Download Technology Spillover and Wage Inequality : A Model of Two Sets of

International Knowledge Spillovers and Wage Inequality in Developing Countries
Ming-cheng Wang, Chen-ray Fang and Li-hsuan Huang
12/02/2008
Abstract
In this paper, international knowledge spillovers are incorporated in a horizontal
innovation model, designed to explain the observed uncertain effects that openness of
trade can have on wage inequality in small developing countries. Openness of trade can
produce two different effects: an increase in the relative price of less-skilled
labor-intensive products and a wider skill discrepancy due to knowledge spillovers from
the more to less developed country. The former triggers a fall in the wage premium, while
the latter widens the wage premium gap in the developing country. These two opposing
forces explain the observed uncertain effects of openness to trade on wage inequality in
developing countries.
JEL Clasification: F110, F430, J310, O300, O410.
Keywords: international knowledge spillovers, wage inequality, developing country,
endogenous growth model

Ming-cheng Wang, Associate Professor, Department of Economics, National Central University, Chungli
320, Taiwan, R.O.C. Tel.: 011-886-3-4227151 ext. 66307, E-mail: [email protected].
Chen-ray Fang, Associate Professor, Department of Economics, National Taipei University, 151,
University Rd., San Shia, Taipei, 237, Taiwan, R.O.C. Tel.: 011-886-2-86747132, Fax:
011-886-2-26739880, E-mail: [email protected].
Corresponding author. Li-hsuan Huang, Professor, Department of Economics, National Central
University, Chungli 320, Taiwan, R.O.C. Tel.: 011-886-3-4227151 ext. 66306, Fax: 011-886-3-4222876
E-mail: [email protected].
1. Introduction
The conventional Stolper-Samuelson theorem in the trade literature1 predicts that
openness of trade will lead to a decrease in wage premium in a country if it is relatively
unskilled-labor abundant. Increased openness should lead to less wage inequality in
developing countries where less-skilled labor is often relatively abundant. The empirical
evidence for this prediction is however mixed. Despite the fact that increased openness
did lead to a decrease in wage inequality in the 1960s in Taiwan and South Korea and in
the 1970s in Singapore [Robbins (1996); and Wood (1996)], this was not the case in some
of the Latin American countries in the 1980s and 1990s.2 We can thus find different
evidence of the effects of openness on wage inequality in developing countries. The
Stolper-Samuelson mechanism seems to ignore factors that increase wage inequality
when developing countries open up to trade. This leaves space for theorists to fill the void
and look for theoretical models that are capable of explaining the above diverse wage
inequality movements.
In the literature, studies on determination of the wage inequality between skilled
labor and less-skilled labor either generally focus on developed countries or neglect
certain trade issues [Aghion, Caroli and Garcia-Penalosa (1999); Galor and Moav (2000);
Aghion (2002) and Acemoglu (2002); Fang, Huang and Wang (2008)].3 Until recently,
one line of trade research has focused in particular on explaining the wage inequality in
developing countries. In these studies, a variety of mechanisms are proposed to model the
impact of trade openness on the observed diverse wage inequality movements in
developing countries such as outsourcing [Feenstra and Hanson (1996)], nontraded goods
1
It refers to the restrictive version of the Stolper-Samuelson theorem in Deardroff (1994).
For instance, as cited in Zhu and Trefler (2005), just over half of 20 developing and newly industrialized
countries in the Freeman and Oostendorp (2001) wage database experienced rising wage inequality
throughout the 1990s.
3
For instance, Acemoglu (2002) develops a model that stresses the market size effect and the endogenous
technology choice, reaching the conclusion that increased openness leads to an increase in wage inequality
in the northern countries.
2
1
with tariff reductions [Xu (2003)], preference heterogeneity [Glazer and Ranjan (2003)],
