The Effects of Trade Liberalization on Wage Inequality and Informality in Indonesia: An Empirical Study

This study investigates the equity perspective of Indonesia’s trade liberalization. Using a two-stage estimation framework, the author exploited labor surveys and international trade data to examine how tariff reductions have influenced Indonesia’s wage inequality and informality during its 1995-2006 episode of liberalization. The results provide evidence that tariff reductions have ambiguously affected inequality among Indonesian workers. First, they have reduced inequality by causing workers of highly liberalized industries – in 1995, their industries were known as low-paying industries – to experience higher wage increases relative to the economy-wide average, thus narrowing the wage gap. Second, they have increased inequality by causing workers of these highly liberalized industries – in 1995, these industries were also known to have a relatively high probability of informal employment – to experience higher increases on the probability of informal employment relative to the economy-wide average.This means that these unfortunate workers were more likely to receive even lower payments, to be employed in poorer working condition and to be covered with less social protection