Inter-industry wage differentials and returns to education in Pakistan

• Main Author: Shah, Vyoma
• Other Authors: Jaffry, Shabbar Abbas ; Collins, Alan Oscar Michael
• Published: University of Portsmouth 2010
• Subjects: 337; Economics
• Online Access: http://ethos.bl.uk/OrderDetails.do?uin=uk.bl.ethos.536126

Few studies deal with the Pakistan labour market and most of them have paid little attention to wage structures and differentials. This study is concerned with the existence and determinants of wage differentials in Pakistan. Therefore, the aim of this study is to fill a research gap and contribute to the empirical work on the Pakistan economy. Previous empirical studies have revealed that there are several theories and approaches, which have been used to explain wage determinants and wage differentials. This study involves identification of some of these theories and approaches, which are believed to be helpful in explaining the determinants of wage differentials in the developing economy. These include i) efficiency wage theory; ii) human capital theory; iii) the segmented labour market and iv) other factors that are theoretically relevant to the determinants of wage differentials. These theories are explained and tested by using different econometric techniques. To do so, this study investigates the wage differential at three different points; the wage differential within the industries, the wage differentials between the public and private sectors, and the role of education in explaining the wage differential. In light of these theories and approaches, the aim of this study is to provide theoretical and empirical analysis, focusing on the role of observable characteristics, which directly and indirectly influence wage determination and wage differentials in the study area. In order to accomplish the objective models are selected based on the above theories and evidence provided by previous empirical studies. The main estimations are based on the calculation of the wage equation with individual, household and job characteristics. To do this the study has employed nine different cross-sectional Labour Force Surveys for the time period between 1990-91 and 2006-07. Estimation suggests the existence of wage differentials across Pakistan, and these wage differentials have grown significantly over time. Results on inter-industry wage differentials shows that even after controlling for individual, household and job characteristics, substantial wage differentials do exist and none of these wage differentials are explained by employer or industry effects. The results on public and private wage differentials found that overall the public sector tends to pay higher wages compared to the private sector and these differentials have widened over the time. On average in 2006-07, private sector employees earned 35 percent less wages compared to their public sector counterparts. The analysis of sector selection models reveal that much of the educated population wish to get employment in the public sector. The same is true for most occupations and industries. Over time, the rate of return to education has increased but there is hardly any change in the return at low levels of education. In other words, a person having completed the primary or middle level of education earns only 3 to 5 percent more compared to the person having little or no education. An assessment of wage inequality based on the level of education also shows that wage inequality spread between people who have acquired higher levels of education are larger compared to the lower level of education across the wage distribution. Decomposition of the wage differential over time shows that much of the wage differentials are explained by observable characteristics. It explains almost 50 percent of the total wage inequality increase between 1990-91 and 2006-07 but when split in two time periods, the observable characteristics have actually helped to narrow down the wage inequality between 1999-00 and 2006-07. It also reveals that in the beginning years, 1990-91 to 1999-00, education has helped to narrow that gap. But still half of the wage differentials are due to unobserved abilities and characteristics. The results provided by the study should prove valuable in explaining the existing system of employment and wage differentials in Pakistan. In addition, it should be of considerable assistance in rationalising the labour market‟s wage policies and narrowing the wage gap across industries and public-private sector. The rate of return to education and wage inequality estimates should help in designing the education policy as much of the population of Pakistan still have little or no education. Overall, the results should prove of major importance to the Pakistan government, in assisting their Education Sector Reforms programme.