product cycles with exogenous northern (developed country) innovations [Zhu (2004)],
southern (developing country) catch-up [Zhu and Trefler (2005)] ,4 trade fragmentation
[Marjit, Beladi and Chakrabarti (2004)], and differences in trade policies before trade
liberalization [Ripoll (2005)].5
In this study we examine the above issue but offer a different mechanism. We
incorporate both international knowledge spillovers (hereafter IKS) and intra-national
(sectoral) knowledge spillovers into Romer’s (1990) horizontal innovation model.
Incorporating sectoral knowledge spillovers is common in a two-sector model setup6. The
justifications for incorporating IKS into the north-south trade model are twofold. First,
empirical evidence for knowledge spillovers from developed countries to developing
countries is significant. Coe and Helpman (1995) and Lichtenberg and Potterie (1998)
consider that international R&D expenditure significantly enhances total factor
productivity; the effects are more profound with the degree of the openness. Moreover,
Coe, Helpman and Hoffmaister (1997) document that 1% of R&D expenditure in
developed countries raised productivity in developing countries by 0.06%.7 Second,
recent theories of economic growth identify trade as a major vehicle for IKS, which
makes available to the developing country products that embody foreign knowledge,
4
Unlike Zhu and Trefler (2005), the innovation rate is endogenous in our model.
Fischer (2001), Beaulieu, Benarroch and Gaisford (2004) and Long, Riezman and Soubeyran (2004)
provide other explanations. Fischer (2001), for example, uses a dynamic specific factors model to explain
the income inequality following trade liberalization and concludes that income inequalities in land
(labor)-abundant countries increase (decrease) dynamically after trade liberalization.
6
See Fang, Huang, and Wang (2008) for examples of the sectoral spillover: the space-age technology of
visco-elastic foam used in manufacturing memory foam pillows and beds to promote good quality sleep;
and the medical lab-technology used in cosmetics services. The presence of sectoral knowledge spillover is
also evident as shown in empirical studies by Bernstein and Nadiri (1988), Griliches (1992), Branstetter
(2001), and Keller (2002).
7
Engelbrecht (2002) utilizes data from 77 developing countries to confirm the positive role of human
capital in the absorption of international knowledge spillovers. Bernstain and Mohnen (1998) and
Branstetter (2001) documents that international knowledge spillover exists in firm level data.
5
2
thereby enhancing productivity.8 It is also likely to open communication channels that
stimulate the adoption of foreign ideas.
The main purpose of this paper is thus to propose a theoretical framework,
incorporating trade and international knowledge spillovers, that is capable of predicting
the above-mentioned uncertain effects of openness on wage inequality in developing
countries. The logic is straightforward. On the one hand, openness of trade facilitates IKS,
which in turn increases the relative demand for skilled labor and pushes up wage
inequality in developing countries. New technologies obtained by the skilled (in the
developing countries) will to some extent diffuse to less skilled workers thereby leading
to an increase in the demand for less-skilled labor. The net effect of these two kinds of
knowledge spillovers on the equilibrium wage inequality in the developing country is
herein referred as the skill discrepancy effect. On the other hand, in a country that is
relatively unskilled-labor abundant, openness of trade can lead to a decrease in wage
premium, which we refer as the price effect. These two opposing effects can both affect
wage inequality in a small developing country after it has been opened to trade.
If it is, in fact, the relative strength of the above two forces that determines wage
inequality in small developing countries, then the effect of increased trade openness on
wage inequality could vary at different time periods and in different countries. Since it is
