ECONOMIC LIBERALIZATION: ASSESING THE CHANGES

IN ECONOMIC STRUCTURE, EMPLOYMENT AND,

PRODUCTIVITY

A Seminar Paper

Submitted by
Robinson Bhandari
Regd no:
Exam Roll no:

Submitted to
Dipak Dahal
Department of Economics

Date
14th February, 2023
 Acknowledgements
I would like to convey my sincere gratitude to our facilitator for Macroeconomics (Subject Code:
ECO 203), Mr. Dipak Dahal, for constantly offering us encouragement and criticism as we
prepared this seminar paper. This was an incredible chance to build practical research skills as
well as gain in-depth understanding of current problems and practices from both a global and
Nepalese viewpoint.This was an incredible chance to build practical research skills as well as
gain in-depth understanding of current problems and practices from both a global and Nepalese
viewpoint. Without our facilitator's knowledge, skill, commitment, and support, none of this
would have been possible.
In addition, I am very appreciative of the college's support and that of my classmates and the
management team at Kathmandu Model College.
 Introduction
We reach economic liberalization as the government's influence over the economy declines and
the market begins to exert more of a sway. A fundamental tenet of economic liberalization is to
establish conditions that will direct economic resources toward more productive sectors,
resulting in long-term growth. It has surely been a hot topic all across the world, with supporters
praising its potential to promote prosperity and economic growth. Some detractors do, however,
also raise concerns about potential harm to employment and productivity. With the assistance of
multilateral organizations like the International Monetary Fund (IMF), World Bank, etc., the
Washington consensus-based policy of economic liberalization spread into developing nations
(Shrestha, 2017). Since the middle of the 1980s, Nepal has been adopting a policy of economic
liberalization in accordance with the global trend; this process accelerated in the 1990s with the
return of a multiparty political system (Khanal, Rajkarnikar, Acharya and Upreti, 2005). Nepal
joined the World Trade Organization as one of the first least developed nations in 1995, along
with Cambodia (WTO). However, after a few years of accelerating the economic liberalization
process, political instability and armed internal conflict started in Nepal in 1996. These conflicts
ended with the signing of the Comprehensive Peace Accord (CPA) in 2006, and now the nation
is undergoing restructuring despite the overwhelming influence of leftists in the Constituent
Assembly (Shrestha, 2017).
With the economic liberalization process in place, the structure of Nepalese Economy may have
changed. Structural transformations that lead into the flow of labors from Agricultural activities
into the activities of higher productivity is considered to be successful for higher economic
growth (Shrestha, 2017). It has been discovered that successful nations' long-term prosperity is
correlated with the shift of their economies to higher-productivity sectors with increasing returns
to scale. In order to make this possible, Nepal removed several limits and conditions placed on
the private sector's ability to engage in various economic activities after the middle of the 1980s.
In addition, it decreased import tariffs and instituted a liberal industrial strategy (Shrestha, 2017).
Though the economic development is somewhat modest, the structural adjustments and
liberalization policies were unable to bring out the best in our employment and production.
It is imperative to assess the structural changes in the economy, employment and productivity in
Nepal along with the process of trade liberalization. A rise in productivity and employment is
vital for sustainable growth of the economy and for raising the standards of the living of people
in the country. Economic prosperity can be achieved at a higher pace if modern needs and
desires are fulfilled by the productive activities of the economy. On a similar note, MacMillan
and Rodrik (2012) argue that only countries that can diversify away from agriculture and other
traditional products and move into modern economic activities can achieve progress by
increasing productivity and income. The structural changes should be focused on growth
enhancing activities. On the other hand, the jobless growth is considered as a major obstacle for
the poor to benefit from the positive growth performance of the economy (Gutierrez, Orecchia,
Paci and Semeels, 2007). For the formulation of appropriate policies, it is crucial to discuss how
economic growth is represented in the creation of jobs and changes in productivity. It is so
because employment growth patterns and sectoral productivity may have a significant impact on
efforts to reduce poverty (Gutierrez et. al, 2007).

Objectives:
1. To evaluate the changes in economic structure, employment and productivity under the
implementation of economic liberalization policies
2. To familiarize with various theories and empirical studies revolving around this topic
Based on the above objectives following research questions are derived:
1. How does economic liberalization affect economic structure, employment and
productivity?
2. What theories and empirical studies have given solidified answers to the question about
the impacts?

