Real wage growth averages between 5.1 and 8.6 percent more than its long-term average in the years immediately after capital market liberalization.
In Capital Market Integration and Wages (NBER Working Paper No. 15204) authors Peter Blair Henry and Diego Sasson find that in the three years that follow a typical developing country opening its stock market to inflows of foreign capital that is, a capital market liberalization -- the average annual growth rate of the real wage in the manufacturing sector increases substantially. This temporary increase in wage growth drives up the level of the average workers annual compensation by $609, or 25 percent of the workers annual salary before the capital market liberalization. The growth rate of labor productivity increases even more than the growth rate of real wages, so rising worker incomes coincide with rising profitability of the manufacturing sector.
Henry and Sasson study patterns of wages, employment, and output in 18 developing countries that opened their stock market to foreign investment at some stage between 1986 and 1995. They compare these countries to a control group of countries whose markets did not open. They also collect data on privatization, stabilization, and trade reforms implemented in some of the countries during the period so that they can more precisely estimate the effect of liberalization reforms.
The authors note that opening capital markets reduces the cost of capital. This provides a strong incentive for manufacturing firms to increase investment. Workers benefit from this additional investment because their productivity increases. Firms step up their demand for more productive labor and drive up manufacturing wages.
Henry and Sasson find that real wage growth averages between 5.1 and 8.6 percent more than its long-term average in the years immediately after capital market liberalization. Productivity growth increases by more than 10 percent per year. Capital market liberalization only explains about half of the increase in real wage growth the adoption of new technology may account for most of the rest. The authors note that more integrated capital markets can facilitate the diffusion of technologies to less developed countries. By importing better equipment and machinery, firms can increase the productivity and efficiency of all production inputs, including labor.
Henry and Sassons results suggest that trade in capital has a profound effect on wages in developing countries. Capital trade increases the rate of wage growth, and it may also provide clues for explaining deepening wage inequality in developing countries. As firms import more new machinery, they demand more skilled labor at higher wages. This concern notwithstanding, the authors conclude that increased capital market integration raised the average standard of living for a significant fraction of the workforce in developing countries.
-- Alexander TeytelboymThe Digest is not copyrighted and may be reproduced freely with appropriate attribution of source.