plausible that the effect of IKS was larger in the 1980s than in the 1960s, we interpret the
widening of wage inequality that occurred in some Latin American countries (for
example: from the mid-1970s to the early 1980s in Argentina and Chile; between the
mid-1980s and the mid-1990s in Colombia, Costa Rica and Uruguay; from 1984 to 1990
in Mexico [Zhu and Trefler (2005)]) was a result of the dominance of the skill
8
Grossman and Helpman (1991), Chuang (1997), Murat and Pigliaru (1998) and Ben-David and Loewy
(2000) incorporate international knowledge spillovers into theoretical models to examine the relationship
between trade and growth. These models, however, consider only one type of labor and are therefore unable
to examine the effects of the increased openness on wage inequality in developing countries.
3
discrepancy effect, while the declining wage inequality in Taiwan and South Korea, after
trade was opened up in the 1960s, was a result of the dominance of the price effect. Our
proposed model can thus explain diverse wage inequality movements in the empirical
evidence in developing countries that have been opened up to trade. This complements
the explanation of the southern wage inequality mentioned in the literature above.
The remainder of the paper is organized as follows. In Section 2 we outline the
model for determining wage inequality under free trade. The home country is specified as
being a small country, with a relative abundance of less-skilled labor. International
knowledge spillovers are built into the R&D sectors. In Section 3 we compare results for
the international trade regime with those under autarky. In the final section some
conclusions are offered.
2. The Model
Consider an economy, endowed with less-skilled denoted by L and skilled labor
H , which produces two final goods, traditional goods X and advanced goods Y. Both
types of labor are either combined with specific capital goods to produce final goods or
hired by R&D firms to design blueprints to produce the associated capital goods. Specific
factors are utilized to produce both types of final goods, in the sense that the traditional
final goods are produced by less-skilled labor and the capital goods that are associated
with this less-skilled labor; the advanced final goods likewise. In the same vein as in the
final goods sectors, specific labor is hired to produce blueprints in the two R&D sectors.
Less-skilled labor is the sole input in the traditional R&D sector, while skilled labor is the
only input for the advanced R&D sector. Both the traditional and advanced capital goods
sectors manufacture the associated capital goods.
The following simplifying assumptions are made. First, the home country is a small
4
open economy; the foreign country (i.e., the rest of the world) is essentially a closed
economy. All the foreign variables are denoted with the superscript *. The home economy
is thus a price taker of the world’s final output and global interest rate. Second, both X
and Y are tradable. The home country has relatively abundant less-skilled labor in the
sense that L / H  L* / H * with H  H * , meaning that under free trade the home country
has a comparative advantage in the traditional output. All other parameters are the same
for both countries. Third, capital goods are not traded, labor does not move across the
border, and international knowledge only spills over from the advanced R&D sector of
the foreign country to its counterpart in the home economy. Finally, traditional goods X
are treated as the numeraire.
The production of final goods is specified as
Z
X  ( LX )1  uj dj,
0
0    1,
A
Y  ( HY )1  vj dj ,
(1)
(1)'
0
where LX and HY are the associated labor inputs for producing X
and Y ,
respectively; u j and v j are the employment of the j th type of capital goods for
producing X and Y , respectively; and Z and A are the measures of the varieties of
capital goods in the traditional and advanced sectors, respectively, with A specified to
be larger than Z to ensure the positive skill premium. The evolutions of the measures of
varieties for the home country are specified as follows:

