A Note on Wage Inequality, Technology, and Trade

doi:10.4236/me.2011.23037

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Modern Economy, 2011, 2, 340-343

doi:10.4236/me.2011.23037 Published Online July 2011 (http://www.SciRP.org/journal/me)

A Note on Wage Inequality, Technology, and Trade

Chu-Ping Lo

Department of Agricultural Economics, National Ta iwan University, Chinese Taibei

E-mail: [email protected]

Received February 24, 2011; revised April 5, 2011; accepted April 25, 2011

Abstract

Zeira (2007) presents a two-country model of endogenous technology and trade, illustrating that trade liber-

alization reduces wage inequality in developing countries. The result contrasts the current outsourcing trade

literature; the conflict is due to the critical assumption made in his model that “the most rewarding technolo-

gies are invested first.” If we relax this assumption, or allow the technology frontier to foster labor gains in

all existing industries, then Zeira’s model is, in fact, consistent with the current outsourcing trade literature.

Keywords: Wage Inequality, International Outsourcing Trade

1. Introduction

In a two-country model, Zeira (2007) shows that trade

liberalization reduces wage inequality in a developing

country bur increases wage inequality in a developed

country. The technological progress that occurs in the

developed country generates a skill-biased technology

change in the developed country, but no impact on the

labor market in the developing country. The trade liber-

alization mentioned in Zeira’s model can be referred to

as international outsourcing trade, because an increase in

trade liberalization leads to greater trade in intermediate

goods in his model. However, in the literature on inter-

national outsourcing trade1, an increase in international

outsourcing trade or technology development leads to a

widening wage inequality not only in the developed

countries but also in the less deve loped countries.

I argue that this conflict between Zeira’s (2007) model

and the current outsourcing trade literature in terms of

the labor market in the less developed countries, may be

derived from the critical assumption in Zeira’s (2007)

model: “the most rewarding technologies are invested

first” and that the technology frontier is irrelevant to the

developing country. If we allow “the most rewarding

technologies are inv ested lately” or allow the technolog y

frontier to foster labor gains in all existing industries,

then the wage inequality o f the less developed country is

likely to increase with trade ex pansion.

The next section provides an introduction to Zeira’s

(2007) model. However, I redefin e the relative labor gain

in his model and reach a new equilibrium in Section 3.

The final section concludes.

2. The Zeira Model

Zeira (2007) assumes that there is one final good pro-

duced for consumption that is not tradable. This final

good is produced by a continuum of tradable intermedi-

ate goods. The tradable intermediate goods are produ ced

using two alternative technologies: either unskilled labor

or skilled labor. No intermediate good is prod uced with a

combination of skilled and unskilled labor. The devel-

oped and less developed countries trade the intermediate

goods with each other based on their comparative ad-

vantages.

More specifically, the set of traded intermediate goods

is t

, which is distributed uniformly over t

, meas-

ured for trade openness as t

tM. Technology

adoption, human capital acquisition, and trade patterns

are determined endogenously. The production of one unit

of intermediate good using skilled technologies re-

quires

dmi





ia units of skilled labor in the developed

country and ()

i in the less developed country.

Zeira (2007) also specifies a variable

to represent

the technology frontier, which measures the level of

technological progress available to a range of intermedi-

ate goods





. He assumes that the populations of the

developed and less developed countries are given exo-

genously by and

L, respectively. The developed

1See Feenstra and Hanson (196), Antràs et al. (2006), and Ethier (2005)

for theoretical analysis, and Epifani and Gancia (2008), Attanasio et al.

(2004), Beyer et al. (1999), and Feenstra and Hanson (1997) for em-

irical analysis. All of these studies found that openness exacerbates the

wage inequality between skilled and unskilled labor in less developed

countries.

