Trade Liberalization and Labour Market Dynamics: Evidence from India

Abstract

The current paper develops a general equilibrium framework containing features of both the specific factor and the Hechsher-Ohlin models of trade to investigate the impact of trade liberalization on the wage rates of the workers. The theoretical results underline that reduction of tariff in a capital-intensive importing sector raises wages of both the skilled and the unskilled workers in an economy in the presence of intra-industry factor reallocation, followed by an expansion of the other sectors. Applying the two-stage least squares (2SLS) method of estimation, the empirical validation of the theoretical construct is carried out for India over 2000-01 to 2019-20. The results reveal that the sectors witnessing greater trade overlap experience lower employment adjustment costs. Moreover, rise in productivity and output levels as well as introduction of specific policy interventions (e.g., Make-in-India initiative in 2014) also reduce such adjustment costs. Conversely, factors such as increase in skilled and unskilled real wage rate, skilled worker intensity and trade openness enhance these expenses. The results indicate that while trade liberalization is not necessarily bad for industrial growth, it may not be sufficient either.