Working Paper: NBER ID: w16106
Authors: Lawrence Edwards; Robert Z. Lawrence
Abstract: Conventional trade theory, which combines the Heckscher-Ohlin theory and the Stolper-Samuelson theorem, implies that expanded trade between developed and developing countries will increase wage inequality in the developed countries. This theory is widely applied. It serves as the basis for estimating the impact of trade on wages using two-sector simulation models and the net factor content of trade. It leads naturally to the presumption that the rapid growth and declining relative prices of US manufactured imports from developing countries since the 1990s have been a powerful source of increased US wage inequality. \n\nIn this study we present evidence that suggests the presumption is not warranted. We highlight the sensitivity of conventional theory to the assumption of incomplete specialization and find evidence that is not consistent with it. Since 1987, although US domestic relative effective prices in industries with relatively high shares of manufactured goods imports from developing countries have declined, effective unskilled worker-weighted prices have actually risen relative to skilled worker-weighted prices. If anything, this suggests pressures for increased wage equality. Also in apparent contradiction to theory, the (six-digit North American Industry Classification System [NAICS]) US manufacturing industries with high shares of manufactured imports from developing countries are actually more skill intensive than the industries with high shares of imports from developed countries. Finally, applying a two-stage regression procedure, we find that developing-country import price changes have not mandated increased US wage inequality. While these results conflict with standard theory, they are easily explained if the United States and developing countries have specialized in products and tasks that are highly imperfect substitutes. If this is the case, the impact of increased trade with developing countries on US wage inequality is far more muted than standard theory suggests. Also methodologies such as the net factor content of trade using US production coefficients and simulation models assuming perfect substitution between imports and domestic products could be highly misleading.
Keywords: trade; wage inequality; Heckscher-Ohlin theory; Stolper-Samuelson theorem
JEL Codes: F11; F16; J3; J31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Increased imports from developing countries (F69) | Greater wage inequality in the United States (J31) |
| Rising effective prices for unskilled labor relative to skilled labor (F66) | Decreased wage inequality pressures in the United States (F66) |
| High shares of imports from developing countries (F10) | More skill-intensive industries in the United States (J24) |
| Declining domestic prices in industries with high shares of imports from developing countries (F14) | Increased effective unskilled worker-weighted prices (F66) |
| Import price changes from developing countries (P22) | No increased wage inequality in the United States (J70) |