Methodology
1. The study is designed in the form of a literature review, i.e., theoretical and empirical
review to evaluate the changes in structure, employment and productivity under
economic liberalization
2. Information about the overall and sectoral growth of economy as well as other required
data were collected from articles, websites, books, etc.
3. The method of analysis is text analysis and statistical analysis of given data which
involves finding mode, frequency and other simple statistical tools.
Descriptive Analysis
Theoretical Review
Economic liberalization refers to the policy actions made by governments to lower taxes,
privatize state-owned businesses, deregulate industries, and lower trade and investment
obstacles. There are many theoretical perspectives from which to examine how economic
liberalization affects economic structure, employment, and productivity, including: Neoclassical
Economics, Marxist Economics, Institutional Economics, Development Economics, etc. All
these theoretical lenses will be discussed further in this section.
Neoclassical economists contend that economic liberalization boosts productivity and efficiency
by enabling markets to more effectively allocate resources. Growth in the economy, higher
employment, and better wages follow from this. This point of view contends that economic
liberalization increases competition, which promotes innovation and technical advancement that
can fuel long-term economic growth. According to the neoclassical theory of trade, when a
country opens up to trade and investment, it can increase its productivity and competitiveness.
This can lead to higher wages for workers, as firms become more profitable and can afford to
pay higher wages (Krugman, Obstfeld, & Melitz, 2014). The endogenous growth theory suggests
that economic liberalization can lead to technological innovation and productivity growth, which
can increase wages (Romer, 1990). The factor endowment theory suggests that economic
liberalization can increase the demand for skilled labor, which can lead to higher wages for
skilled workers (Heckscher & Ohlin, 1933). As market forces take the place of government
interference in resource allocation decisions, the resource allocation theory contends that
economic liberalization can result in a more effective distribution of resources. This may cause a
shift in the production and employment mix in favor of more productive sectors, which may
result in structural change (Hirschman, 1958). The new growth theory suggests that economic
liberalization can lead to technological innovation and productivity growth, which can shift the
structure of an economy towards more knowledge-intensive industries (Romer, 1990). The trade
theory of comparative advantage suggests that economic liberalization can lead to specialization
in industries in which a country has a comparative advantage, which can lead to structural
changes in the composition of production and exports (Ricardo, 1817). Ferreira and Rossi (2003)
concluded that there is a significant and robust relationship between productivity and economic
liberalization. Furthermore, in the cross-sectional dimension, their estimations, data and analysis
imply that the higher the protection the lower the growth rate of TFP and labor productivity of a
given industry. In addition, Fernandes (2007) also iterates that the higher level of trade protection
results to a decline in the productivity of industries.
Economic liberalization is seen by Marxist economists as a means of boosting capitalist
companies' profits at the expense of workers. They contend that because businesses want to
boost profits by reducing labor costs, liberalization policies result in increased worker
exploitation and decreased job security. Furthermore, they contend that policies that liberalize
markets frequently result in greater wealth disparity and economic instability since businesses
aim to maximize short-term profits rather than make investments in long-term expansion.
According to the Stolper-Samuelson theorem, economic liberalization can lead to a decrease in
the real wage of workers in industries that face import competition. This is because economic
liberalization can increase the supply of imported goods, which can put downward pressure on
the wages of workers in import-competing industries (Stolper & Samuelson, 1941). Although the
economic liberalization, according to Heckler and Ohlin (1993), increases the labor demand, it
only increases the wage of skilled labors, the wages of unskilled labors keep on declining. This is
because economic liberalization can increase the demand for goods that are intensive in skilled
labor, which can increase the relative price of skilled labor. The efficiency wage theory suggests
that economic liberalization can lead to an increase in labor market competition, which can put
downward pressure on wages as employers seek to minimize labor costs (Shapiro & Stiglitz,
1984). The segmentation theory of labor markets suggests that economic liberalization can
increase labor market segmentation, which can lead to lower wages for workers in more
competitive, flexible sectors and higher wages for workers in more protected, regulated sectors
(Doeringer & Piore, 1971). The labor market search theory suggests that economic liberalization
can increase labor market competition, which can increase unemployment and put downward
pressure on wages (Mortensen & Pissarides, 1994). The rent-seeking theory suggests that
economic liberalization can lead to increased rent-seeking behavior by firms, which can lead to
lower wages for workers (Tullock, 1967). The bargaining power theory suggests that economic
liberalization can reduce the bargaining power of workers, as firms can more easily replace them
with cheaper labor from other countries. This can lead to lower wages for workers (Visser,
2017).
There are several theoretical evidences implicating that the economic liberalization does not
necessarily lead to structural change in an economy. According to the path dependency theory,
economic liberalization may not lead to structural change if the existing structure of the economy
is path-dependent and resistant to change. This is because the existing economic structure may
be supported by established interests and institutions that are resistant to change (David, 1985).
The rent-seeking theory suggests that economic liberalization can lead to increased rent-seeking
behavior by established firms, which can maintain the existing structure of the economy and
prevent structural change (Tullock, 1967). The institutional complementarity theory suggests that
economic liberalization may not lead to structural change if the institutions that support the
existing economic structure are complementary and interdependent. This is because changing
one institution may require changes in others, which can be difficult to achieve (Hall & Soskice,