Z

dZ
  A Z 1 LZ ,
dt
A   ( A* ) A1 H A ,
  0, 0    1,
(2)
  0, 0    1.
(2)’
In equation (2), intra-national (sectoral) knowledge spillover is allowed in that
technology spills over from the advanced R&D sector to the traditional R&D sector with
5
 as the sectoral spillover efficiency and 0    1 . The IKS is allowed in equation (2)’
in that technology spills over from the advanced foreign R&D sector to the advanced
home R&D sector with  being the IKS efficiency and 0    1 .9 Note that  and
 indicate the production efficiency of the two R&D sectors, respectively. The term LZ
( H A ) is the only paid input in the traditional (advanced) R&D sectors. Intra-national
spillover from skill intensive industries and/or firms to their less skilled counterparts is
evident.10 It is noted that ( A / Z ) in equation (2) captures the one-way positive sectoral
spillover, and the effect increases with the skill discrepancy between the advanced and
the traditional R&D sector, i.e., A / Z .11
Likewise ( A* / A) in equation (2)’ captures the IKS effect in the skilled home
R&D sector. A* contributes to the evolution of A so as to echo both the theoretical
and empirical findings that openness to trade enables the developing country’s products
to embody foreign knowledge and to enhance productivity [Grossman and Helpman
(1991), Ben-David and Loewy (2000), and Branstetter (2001)]. Despite missing a direct
effect for the IKS on the traditional R&D sector, equations (2) and (2)’ together do imply
that the evolution of Z is indirectly affected by A* .
Assume that markets for final goods are competitive. The objective function of the
Z
Z
0
0
representative firm in sector X is  X  ( LX )1  uj dj   P(u j )u j dj  WLX LX , where
P(u j ) is the rental price of the traditional capital good j ; and WLX is the wage rate of
L X . Under a symmetric setup ( u j  u ), the optimality conditions are
  0 is the case with no IKS.
See for example, Fang, Huang, and Wang (2008); Bernstein and Nadiri (1988); Griliches (1992),
Branstetter (2001); and Keller (2002) for theoretical concerns and empirical support.
11
We can alternatively specify equation (2) to be Z  [A  (1   ) Z ]Lz . The results are, however,
similar. It is also noted that the model reduces to the case with no sectoral spillover if   0 .
9
10
6
WLX  (1   )( LX ) Zu
and
P(u )   ( LX )1 u 1 .
(3)
(4)
Similarly, the optimality conditions for the representative firm in sector Y are
WHY  (1   ) PY ( HY ) Av
and
P(v)   PY ( H Y )1 v 1 ,
(3)’
(4)’
where W H Y is the wage rate for H Y ; PY is the price of Y ; and P (v ) is the rental
price of the advanced capital good.
For simplicity, we assume that one unit of capital good is produced by one unit of
the associated final good, and that the two capital goods markets are monopolistically
competitive. The instantaneous profit functions for the capital goods producers are
 u  P(u)u  ru
and
 v  P(v)v  rPY v,
(5)
(5)’
where r is the real interest rate. Using equations (4) and (4)’, the optimality conditions
of the capital goods producers are
 2 ( LX )1 u 1  r
 2 ( H Y )1 v 1  r .
and
(6)
(6)’
Substituting equations (4) and (6) into equation (5) and equations (4)’ and (6)’ into
equation (5)’, respectively, we obtain
u 
v 
1

1

ru
and
rPY v .
(7)
(7)’
We assume in a competitive market that the R&D firm in each sector will sell its
7
blueprints to the capital goods producers at prices PZ and PA . With a constant r ,12 PZ
and PA can be derived as follows:

PZ   e  rt u (t )dt 
0

PA  0 e  rt v (t )dt 
1

1

and
u
(8)
PY v .
(8)’
Due to free entry, these are the prices of the blueprints that make the monopolistically
competitive firms with zero economic profit.
As to the two R&D sectors, the representative firm’s profit functions are

 Z  PZ Z  WL LZ
Z

and
 A  P A A WH H,A
A
where WLZ and WH A are the wage rate for LZ and H A , respectively. Using equations
(2) and (2)’, the optimality conditions are
WLZ  PZ  A Z 1
and
WH A  PA ( A ) A1 .
(9)
(9)’
Equation (9) says that the real wage paid by the R&D firm is equal to the marginal
product of low skilled labor, which depends upon the sectoral spillover, i.e., ( A Z ) , and
equation (9)’ says that the real wage received by the skilled labor depends upon the
international spillover, i.e., ( A A) .
The equilibrium in the two labor markets requires
LX  LZ  L
and
HY  H A  H .
(10)
(10)’
Assume free mobility for each type of labor between the associated final goods sector and
the R&D sector. Arbitrage then implies that
12
r is constant in a balanced growth equilibrium.
8
WLX  WLZ  WL
and
(11)
WHY  WH A  WH .
(11)’
Using equations (3), (9), (3)’ and (9)’, equations (11) and (11)’ give rise to

1  Z 
 
PZ 
  ( LX ) u
  A
PA 
1

PY ( H Y )  v (
and
A 
) .
A
(12)
(12)’
These are blueprint prices that allow R&D firms to employ labor to engage in their R&D
activities. Labor arbitraging between the final goods sector and the R&D sector results in
a PZ that rises with (Z / A) . The logic is as follows. The higher the skill
discrepancy ( A Z ) is, the higher the productivity of the traditional R&D sector that can
be obtained through sectoral spillover. Other things being equal, this causes the supply of
less-skilled blueprints to increase and thus lowers PZ . The same reasoning applies to the

