually higher in the sector, other things equal. The results show that employment in the sector is associated with a wage premium of nearly 3 per cent compared with the results reported by, amongst others, Arbache et al. (2004), who find a negative impact of nearly 30 per cent. The main reason for the change is the inclusion of education in the earnings function. As noted above, educational qualifications are lower in the trade sector than in the non-trade sector of the economy. After controlling for these differences, we find that trade sector wages are actually higher than those in the non-trade sector. To examine these findings in more detail, we have considered the rates of return to different educational qualifications in both the trade and non-trade sectors, and pre- and post-1990. The results of this analysis are reported in Table 4. They suggest a rather complex picture. First, there is a decline in the rate of return to tertiary qualifications across all industrial sectors with the exception of lowertier diploma qualifications in the non-trade sector. In contrast, the returns to intermediate- and lowerlevel qualifications have generally increased, though for the former this is more evident in the nontrade sector, whereas for the latter this is more so in the trade sector. The picture that emerges from this analysis, therefore, is one that is consistent with standard trade theory with increased openness associated with an increase in the relative demand for less-skilled and less-well-qualified workers, thus increasing wage equality. To explore these findings further, we focus in what follows on the manufacturing sector only and use direct measures of trade openness and TFP to examine their effects on relative wages. This approach has the advantage that, because changes in trade protection have varied across industrial sectors, it is possible to distinguish their differential effects on wage inequality from other economy-wide policy changes. Before we present the results, we address two estimation issues. First, we noted earlier that Malaysia has experienced a significant influx of foreign workers who are predominantly less skilled. Such an increase in labour supply may well have affected the movement of relative wages between groups of workers with different educational qualifications. However, there is evidence that, whilst the increased supply of foreign workers has had some impact on wages, at least amongst unskilled labour, the effect has been small (Athukorala & Devadason, 2012). Also, the estimates presented below control for

Trade Openness and Wage Inequality 1127 Table 4. Rates of return to education in the trade and non-trade sectors Constant Male Married Age Age Squared

6.326 0.315 0.098 0.097 −0.001

(0.0139)* (0.0025)* (0.0028)* (0.0085)* (0.00001)*

Pre-1990

Education Degree Diploma MCE/SPM MCE/ SPMV High School Cert LCE/SRP/PMR R-Squared F N

Post-1990

Trade sector

Non-trade sector

Trade sector

Non-trade sector

1.693 (0.030)* 1.213 (0.0439)* 0.458 (0.0084)*

1.522 (0.0314)* 0.937 (0.0387)* 0.568 (0.0257)*

1.499 (0.0251)* 1.04 (0.0218)* 0.563 (0.0055)*

1.401 (0.0088)* 0.981 (0.0065)* 0.602 (0.0036)*

0.749 (0.0332)* 0.297 (0.0103)*

0.765 (0.041)* 0.314 (0.0176)*

0.726 (0.0188)* 0.372 (0.007)*

0.768 (0.0086)* 0.330 (0.0050)*

0.3879 7569.7 289337

Note: Standard errors shown in parentheses; *denotes significance at 1 per cent.

industry-specific effects, which presumably capture inter-industry variations in the degree of dependence on foreign workers. Turning to the second issue, as Goldberg and Pavcnik (2007) point out, whilst most studies assume that changes in trade liberalisation are exogenous, this may not be the case but could arise because of such things as lobbying by industry-related interest groups or reflect the various other policy changes that took place simultaneously with those policies aimed at improving trade openness. In fact, many of the other policies pursued were in fact economy-wide and would affect all industries equally. However, to address the possibility that the measures of trade openness and TFP used are endogenous, we use an instrumental variable estimator in which the instruments used are the lagged values of these variables.4 These instruments are not perfect, but in the absence of data on alternatives they represent the only option. The results, reported in Table 5, include industry-specific and time-specific fixed effects to control for inter-industry and time-related wage differentials not associated with the trade and TFP variables.5 In column 1 of Table 5 we show the impact of the degree of import and export penetration and of TFP on real wages. The results indicate that the degree of openness to trade is found to be positively associated with earnings in those industries where openness increased the most in terms of rising import penetration. However, in those industries that are most open to competition in international export markets, wages are found to be lower, a finding more in line with previous work. The results also show that TFP is positively correlated with real wages, other things equal. To consider how these changes have affected different skill levels, in column 2 of Table 5, interaction effects between import and export penetration and TFP, on the one hand, and educational qualifications, on the other, are reported. The parameter estimates show both the general effect of the former variables and their differential impact by level of educational qualification. Their joint effects with standard errors are reported in column 3. If we look first at import penetration, we find that whilst the wages of employees working in those sectors of the Malaysian economy most open to international competition in the domestic market have increased (by around 31 per cent on average); this is especially the case for those employees with no qualifications and those with intermediate- or low-level qualifications. Higher-level educational qualifications, on the other hand, have not attracted wage premiums associated with increased international openness. Interestingly, increased openness has resulted in falling real wages for those

