Prior to Krugman's work, trade theory emphasized trade based on the comparative advantage of countries with very different characteristics, such as a poor country exporting agricultural goods to a rich country in exchange for industrial products. However, in the 20th century, an ever larger share of trade occurred between countries with verysimilar characteristics, which is difficult to explain by comparative advantage. Each country may specialize in producing a few brands of any given type of product, instead of specializing in different types of products.
Krugman's model also involved introducing transportation costs, a key feature in producing the "home market effect" which would later become key for Krugman's work on the new economicgeography. The home market effect "states that, ceteris paribus, the country with the larger demand for a good will, at equilibrium, produce a more than proportionate share of that good and be a net exporter of it." Many models of international trade now follow Krugman's lead, incorporating economies of scale in production and a preference for diversity in consumption. This way of modeling tradehas come to be called New Trade Theory.
This paper helps us to understand that trade has only modest effects on inequality rests on relatively old data and that there has been a dramatic increase in manufactured imports from developing countries since the early 1990s. Due to this increase there is an inequality in the United States and other advanced countries. This analysis shows us also thechanging nature of world trade but also how it has outpaced our ability to engage in secure quantitative analysis.In his conclusion Paul Krugman end the analysis with a question which is ‘How can we quantify the actual effect of rising trade on wages?’
Paul Krugman had concluded by the past that trade with poor countries played only a small role in America's rising wage inequality, explainingperhaps one-tenth of the widening income gap between skilled and unskilled workers during the 1980s. Mr. Krugman's paper convinced that trade was a bit-part player in causing inequality.
Other factors, particularly technological innovation that favoured those with skills, were much more important.
In theory, although trade brings gains to the economy as a whole, it can have substantial effects on thedistribution of income. When a country with relatively more high-skilled workers (such as America) trades with poorer countries that have relatively more low-skilled workers, America's low skilled will lose out. But when the effect appeared modest, economists heaved a sigh of relief and moved on.
In recent years, however, the issue has returned. Opinion polls suggest that Americans have becomeincreasingly convinced that globalisation harms ordinary workers. As a commentator, Mr Krugman has become more sceptical and he offered two reasons why. First, more of America's trade is with poor countries, such as China. Second, the growing fragmentation of production means more tasks have become tradable, increasing the universe of labour-intensive jobs in which Chinese workers compete withAmericans. His new paper set out to substantiate these assertions.
That proved hard that America's trade patterns have changed certainly.
Poor countries' share of commerce in manufactured goods has doubled. In contrast to the 1980s, the average wage of America's top-ten trading partners has fallen since 1990. All of which, you might think, would increase the impact of trade on wage inequality.The effect on wages has increased. The trade widened wage inequality between skilled and unskilled workers increased widely. But even with that increase, trade is still far from being the main cause of wage inequality.
Even this is almost certainly an overstatement. Many imports from China have moved up-market from easy-to produce products, such as footwear, to more sophisticated goods, such as...