International Trade and Pay Inequality: A Comparative Analysis

This report analyzes the relationship between trade openness and industrial pay inequality in Australia and the Philippines from 1985 to 2005. It examines the correlation coefficients between trade openness and Industrial Pay Inequality (IPI), revealing a moderate positive correlation for Australia and a moderately weak negative correlation for the Philippines. The study applies the Stolper-Samuelson Theorem to interpret these findings, suggesting that Australia's data aligns with the theory, while the Philippines' does not. The analysis utilizes the Heckscher-Ohlin model to understand the effects of free trade, labor productivity, and wage stagnation. The report explores the economic implications of trade openness, considering factors of production, real wage rates, and the impact of free trade on skilled and unskilled labor. The conclusions highlight the importance of understanding the complex relationship between international trade and income distribution.

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Q1.
Figure 1.0: Australia's Openness to trade against the Industrial Pay Inequality
Figure 2.0: Philippines Openness to Trade against the Industry Pay Inequality

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The graphs in figure 1.0 and figure 2.0 show the trends for the trade openness and the
Industrial Pay Inequality in Philippines and the Australia economy that are extracted both from
World Bank data and UTIP-UNIDO respectively from 1985 to 2005. The trade openness was
calculated as a percentage of Gross Domestic Product. The first graph is for Australia's openness
to trade against its Industrial Pay Inequality, and the second one is for the Philippines openness
to trade against its Industrial Pay Inequality. The graphs were extracted from the excel sheet that
was used to draw the diagrams and found it their relationships
Q2.
In measuring economic inequality, most economies apply the Theil Index, which is also
an alternative substitute for the ratio of both the skilled and unskilled income in practical studies
(Neves and Silva, 2014). When the Theil Index is higher, the more open an economy in trading
i.e., increasing the rate of trade leads to a rise in income inequality. As a result, the study applies
the correlation coefficient that shows the relationship between the trade openness and the
Industrial Pay Inequality as shown below;
The above formula will help in understanding and interpreting the relationship between
Australia and the Philippines in terms of their Openness and the Industrial Pay Inequality
between 1985 to the year 2005. However, the correlation ratio lies between -1 to +1 with zero
showing no correlation. A positive one correlation coefficient shows that openness and Industrial
Pay Inequality are perfect. A strong positive relationship between openness and IPI will be
experienced when the correlation coefficient is closer to +1. On the other hand, the closer the

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correlation coefficient to -1, the stronger the negative correlation, the trade openness and the IPI
i.e., as the trade openness decrease, so do the IPI (Helpman et al., 2017).
a) Australia Correlation Coefficient was found to be 0.65379, which is moderate and strong
positive correlation coefficient. It, therefore, shows that Australia became more open to
trading with an increased, though modest rise in industrial pay inequality during the
1985-2005 periods. Both the trade openness and the IPI increased since the correlation is
more than 0.5 showing a strong positive relationship between the two variables. An
increase in trade openness with one unit thus leads to a rise in the Industrial Pay
Inequality at 0.65379 units.
b) The Philippines Correlation Coefficient was found to be -0.515, which is moderately
weak. Thus, the relationship between trade openness and Industrial Pay Inequality is
negatively weak. It, therefore, shows that there is a decrease in IPI in the Philippines
economy while the openness to trade increases. An increase in trade openness with one
unit in the Philippines leads to the decline in the Industrial Pay Inequality by 0.515 units,
and a decrease in the trade openness by a unit leads to an increase in the IPI by 0.515
units. As a result, it can be confirmed that the Philippines economy in terms of trade
openness has a little sway on the industrial pay inequality. However, the Philippines is
one of the countries regarded in the current world Economic order as among the top
twenty economies with the highest trade openness as compared to other Tigers of Asia.
Q3.
The Stolper-Samuelson Theory is among the principal international trade theory based on
the Heckscher-Ohlin model (Feenstra, 2015). It promulgates the relationship between
international trade output and the national income distribution. The theory postulates that when

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there is an increase in the prices of goods and services, then the costs of the abundantly available
factors of production will also increase at a decrease in the return of factors of production
(Baldwin et al., 2014). This can be illustrated using the following figure 3.0 which demonstrates
that when the trade openness, income from the factors of production, and the income from scares
resources fall, there will be a shift in the curves as shown;
Figure 3.0: Real Wage Rate Equilibrium and the Labour Substitutability.
Now, suppose there are two countries producing goods, the Apparel and the plastic as
shown in figure 3.0 above. Assuming that country A is skilled-labor intensive while country B is
unskilled-labor intensive and the prices of Apparel PA/PP falls as price of plastic increases; there
will be an increase in the wage rate for the skilled-labor and unskilled-labor, Ws/PA and Wu/PA
respectively. Due to free-trade experienced the decrease in the relative price of the unskilled-
labor intensive products results in a negative term of trade both for the skilled and unskilled
laborers.

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Using Stolper-Samuelson Theorem, there will be trade gain in terms of labor abundant
factors while the scare factors will be worse off from trade. As a result, there will be an increase
in the prices of the plastic due to growth in income of the skilled-labor as per in the country A.
However, due to unskilled-labor experienced in country B, there will be negative effects for the
skilled labor as unskilled labor gains in terms of the trade-off.
It can, therefore, be assumed that the data retrieved from the World Bank for Australia is
in line with the Stolper-Samuelson Theorem whereas that of Philippines does not match the
theory. This is because as previously stated, an increase in the relative price of the goods and
services leads to a price increase in the abundant factors of production with a decrease in other
scarce factors. Comparing the two countries correlations, Australia's correlation coefficient,
which was found to be 0.65379 indicates a positive correlation; thus, there exist a strong
relationship between openness to trade and the industrial income inequality. In regards to
Australia's economy, openness to trade leads to an increase in income, whereas scarce factors go
reduces in terms of produce (Haley, 2018). Increase in the price of factors of production will
therefore guarantee an increase in the production.
Philippines correlation coefficient was found to be -0.515, which shows a negative
relationship between trade openness and the IPI thus disagreeing with the Stolper-Samuelson
Theorem. Philippines is among the most developing economies in the Asian Continent, known as
the Tigers of Asia with much focus on the service and industrial growth which contributes to
about 65.45% and 20.25 % respectively whereas less than 5% GDP comes from the Agricultural
services (Ghani and O'Connell, 2014). As a result, openness to trade in the Philippines does not
guarantee an increase in income as scarce factors reduce in terms of their produce. This is

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because the country has a greater percentage of unskilled labor that does not promote the
manufacturing industries in the economy as a compared to Australia.

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References
Baldwin, R. and Robert-Nicoud, F., 2014. Trade-in-goods and trade-in-tasks: An integrating
framework. Journal of international Economics, 92(1), pp.51-62.
Feenstra, R.C., 2015. Advanced international trade: theory and evidence. Princeton university
press.
Ghani, E. and O'Connell, S.D., 2014. Can service be a growth escalator in low-income
countries?. The World Bank.
Haley, J.A., 2018. Did Trade Liberalization Go Too Far? Trade, Inequality and Unravelling the
Grand Bargain.
Helpman, E., Itskhoki, O., Muendler, M.A. and Redding, S.J., 2017. Trade and inequality: From
theory to estimation. The Review of Economic Studies, 84(1), pp.357-405.
Neves, P.C. and Silva, S.M.T., 2014. Inequality and growth: Uncovering the main conclusions
from the empirics. Journal of Development Studies, 50(1), pp.1-21.