2001). The product life cycle theory suggests that economic liberalization may not lead to
structural change if the economy is in a mature stage of development, and the existing industries
are producing established goods with stable demand. This is because the existing industries may
be able to maintain their position in the market without undergoing significant structural change
(Vernon, 1966). The sunk cost theory suggests that economic liberalization may not lead to
structural change if the existing firms have invested heavily in specific assets that are specific to
the current structure of the economy. This is because the sunk costs of these assets may make it
difficult for firms to change their production processes and move into new industries (Irwin,
2002). The skill-biased technological change theory suggests that economic liberalization may
not lead to structural change if the existing industries are able to adapt to new technologies and
maintain their position in the market. This is because the existing industries may be able to adapt
to new technologies and maintain their relative productivity and profitability (Acemoglu &
Autor, 2011). The dominant design theory suggests that economic liberalization may not lead to
structural change if the existing industries have established a dominant design for the products
they produce, which is difficult for new entrants to challenge. This is because the existing firms
may be able to maintain their position in the market without undergoing significant structural
change (Utterback & Abernathy, 1975).
Institutional economists argue that the impact of economic liberalization on economic structure,
employment, and productivity depends on the specific institutional arrangements in place in a
given country. According to this view, liberalization policies must be accompanied by effective
institutions that ensure fair competition, protect workers' rights, and regulate markets to prevent
abuses of market power. In the absence of effective institutions, liberalization policies can lead to
economic instability, social unrest, and reduced productivity. Institutional economics provides a
framework to analyze the effects of economic liberalization on economic structure, employment,
and productivity. Economic liberalization can lead to a shift in economic structure from labor-
intensive to capital-intensive production, leading to job losses for low-skilled workers.
According to North (1990), "Economic liberalization can have unintended consequences on the
distribution of income and employment, leading to the displacement of low-skilled labor."
Institutions such as labor laws and trade unions play an important role in protecting workers'
rights and bargaining power, and their weakening can lead to a decline in wages and working
conditions. According to Freeman (2007), "Institutional changes that weaken labor protection
can lead to a race to the bottom in wages and working conditions, reducing productivity in the
long run." Economic liberalization can lead to a concentration of economic power in the hands of
a few large firms, leading to reduced competition and innovation. According to Scherer (2000),
"Economic liberalization can lead to the formation of oligopolies and monopolies, which can
reduce incentives for innovation and technological progress." Weak institutions such as weak
property rights and contract enforcement can lead to a lack of trust and reduced investment,
leading to reduced productivity. According to Williamson (2000), "Institutions play a critical
role in providing the framework for economic activity, and weak institutions can lead to a lack of
trust and reduced investment, leading to reduced productivity." The quality of institutions such as
regulatory agencies and legal systems can impact the effectiveness of economic liberalization
policies. According to Rodrik (2006), "The quality of institutions such as regulatory agencies and
legal systems can determine the effectiveness of economic liberalization policies, and weak
institutions can lead to unintended consequences such as corruption and rent-seeking behavior."
Institutional changes such as the privatization of public assets can lead to a concentration of
wealth and power in the hands of a few, leading to reduced social welfare. According to Polanyi
(1944), "Institutional changes such as the privatization of public assets can lead to a
concentration of wealth and power in the hands of a few, leading to reduced social welfare and
increased inequality." Institutions such as education and training programs play an important role
in preparing workers for changes in the economic structure, and their neglect can lead to long-
term unemployment and reduced productivity. According to Mincer (1995), "Investments in
education and training programs can prepare workers for changes in the economic structure, and
neglecting these institutions can lead to long-term unemployment and reduced productivity."
Development economists argue that the impact of economic liberalization on economic structure,
employment, and productivity depends on the stage of development of the country in question.
They argue that liberalization policies can be beneficial in countries that have reached a certain
level of development, but can be harmful in countries that lack the institutional capacity to
manage the effects of liberalization. Moreover, they argue that liberalization policies should be
accompanied by investments in human capital, infrastructure, and social protection programs to
ensure that the benefits of liberalization are distributed more equitably across society. Economic
liberalization can lead to increased foreign investment, but this can also lead to a "race to the
bottom" in terms of wages and working conditions for local workers. According to Stiglitz
(2002), "Economic liberalization can lead to a race to the bottom in wages and working
conditions, as countries compete to attract foreign investment." Economic liberalization can lead
to a shift in the structure of the economy from traditional sectors to modern sectors, but this can
also lead to a loss of traditional knowledge and practices. According to Sen (1999), "Economic
liberalization can lead to a shift from traditional sectors to modern sectors, but this can also lead
to a loss of traditional knowledge and practices, which can have negative impacts on social
welfare." The distribution of benefits from economic liberalization can be uneven, with some
regions and social groups benefiting more than others. According to Todaro and Smith (2014),
"The distribution of benefits from economic liberalization can be uneven, with some regions and
social groups benefiting more than others, leading to social unrest and political instability."
According to Krugman (1994), economic liberalization may not have a significant impact on
