Trade Liberalization, Rise In Wage Inequality And HOS Theory: Reconciliation In A Dynamic General Equilibrium Model. ¤
Manoj Atolia Indiana University May 1, 2002

Abstract We work with a 4-sector 5-factor model that captures relevant structural characteristics of the developing economies: the unskilled wage is indexed in the manufacturing sectors, the capital in each sector is produced with imported machines and non-traded goods (e.g. construction), and the imported intermediates are used in production. In the long-run, for plausible parameter values, a tari® reduction increases the skilled wage relative to both the competitive and the indexed unskilled wage even when export-manufacturing sector is up to 35% more intensive in the use of the unskilled labor in terms of the cost shares. We derive a very simple analytical condition relating changes in wage inequality to parameters of the model. A long-run increase in wage inequality is accompanied by a steady rise in wage inequality and real skilled wage during transition if the elasticity of substitution of skilled and unskilled labor for other factors are equal. When it is easy to substitute the skilled labor for other factor compared to the unskilled labor, a short-run rise in wage inequality vis-a-vis the competitive unskilled wage occurs for up to 40 years in cases where wage inequality falls in the long-run. However, the real skilled wage does not rise during transition as empirically observed in the recent episodes of trade reforms. Thus, the paper allows for a reconciliation of the rise wage inequality that has accompanied trade liberalizations in past two decades with the factor proportions theory in a dynamic general equilibrium model.

Keywords: Wage Inequality, TradeReform, HOS, Dynamic Analysis. JEL Classi¯cation: F11, J31, F13, F17.
¤ I am grateful to Shouyong Shi, Hugh Kelly and specially to Edward Bu±e for thoughtful comments. All errors remaining are mine. Comments are welcome and may be sent