C.-P LO341

country has a larger share of skilled labor in the popula-

tion than the less developed country as AB

. Using

primitive technologies, the production of one unit of in-

termediate good , requires

hh

i()ni a unit of skilled la-

bor in the developed country and in the less de-

veloped country. The relative ga in of adopting the skilled

()ni



technology is given by



gi si , but at the cost





of paying a skill premium for the skilled labor. A key

assumption in Zeira’s model is that the most rewarding

technologies are invented first. Here, the technologies

with higher relative gains are researched and invented

first, such that . This critical assumption im-

plies that the frontier technology has the smallest relative

labor gain in replacing unskilled with skilled labor,

namely,



0







fgi for all 0. if

zv



In equilibrium with full specialization, there is a trade

threshold . We always have B to indi-

cate that the less developed country cannot access the

frontier technology. The developed country is exporting

the set of intermediate goods

v1f







0, 0,

fv, all of

which are produced by the skilled labor. The less devel-

oped country is expor ting intermediate goods





v,

which are produced by unskilled labor as shown in Fig-

ure 1, which illustrates the equilibrium conditions for

labor markets while ,,SA SB

wa. Note that the less

developed country produces a set of nontradable inter-

mediate goods

w





z by applying skilled labor

for domest i c use.

3. Equilibrium

Zeira (2007) assumes that the developed country is suffi-

ciently more skill abundant and has a lower wage ine-

quality than the less developed country. As illustrated in

Figure 1. Equilibrium with Full Specialization. Note: A

denotes the developed country and B denotes the less de-

veloped country.

Figure 1, the equilibrium conditions for skilled and un-

skilled labor in country A (i.e., the developed country) is

given by



 



 



AAA B

Lha siXiXii

asiXi i

















and







AA A

Lh aniXi











respectively. Similarly, the equilibrium in the market for

skilled and unskilled labor in country B (i.e., developing

country) are g iven by

 



0, d

BB B

Lhsi Xii





and







 



 



BBB A

LhniXi Xii

niXi i



 







,

respectively. From the equilibrium conditions of these

labor markets, we can derive the wage inequality in the

two countries2. Therefore, in the benchmark case of full

specialization in Zeira’s model, the wage inequality in

the developed country is



 



11 1

Whmf

 





, (1)

which increases with an increase in trade liberalization

. The wage inequality in the less developed country is

then determined by

 



BBBB

Wgz hzm



 

. (2)

It is the developed country that determines the tech-

nology frontier, and the creation of new technology is

without cost.

The key assumption in reducing relative labor gains

(i.e. () 0gi





) in Zeira’s (2 007) model is represented by

the downward sloping curve G in Figure 2, while A

and W

are upward sloping. As in (1) and (2), an in-

crease in shifts A

W curve upward and

W curve

downward, leading to a higher wage inequality in coun-

try A but a lower wage inequality in country B. Specifi-

cally,

W must reduce with while m()gi0





. It

also shows that the development of the frontier technol-

ogy increases the wage inequality in the developed coun-

try, but has no impact on the wage inequality in the de-

veloping country.

However, if we relax this critical assumption of “the

2See Appendix 1 in Zeira (2007) for more details.

C.-P. LO

342

Figure 2. Equilibrium in Zeira’s (2007) model.

most rewarding technologies are invested first” and al-

low the technology with higher relative gains to be in-

vested into later, then the G curve becomes an upward

sloping curve while for . This al-

ternative assumption allows Zeira’s (2007) model to

correspond with the current literature on outsourcing

trade; specifically, that the wage inequality in both the

developed and developing country increases with trade

liberalization as shown in Figure 3. Nevertheless, tech-

nology development is irrelevant to the labor market in

the developing country.

() 0gi

0if

ven if it stands to reason that “the most rewarding

technologies are invested first,” I argue that Zeira’s (2007)

model may still lead to an increase in wage inequality in

the less developed country if the trade expansion is due

to technology development. Throughout human history,

the development of frontier technology usually leads to

Figure 3 Equilibrium when

skill-biase proves productivity

began with

of the

()0gi.

d technology changes and im

in all other industries. Evidence for this exists in the

following historic events: the Industrial Revolution that

occurred during the late 18th and early 19th centuries

and the evolution of the Internet and personal computers

that took place during the late 20th century.

The Industrial Revolution in Great Britain

e mechanization of the textile industry through the

utilization of steam power, which transferred the primarily

manual labor and draft animal-based economy towards

machine-based manufacturing. This resulted in a dramatic

increase in productivity capacity and spurred the

manufacture of increasingly productive machinery for

use in other industries (Meier and Rauch, 2000).