wages because it does not necessarily lead to a significant increase in the demand for labor.
Krugman argues that liberalization policies, such as reducing trade barriers, may lead to a shift in
the composition of production towards sectors that use more skilled labor, but the overall level of
demand for labor may remain the same, resulting in little change in wages. Another possible
explanation for the lack of effect of economic liberalization on wages is the "race to the bottom"
argument, which suggests that the competition for investment among countries can lead to a
downward pressure on wages and working conditions. According to Freeman and Katz (1995),
the globalization of production can lead to a race to the bottom in terms of wages and working
conditions, with countries competing to attract investment by offering lower labor costs. In this
scenario, economic liberalization may not have a significant effect on wages, as any gains in
productivity or growth may be offset by the downward pressure on wages.
Empirical Review
The purpose of this section is to provide a critical evaluation of previous empirical research on
this issue. This review will identify the key findings and theoretical frameworks that have been
used to examine the phenomenon. This issue has been the subject of a significant body of
empirical research in recent years. Studies have examined the phenomenon from various
theoretical perspectives, including endogenous growth theory, bargaining power theory and
much more.
A study by Pavcnik (2002) analyzed the impact of trade liberalization on wages in Chile. The
study found that trade liberalization led to an increase in wages for skilled workers, while wages
for unskilled workers remained unchanged. The study used household-level data from the
Chilean labor market over the period 1987-1997. Another study by Harrison and Hanson (2000)
examined the impact of trade liberalization on wages in Indonesia. The study found that trade
liberalization led to an increase in wages for both skilled and unskilled workers. The study used
firm-level data from the Indonesian labor market over the period 1985-1996. A third study by
Goldberg and Pavcnik (2007) examined the impact of trade liberalization on wages in Colombia.
The study found that trade liberalization led to an increase in wages for both skilled and
unskilled workers. The study used household-level data from the Colombian labor market over
the period 1984-1999. A study by Amiti and Konings (2007) analyzed the impact of trade
liberalization on productivity in the manufacturing sector in India. The study found that trade
liberalization led to an increase in productivity, especially in firms that were more exposed to
competition. The study used firm-level data from the Indian manufacturing sector over the period
1989-2000. Another study by Harrison and Rodriguez-Clare (2010) examined the impact of trade
liberalization on productivity in Costa Rica. The study found that trade liberalization led to an
increase in productivity in both the manufacturing and service sectors. The study used firm-level
data from the Costa Rican labor market over the period 1991-2005. A third study by Tybout and
Westbrook (1995) examined the impact of trade liberalization on productivity in Colombia. The
study found that trade liberalization led to an increase in productivity in the manufacturing
sector, especially in firms that were more exposed to competition. The study used firm-level data
from the Colombian manufacturing sector over the period 1977-1986. A study by Chandra and
Khan (2018) analyzed the impact of trade liberalization on the structure of the Indian economy.
The study found that trade liberalization led to a shift in the economic structure of India from
being primarily agriculture-based to being more service-oriented. The study used sectoral data
from the Indian economy over the period 1970-2010. Another study by Brülhart and Torstensson
(1996) examined the impact of trade liberalization on the structure of the Swiss economy. The
study found that trade liberalization led to a shift in the economic structure of Switzerland from
being primarily industry-based to being more service-oriented. The study used sectoral data from
the Swiss economy over the period 1970-1990. A third study by Lee and Lim (2001) examined
the impact of trade liberalization on the structure of the Korean economy. The study found that
trade liberalization led to a shift in the economic structure of Korea from being primarily
manufacturing-based to being more service-oriented. The study used sectoral data from the
Korean economy over the period 1960-1997.
A study by Stiglitz and Charlton (2005) examined the impact of economic liberalization on the
structure of the African economy. The study found that trade liberalization led to a deterioration
of the African economy's structure, with a decline in manufacturing and an increase in the export
of primary commodities. The study used country-level data from African economies over the
period 1980-2000. Another study by Dutt (2006) examined the impact of economic liberalization
on employment in India. The study found that trade liberalization led to a decline in employment
in the formal sector, as firms shifted towards capital-intensive production methods. The study
used firm-level data from the Indian manufacturing sector over the period 1980-2000. A third
study by Gereffi (1999) examined the impact of economic liberalization on the industrial
structure of Mexico. The study found that trade liberalization led to a decline in the
competitiveness of Mexican industries, with a shift towards low-wage manufacturing and a
decline in high-wage manufacturing. The study used sectoral data from the Mexican economy
over the period 1980-1995. A study by Bussolo and Niimi (2006) analyzed the impact of trade
liberalization on productivity in the Indonesian manufacturing sector. The study found that trade
liberalization led to a decline in productivity, as firms faced increased competition and a decline
in protection. The study used firm-level data from the Indonesian manufacturing sector over the
period 1986-1995. Another study by Naqvi and Ahmed (2002) examined the impact of economic
liberalization on employment in Pakistan. The study found that trade liberalization led to a
decline in employment in the manufacturing sector, as firms faced increased competition and a
decline in protection. The study used sectoral data from the Pakistani economy over the period
1972-1995. A study by Rana and Hasan (2016) analyzed the impact of economic liberalization
on the structure of the Pakistani economy. The study found that trade liberalization led to a
decline in the competitiveness of Pakistani industries, with a shift towards low-wage
manufacturing and a decline in high-wage manufacturing. The study used sectoral data from the
Pakistani economy over the period 1975-2010.