1128 R. McNabb & R. Said Table 5. Trade liberalisation and wage inequality – instrumental variable estimates 1 Constant Educational qualifications Tertiary Intermediate Low Na-qual Male Married Age Age squared Trade Sector import penetration Sector export penetration TFP Interaction effects Tertiary*import Intermediate*import Low*import NA/import

6.488 (0.0348)*

2

3

6.446 (0.0396)*

1.112 (0.0124)* 0.372 (0.0057)* 0.189 (0.0068)* –0.381 (0.0349)* 0.335 (0.0055)* 0.104 (0.0058)* 0.094 (0.0015)* –0.001 (0.00002)*

1.467 0.507 0.324 –0.219 0.335 0.104 0.094 –0.001

(0.042)* (0.0289)* (0.0307)* (0.039)* (0.0057)* (0.0058)* (0.0015)* (0.00002)*

0.158 (0.0225)* –0.222 (0.0217)* 0.103 (0.025)*

0.264 (0.0356)* –0.330 (0.0389)* 0.135 (0.0327)* –0.229 (0.0594)* –0.0170 (0.0347)* –0.155 (0.0385)* –0.441 (0.062)*

0.035 0.093 0.108 –0.178

(0.053) (0.020)* (0.027)* (0.055)*

Tertiary*export Intermediate*export Low*export NA qual*export

–0.012 0.140 0.191 –0.006

–0.342 –0.190 –0.139 –0.336

(0.052)* (0.219)* (0.0289)* (0.061)*

Tertiary*TFP Intermediate*TFP Low*TFP NA qual * TFP

–0.204 (0.031)* –0.099 (0.025)* –0.118 (0.026)* –0.049 (0.028)**

R-squared N

0.365 69770

0.366 69770

(0.061) (0.038)* (0.0425)* (0.067)

–0.069 (0.019)* 0.0354 (0.012)* 0.0163 (0.0135) 0.086 (0.0182)* 69770

Notes: (1) The equations are estimated using lag values of export, import and technological change as instruments. (2) The equations include industry-specific and year fixed effects. (3) Standard errors are shown in parentheses – * denotes significance at 1 per cent; ** at 10 per cent. (4) The figures shown in column 3 are the joint effects of export, import, and technology, on the one hand, and the educational qualification variables, on the other.

workers with Islamic qualifications or foreign qualifications not recognised by the Malaysian government, including migrant workers. If we turn to the impact of increasing export competition upon relative wages, we see that the negative effect of increased openness on wages has been most significant for the more skilled and better educated. The parameter estimates show that wages were, on average, 29 per cent lower for those with the highest-level qualifications compared to those with no qualifications. Similarly, those with intermediate qualifications were paid 17 per cent less. The results suggest that there has been a marked shift in relative demand towards lower-skilled groups and an increase in wage equality in those industries most open to increased competition in international markets. Turning to the impact of TFP, overall, productivity gains associated with technical efficiency and/or technical change have also favoured less-skilled workers, indicating a shift in relative demand towards those with no formal qualifications and with lower-level educational qualifications. Mahadevan (2002) notes that during the 1990s the benefits of technological change associated with major increases in foreign direct investment were limited due to the fact that Malaysian manufacturing was focused on low-skilled assembly-level activities. This mirrors Devadason’s (2002) finding that Malaysia’s trade

Trade Openness and Wage Inequality 1129 Table 6. Trade liberalisation and wage inequality – instrumental variable estimatesexcluding TFP 1 6.585 (0.0261)*

2

Constant Educational qualifications Tertiary Intermediate Low Na-qual Male Married Age Age squared

