Ebook Trade Liberalization and Rising Wage Inequality in Latin America: Reconciliation with HOS Theory
Trade liberalization in Latin America in the past two decades has been accompanied by rising wage inequality and increase in real skilled wage (Robbins, 1996; Goldberg and Pavcnik, 2004). The pattern of increasing wage inequality is contrary to what one would expect to happen based on Krueger (1981), who finds that import-competing sector is relatively skill intensive in developing countries. Thus, reconciling rising wage inequality in Latin America with HOS theory has been an active and important area of research.
Wood (1997) reconciles rising wage inequality in Latin America with the HOS theory based on the entry of large low-income exporters such as China, India, Bangladesh, Indonesia, and Pakistan in 1980s and 90s. Their entry, Wood argues, has reduced the relative price of less skill intensive exports thereby eliminating the comparative advantage of middle-income countries. But, then wage inequality would have risen not only in the countries that liberalized their trade regimes but also in already relatively open middle-income countries. In addition, wage inequality would have fallen in the low-income exporters. Evidence on former is inconclusive (see Wood, 1997). Further, on latter, Kijima (forthcoming) reports contradictory evidence: rising wage inequality in urban India beginning in late 1980s driven by increasing demand of skilled labor.
Feenstra and Hanson (1996) show that a simultaneous rise in wage inequality in the North and the South occurs when international capital movement shifts the production of middle skill-intensive goods from the North to the South thereby raising skill intensity of employment everywhere. Trefler and Zhu (2005) show that such product shifting can also result from technological catch-up in the South. Recent literature on trade in intermediate inputs and fragmentation of production, by linking foreign investment and technological catch-up with trade liberalization, then forges the connection between trade liberalization and wage inequality (see Jones, 2000). Jones (1999), however, shows that product shifting does not unambiguously lead to rise in wage inequality. Xu (2003), therefore, addresses the question whether southern trade liberalization alone, without increased foreign investment or induced technical change, can cause Southern wage inequality to rise.
In his set up, the imposition of a tariff has an effect on terms of trade that causes not only some importables but also some exportables to become nontradables. If more exportable-turned-nontradables become tradable on reduction of tariff than the importable-turned-nontradables, then wage inequality can rise. The effect is, however, quantitatively very small in his simulations. Furthermore, as tariff is progressively reduced by a larger amount, this effect gets weaker and finally wage inequality starts falling.
Another line of research beginning with Harrison and Hanson (1999) argues that recent reforms in Latin America involved deprotection of unskilled labor intensive manufacturing industries i.e. unskilled labor intensive compared to other manufacturing industries. While Harrison and Hanson (1999) provide such evidence for 1985 Mexican reforms, Pavcnik, Blom, Goldberg, and Schady (2004) and Attanasio, Goldberg, and Pavcnik (2004) do so for Brazil and Colombia. Such reforms imply a greater decline in relative prices of unskilled labor intensive manufactured goods which in turn would increase wage inequality as has been observed in Latin America. Robertson (2004) also uses a closely related argument to reconcile rise in wage inequality in Mexico over 1988-94 with HOS theory.
The conclusion in these papers, however, depends on the very strong (implicit) assumption of no resource reallocation across manufacturing and other sectors e.g. the primary export sector. In fact, for plausible relative sizes of different sectors of production in the countries in Latin America, deprotection of unskilled-labor-intensive import-competing manufacturing sector leads to a decline in wage inequality in the long run. The reason is that overall export sector turns out to be unskilled labor intensive relative to import-competing sector even when import-competing manufacturing sector is unskilled labor intensive relative to export manufacturing.
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