Furthermore, the revolutionary development

ternet and personal computers pushed machine-based

manufacturing towards computation-based manufacturing,

thus generating more skill-biased technology changes

and stimulating productivity improvements in all other

industries. While the relative labor gains in the existing

industries should increase with the development of the

technology frontier, I redefine Zeira’s (2007) relative labor

gain as





if , where



gif but





gif.

In this way, te wage inthe le

country is then determined by



h equality in ss developed



h

,11

BB BB

Wgzf hzm







, (3)

where





gzf



but .

assume that te barriers are ced by ei-

nsion is improved by the reduction of po-

lit



gzf

Let’s he tradredu

er the removal of political barriers or the improvement

of technologies. Using the Industrial Revolution as an

example again, the introduction of steam power, fuelled

primarily by coal, expanded world trade enormously by

providing a quick and easy way to transport goods, as

well as an easy way to transport mail and information

through the wide utilization of steam-powered trains and

ships (Meier and Rauch, 2000). The innovation prompted

by the personal computer and the Internet are fostering

more efficient ways of trade and communication as well.

Thus, the development of the technology frontier ex-

pands trade.

If trade expa

ical barriers, as in Zeira’s (2007) model, the wage ine-

quality in the developing country decreases with trade as

represented by the equilibrium b in Figure 4. However,

in contrast to Zeira’s model, if trade expansion is in-

duced by the development of technology frontier, I argue

that wage inequality in the developing country may in-

crease with trade if the skill-biased technology change is

sufficiently large. As shown in Figure 4, an increase in

, which shifts the G curve upward, also induces trade

expansion, thus shifting the

W curve downward. The

C.-P LO

343

5. Reference

[1] P. Antràs, L. Garicano and E. Rossi-Hansberg, “Offshor-

ing in a Knowledge Economy,” Quarterly Journal of

Economics, Vol. 121, No. 1, 2006, pp. 31-77.

[2] O. Attanasio, P. K. Goldberg and N. Pavcnik, “Trade

Reforms and Wage Inequality in Colombia,” Journal of

Development Economics, Vol. 74, No. 2, 2004, pp. 331-

366. doi:10.1016/j.jdeveco.2003.07.001

[3] H. Beyer, P. Rojas and R. Vergara, “Trade Liberalization

and Wage Inequality ,” Journal of Development E conomics,

Vol. 59, No. 1, 1999, pp. 103-123.

doi:10.1016/S0304-3878(99)00007-3

[4] P. Epifani and G. Gino, “The Skill Bias of World Trade,”

Economic Journal, Vol. 118, No. 530, 2008, pp. 927-960.

doi:10.1111/j.1468-0297.2008.02156.x

[5] W. J. Ethier, “Globalisation: Trade, Technology, and

Wages,” International Review of Economics and Finance,

Vol. 14, No. 3, 2005, pp. 237-258.

doi:10.1016/j.iref.2004.12.001

Figure 4. New Equilibrium.

net effect may, which indi-

ates a higher wage inequality for the developing country

ue that Zeira’s (2007) model corre-

sponds with the current literature of outsourcing trade

lead to a new equilibrium c

c [6] R. C. Feenstra and G. H. Hanson, “Foreign Investment,

Outsourcing and Relative Wages,” The Political Eco-

nomics of Trade Policy: Papers in Honor of Jagdish

Bhagwati, MIT P ress, Cam bridg e, 1996, pp. 89-127.

than in the initial equilibrium a.

4. Conclusions [7] R. C. Feenstra and G. H. Hanson, “Foreign Direct In-

vestment and Relative Wages: Evidence from Mexico’s

Maquiladoras,” Journal of International Economics, Vol.

42, No. 3-4, 1997, pp. 371-393.

In this paper, I arg

(e.g., Feenstra and Hanson, 1996) if we allow the tech-

nology with higher relative gains is to be invested into

later. This paper also shows that development in the

technology frontier in the developed country induces

skill-biased technology change in the labor markets in

the developing country through trade.

[8] G. M. Meier and J. E. Rauch, “Leading Issues in Eco-

nomic Development,” Oxford University Press, New

York and Oxford, 2000.

[9] J. Zeira, “Wage Inequality, Technology, and Trade,”

Journal of Economic Theory, Vol. 137, No. 1, 2007, pp.

79-103. doi:10.1016/j.jet.2006.03.011