A Survey of Trade and Wage Inequality: Anomalies, Resolutions and New Trends

Abstract

This paper surveys recent studies on trade and wage inequality. We first introduce some trade-based explanations for increased wage inequality. There are, however, a number of criticisms of this line of thought based on the 'trade-wage inequality anomaly', the 'price-wage anomaly', and the small volume of trade. Mainly due to these criticisms, trade-based explanations for rising wage inequality have been limited in the economic literature. Rather, the primary explanations for wage inequality have been based on skill-biased technological change. Some trade models, however, have weakened the above criticisms, and more economists now argue that the effect of trade, though relatively small compared to that of technological change, is more significant than generally believed. Finally, we attempt to link new trends in inequality, such as job polarization and within-group inequality, to the trade and wage inequality literature. Increased Trade and Increased Wage InequalityAs Figure 1 shows, the relative wage of high-skilled to low-skilled workers began to increase in US manufacturing industries in the late 1980s, and this phenomenon was also observed in Mexico. 1 As can be seen, these two countries showed surprisingly similar movements in relative wages in the late 1980s and early 1990s. 2 What is the cause of this recent increase in wage inequality in these countries?The data also indicate that, as shown in Figure 2, US-Mexican trade as a percentage of US GDP increased dramatically during the same period. 3 Hence, this increased trade might have contributed to the recent increase in skill premiums in both countries. 4 Past studies, such as Wood (1994), have investigated the possible relationship between trade and wage inequality. It is still a topic of interest and heated debate among economists.However, there are a number of criticisms of trade-based explanations for increased wage inequality. One criticism is based on the 'trade-wage inequality anomaly' -a discrepancy between the standard Heckscher-Ohlin (H-O) model and the data. According to the H-O model, the relative wage of highskilled to low-skilled workers should increase in the high-skill abundant US but decrease in low-skill abundant Mexico after trade liberalization. However, as we have seen in Figures 1 and 2, the data show that the wage inequality increased along with the increase in trade in both countries in the late 1980s and early 1990s. This is the 'trade-wage inequality anomaly'.A second criticism is based on the 'price-wage anomaly' -another discrepancy between the standard H-O model and the data. In the H-O model, an increase in the relative wage of high-skilled to low-skilled workers should be driven by an increase in the relative price of high-skill to low-skill intensive goods in the high-skill abundant US. This price-wage linkage is known as the Stolper-Samuelson theorem of the in the 1980s led to an increase in the demand for high-skilled workers, who were complements for this equipment, and a decrease in the demand for low-skilled workers, wh...

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