Trade Liberalization and Labor Markets: The Case of Indonesia

M. Thea Sinclair, Guntur Sugiyarto and Adam Blake

No 331196, Conference papers from Purdue University, Center for Global Trade Analysis, Global Trade Analysis Project

Abstract: Trade liberalization has long been advocated for standard reasons of increasing competition and welfare. Yet, there is still considerable debate, particularly in developing countries, about the range of effects that result from liberalization and the relative magnitudes of different effects. Such debate stems, in part, from the fact that trade reform takes place in a distortionary context. The effects of trade reform in the presence of other distortions fall into two strands: trade liberalization and distortionary domestic taxes, and trade liberalization and labor market distortions. Whereas the former has received significant attention, the analysis has generally been undertaken in the context of an unchanging labor market regime. However, labor market reforms are commonly under consideration, so that it is important to take account of their possible effects on trade liberalization and welfare of different sectors of the population. This paper examines trade liberalization in the presence of alternative labor market regimes in urban and rural sectors. The analysis first considers a form of labor market distortion that is relatively common in developing countries. The presence of wage rigidities in the form of minimum wages, unionized labor or government controls in formal or urban sectors contrasts with the absence of such rigidities in informal or rural sectors. This paper examines the consequences of trade liberalization in such a setting, showing that, under certain conditions, labor market rigidities can mean that trade liberalization reduces welfare. The paper also examines the effects of trade liberalization in the context of higher or lower rigidities in labor markets. The alternative combinations of labor market rigidity/liberalization and trade liberalization are tested in a computable general equilibrium model of Indonesia that incorporates 18 production sectors, 8 types of labor, 5 types of capital and 8 representative household groups. While full trade liberalization is found to be welfare improving, liberalizing only part of the tariff schedule can lead to welfare losses.

Keywords: International Relations/Trade; Labor and Human Capital (search for similar items in EconPapers)
Pages: 20
Date: 2004
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