result that PA rises with ( A A ) .
Equating PZ from equations (8) and (12) and PA from equations (8)’ and (12)’
implies that
u 1 
 A
( ) ( LX )
 Z
v 1 
 A* 
( ) ( HY ) .
 A
and
(13)
(13)’
These two equations demonstrate the relationship between the employment of capital
goods and labor in the two final goods sectors. When the skill discrepancy is larger,
unskilled labor benefits more from the sectoral spillover and thus less capital goods are
needed to produce the same amount of traditional final goods.
The demand side of the economy is specified below. The optimization problem
9
facing the representative household in the economy is

max
 t
0 e [  log CX (t )  (1   ) log CY (t )] dt ,
s.t.
 rt
 rt
0 e [CX (t )  PY (t )CY (t )] dt  0 e [WL (t ) L  WH (t ) H ]dt ,


where  is the time preference rate; and C X and CY are the consumption of the two
final goods, respectively.13
Let g be the growth rate along a balanced growth path (hereafter BGP), i.e.,






C
Z A C
X Y
g    X  Y   . Given the optimality conditions from the above
Z A C X CY X Y
maximization problem, we obtain the following results, under the assumption that the
home country is a small both in the international goods market and the capital market:
(1   )C X
CY

PY  PY 
and
(14)
g  r    r   .
(15)
Moreover, the aggregate resources constraints in the economy are

X  CX  Z u
and
(16)

Y  CY  Av .
(16)'
g * and PY* , along the BGP, can be obtained for the foreign country by
g*  r*   
 H *  
1 
1
1
1       L* 
P 


     H * 
*
Y
and
14
(17)
1

.
(18)
We now make some remarks on the above results. First, the main features of Romer
13
The intertemporal budget constraint is equivalent to the asset’s law of motion with a transversality
condition imposed.
14
A mathematical appendix explaining the derivation of the equations in this paper is available upon
request.
10
type models are preserved in equation (17), specifically, the perpetual growth increases
with the amount of skilled labor and the efficiency at the skilled R&D sector in the
economy. Second, equation (18) indicates that the relative price of the advanced final
goods PY* , is determined by the relative supply of skilled labor as well as the spillover
efficiency. A higher relative endowment H  L induces a larger relative supply of the
advanced goods and thus a lower relative price. On the other hand, a higher efficiency of
sectoral spillover, i.e., a larger  , implies a higher productivity of R&D labor in the
traditional sector, thus enlarging the variety of capital goods in the traditional final goods
sector. It in turn increases the supply of traditional final goods X and therefore causes
the price to fall and the relative price PY to rise. Finally, PY* is the world price faced by
the home country, and the growth rate of the foreign country g * is also the growth rate
of the home country along the BGP under free trade, for g   r     r    g .15
The analytical solutions of H A , H Y , LX , LZ , v , u , A/ Z , etc., for the home
country can now be easily obtained once the growth rate g is known. Take for example,

Z
A
r    g  g Z    ( ) LZ
Z
Z

and
(19)

A
A*
r    g  g A    ( ) H A .
A
A

(19)’
Therefore, via equations (19) and (13) and equations (19)’ and (13)’, respectively, we
obtain
g 
15
 ( A / Z ) L  
1 
Since the foreign country is essentially a closed economy,
and
(20)
r * is determined in exactly the same way as
*
r is determined in an autarky economy. To be specific, r *   ( H   ) .
1 
11
g 
 ( A* / A) H  
.
1 
(20)’
Under free trade, g  g  . Combining this with equations (20) and (19) gives rise to
the following skill discrepancy for the home country:
1


 H *  
1
(1


)(
)


* 



H 
A  (1   ) g   
1 

 
 
 .
Z 
 L
 L



 L 




1
(21)
Equation (21) shows that the domestic skill discrepancy between the two R&D sectors
depends upon the relative size of the foreign skilled labor endowment, as opposed to the
domestic skilled labor, to the domestic unskilled labor along the BGP. It is essentially due
to the fact that the international knowledge spills over directly from A* to A and
indirectly from A to Z along the BGP. Therefore, through the effects of A* on A , the
domestic skill discrepancy A / Z is determined by ( H * / L) .
Equation (21) can be rewritten as
1
1
A  H *    H * H 
   ( )( )  .