Contextual Examples
Economic liberalization in Nepal led to an increase in foreign direct investment (FDI), which
contributed to the growth of certain industries such as the hydropower industry. By reducing
restrictions on foreign investments, the Nepalese government made it easier for foreign
companies to set up operations in Nepal and invest in the country. This influx of foreign capital
allowed for the growth of industries such as hydropower, which has since become a major
economic driver in the country. According to a report by the United Nations Conference on
Trade and Development (UNCTAD), Nepal experienced a significant increase in FDI inflows in
the late 1990s and early 2000s, which helped to expand the country's hydropower industry and
increase its electricity generation capacity. This foreign capital was used to build infrastructure
such as dams and power plants and allowed Nepal to tap into its abundant water resources. This
in turn created jobs and increased the country's economic output.1
There is no doubt that Nepal's manufacturing sector has struggled to compete with cheaper
imports, particularly from China and India, despite an increase in the amount of foreign direct
investment. This has resulted in a decline in domestic manufacturing and a shift toward service-
1
Source: UNCTAD (2005). World Investment Report 2005: Transnational Corporations and the Internationalization
of R&D.
based industries, such as tourism and finance, which has resulted in a decline in manufacturing.
There has been a stagnation in Nepal's manufacturing sector for over two decades now,
according to a report by the World Bank. Additionally, as a result of the country's reliance on
imported goods, its trade deficit has increased as well.2
The liberalization of Nepal's economy has also had a mixed impact on employment. While some
industries such as tourism have seen significant job creation, others such as agriculture and
manufacturing have struggled to create jobs. According to the International Labor Organization
(ILO), Nepal has a high rate of unemployment and underemployment, particularly among young
people and women.3
Economic liberalization in Nepal has also contributed to increased productivity in certain
industries such as the tourism industry. According to a report by the Asian Development Bank,
Nepal's tourism industry has grown rapidly in recent years, with a significant increase in the
number of tourists visiting the country. This has led to an expansion of hotels, restaurants, and
other tourism-related services, contributing to increased productivity in these industries.4
However, Nepal's economic liberalization has also led to increased income inequality, as the
benefits of economic growth have been concentrated among a small elite. According to a report
by the United Nations Development Program (UNDP), Nepal's Gini coefficient, a measure of
income inequality, has increased significantly since the 1990s.5

2
Source: World Bank (2019). Nepal Development Update.
3
Source: ILO (2018). Nepal Labor Force Survey 2017-18.

4
Source: Asian Development Bank (2019). Nepal: Country Partnership Strategy 2019-2023.
5
Source: UNDP (2019). Human Development Indices and Indicators: 2019 Statistical Update.
Discussion
It can be inferred from theoretical and empirical studies that economic liberalization significantly
affects a country's economic structure, employment, and productivity. However, different authors
and their distinct empirical hypotheses have demonstrated various effects of economic
liberalization on economic structure, employment, and production. Government policies that
decrease taxes, privatize state-owned companies, deregulate industries, and remove trade and
investment barriers are referred to as economic liberalization. While assessing the impact of