1.11 (0.0124)* 0.371 (0.0057)* 0.190 (0.0068)* –0.380 (0.0122)* 0.344 (0.0051)* 0.104 (0.0058)* 0.094 (0.0015)* –0.001 (0.00002)*

1.216 0.403 0.193 –0.268 0.345 0.104 0.094 –0.001

Trade Sector import penetration Sector export penetration

0.180 (0.0211)* –0.261 (0.0211)*

0.293 (0.0349)* –0.310 (0.0381)*

3

6.566 (0.0279)* (0.022)* (0.0123)* (0.0132)* (0.021)* (0.0052)* (0.0058)* (0.0015)* (0.00002)*

Interaction effects Tertiary*import Intermediate*import Low*import NA/import

–0.229 –0.017 –0.155 –0.441

(0.0594)* (0.0347)* (0.0385)* (0.062)*

0.013 0.097 0.120 –0.166

(0.052) (0.020)* (0.027)* (0.055)*

Tertiary*export Intermediate*export Low*export NA qual*export

–0.012 0.140 0.191 –0.006

(0.061) (0.038)* (0.0425)* (0.067)

–0.322 –0.214 –0.161 –0.336

(0.050)* (0.206)* (0.0276)* (0.061)*

R-squared N

0.371 69770

0.372 69770

69770

Notes: (1) The equations are estimated using lag values of export, import and technological change as instruments. (2) The equations include industry-specific and year fixed effects. (3) Standard errors are shown in parentheses – * denotes significance at 1 per cent; ** at 10 per cent. (4) The figures shown in column 3 are the joint effects of export, import, and technology, on the one hand, and the educational qualification variables, on the other.

sector is narrowly based and focused on relatively labour-intensive component production and assembly, and which has involved limited improvement in quality, thus hindering skill upgrading. Finally, we consider the impact of trade openness on wage inequality excluding TFP. The results of this exercise are shown in Table 6. A comparison of the parameter estimates shows that excluding TFP from the estimated equations makes little quantitative difference to any of the estimates of the original model.

6. Conclusions The Malaysian economy has undergone a major restructuring since the mid-1980s as successive governments have sought strong economic growth through a very open trade policy regime and in a climate of more open and competitive world markets. In many respects, the policies pursued have been successful in producing strong growth and greater wage equality. However, the results suggest that this conclusion requires qualification in that the benefits of trade liberalisation have impacted upon the position of the less educated and lower skilled in that trade liberalisation has been biased in favour of the employment of workers with limited skill levels and not, as in many emerging economies, towards the employment of more highly skilled labour. One possible explanation for this would be that the high levels of FDI enjoyed by Malaysia have been associated with capital investment that focuses on intermediate rather than on high value-added production. As a result, the overall impact has been a

1130 R. McNabb & R. Said trend towards greater wage equality. However, it also means that since the gains from liberalisation have been at the lower end of the wage distribution, the economy has not seen the same increase in average wage levels experienced by many other emerging economies and remains a relatively lowwage economy. Inevitably, the conclusions that can be drawn from the study are constrained by the data available. The lack of a direct measure of technological change clearly limits the conclusions about the way FDI has impacted on the Malaysian economy. Understanding the dynamics of wage inequality would also be better understood if those factors associated with changes in technical efficiency, such as limitations in managerial and employee adaptability and capabilities, could also be captured.

Notes 1. Goldberg and Pavcnik (2007) provide a detailed survey of the theoretical and empirical literature. 2. More elaborate theoretical models than the two-country, two-factor one can generate an increase in the relative skilled wage premium (Atolia, 2007; Chaudhuri, 2008; Marjit, Beladi, & Chakrabarti, 2004). In addition Mamoon and Murshed (2008) suggest that the way increased trade openness effects wage differentials depends crucially on a country’s initial skill endowments. Meschi and Vivarelli (2009) also find significant inter-country differences in the nature of the relationship between trade and wage inequality. 3. All the data used in the study including the conversion of ISIC codes into Malaysian Industrial Classification codes are available on request from Dr Said, [email protected]. 4. We are grateful to a referee for suggesting this approach. 5. Although the choice between fixed and random effects models is not straightforward (see Gelman, 2005), Wu–Hausman tests strongly suggest that a fixed effect model was appropriate (Hausman, 1978).

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