Z  L 
 H L 
(22)
Holding ( /  ) constant, it is evident that determination of the domestic skill
discrepancy between the two R&D sectors comprises two forces: the relative size of the
skilled labor in the foreign country compared to its counterpart in the home country, and
the relative supply of skilled labor in the home country. The larger either of the above two
terms, the larger the domestic skill discrepancy. To be more specific, the skill discrepancy
is affected positively by the relative supply of skilled labor in the foreign and the home
country, and the relative supply of domestic skilled and unskilled labor. Furthermore, the
skill discrepancy varies inversely with the sectoral spillover efficiency  from the
advanced R&D sector to the traditional R&D sector.
12
Similarly, the equilibrium skill discrepancy between the home country and the rest
of the world, as derived from equations (17) and (20)’, is determined by the relative
supply of skilled labor as follows:
1
A*  (1   ) g   


A 
H

1


 H *  
1
(1


)(
)


* 




H
1 

 
 .
 H


 H 




(23)
Note that, according to equation (19)’, other things being equal, an increase in the IKS
efficiency  can cause A to increase at any point of time along the BGP. That is to
say, a change in  has a level effect for the home country although it does not show a
growth effect for g *  r *    ( H *   ) /(1   ) . Similarly, other things equal, a
change in H has a level effect, but no growth effect.
3. A Comparison of the Wage Premium under Autarky and International Trade
With a view to examining the effect of trade on wage inequality in developing
countries, we now let superscripts tr and au denote variables pertaining to the home
country under free trade and under autarky, respectively. The wage inequality between
skilled and less-skilled labor can be obtained for the home country under free trade as
follows:
tr
 WH 
PY* ( HY ) Av
 A
 PY*  
=




( LX ) Zu
Z
 WL 
tr
1
1
1

* 1  
* 





1     L
 H

.
      H *     L 


(24)
13
Several points should be highlighted. First, the second equality in equation (24)
indicates that the wage inequality under free trade hinges on the relative price and the
skill discrepancy; the magnitudes of the two forces are shown in the last equality of
equation (24). Second, the last equality of equation (24) implies that the larger the
sectoral knowledge spillover across various skilled workers, the smaller the wage
premium for skills is. Finally, from equation (24), it is also evident that a change in 
will not affect (WH / WL ) , for the world price PY* is not influenced by  , and A and
Z change proportionally along the BGP.
It is worth mentioning that in the study by Acemoglu (2002) the factors that
determine the wage premium are the price effect and the market size effect. In relation to
the price effect, he reaches the conclusion that the wage premium in northern countries
rises in response to an increase in the relative supply of skilled labor. In equation (24) of
our model however, it is shown that a change in the relative supply of skilled labor in a
small developing (home) country (with both international and sectoral knowledge
spillovers) does not give rise to an increase in wage inequality.
We now compare wage premiums under free trade with that under autarky.
tr
W
W
 A
 A
( H )tr  ( H )au  PY*    PYau  
WL
WL
Z
Z

1 

 

1
  
 
 
1 
1
 L* 
 *
H 
1
1

au
1


* 



H
1 




  L 
 


1
  
 
 
1
L
 
H
1

1





H

   L 

1
H * 1 H *
H

[( * )  ( )   ( ) -1 ] .

L
L
L
(25)
Observe from the second equality in equation (25) that
PYtr  PY*  PYau
and
A Z
au
A Z .
tr
This is due, on the one hand, to the assumptions that unskilled labor is relatively
14
abundant in the home country and that the two countries have the same preferences. A fall
in the price of the advanced goods after trade causes the wage inequality of home country
to fall. This is the so-called price effect. On the other hand, the domestic skilled sector
directly benefits from international knowledge spillovers; the domestic unskilled sector is
affected only indirectly. Consequently, skill discrepancy in the two sectors, as measured
by the ratio A / Z , will increase as we move from autarky to free trade, and therefore the
wage inequality of the home country rises. This is the skill discrepancy effect. One may
argue that IKS affects not only the skilled R&D sector, but also the less-skilled R&D
sector in the home country, and the skill discrepancy effect in equation (25) would be
loosened. Nonetheless, compared to skilled labor, less-skilled labor is less efficient at
absorbing international knowledge, and the skill discrepancy effect shall not be fully
offset. As a consequence, wage inequality in a small open developing country is thus
driven by two opposing forces: a fall in the relative price of the advanced goods that
reduces wage inequality and a rise in skill discrepancy that increases wage inequality.
The former confirms the Stolper-Samuelson mechanism, whereas the latter force
contradicts the effect of the Stolper-Samuelson mechanism.
Our proposed model can thus explain diverse wage inequality movements observed
in the empirical evidence after developing countries have been opened up to international
trade. The declining of wage inequalities in Taiwan and South Korea after increased
openness to trade in the 1960s and the widening of wage inequalities that occurred in
some Latin American countries in the 1980s provide excellent examples on which to
apply our model. It is well documented that the U.S. and many OECD countries have
experienced fundamental changes in the pattern of wage inequality between skilled and
unskilled labor in the last three decades. Specifically, a decline has been documented as
in the US from the late 1960s to the mid 1970s, and then a sharp increase in the 1980s
15
and 1990s [Juhn, Murphy, and Pierce 1993; Autor, Katz, and Krueger 1998; Goldin and
Katz 1998; and Juhn 1999]. In many OECD countries, such as Finland and Sweden, it has
been demonstrated that earnings inequality increased during the 1980s following a sharp
decline during the 1970s [Gottschalk and Smeeding 1997]. Speedy (slower) technological
change has been recognized as one of the main driving forces behind the increasing
(decreasing) inequality in already developed countries. It is thus plausible that the IKS
effect was much stronger and more influential in the 1980s than in the 1960s. Evidence
shows that decreases in the wage inequalities in developed countries in the 1960s
coexisted with decreasing wage inequality in Taiwan and South Korea. It can be reasoned
that since IKS was weaker, due to slower technological change in the developed countries
during that time period, so was the skill discrepancy effect. On the other hand, the
increasing wage inequalities in most developed countries in the 1980s and 1990s, due to
faster technological change, coexisted with the widening of wage inequalities in Latin
American countries who became involved in free trade with more developed partners in
the 1980s [Zhu and Trefler 2005; Freeman and Oostendorp 2001]. The case of Taiwan
and South Korea in the 1960s illustrates a situation where the price effect was dominant
after the opening of trade, while the Latin American case in the 1980s is a result of the
dominance of the skill discrepancy effect. Our model thus supports the results reported in
the literature, offering a sensible and plausible explanation for empirical evidence of
diverse movements in terms of wage inequalities in developing countries that have been
opened to trade.
4. Conclusion
Empirical evidence indicates that the Stolper-Samuelson mechanism seems to ignore
factors that force wage inequalities to increase, leading to an uncertain outcome when
developing countries are opened to trade. The main purpose of this study is thus to
16
propose a theoretical framework that is capable of predicting the above uncertainties. To
be more specific, we set up a two country trade model between a (large) developed and
(small) developing country that takes into account international and intra-national
knowledge spillovers, and examine the effects of openness to trade on wage inequality.
In our model there are essentially two opposite effects which determine wage
inequality in a small a small developing country after it has been opened up to trade, the
price effect and the skill discrepancy effect. The former reduces wage inequalities and the
latter increases wage inequalities. It is these two competing forces that have led to the
uncertainty in prediction of the effects of trade openness on wage inequality in small
developing countries. We outline a model that can explain the empirical evidence, the
inconsistent movements in wage inequality in different countries. It thus complements the
literature in explaining the southern wage inequality.
Acknowledgements
We are grateful for the helpful comments made by seminar participants at National
Central University, Tamkang University, and National Taipei University. Financial
support was provided by the National Science Council of Taiwan under grant NSC
92-2415-H-008-003 to M. Wang.
17
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