The discernible increase in wage inequality in developed countries over the past several decades has been a topic of considerable interest in both the international trade and labor economics literatures. A number of studies have identified at least some role for international trade in these increasing wage disparities. (1) Recent contributions to the New Economic Geography literature by Head and Mayer (2006), Hanson (2005), Mion (2004), and Redding and Venables (2004) have emphasized the influence of the geography of trade on wages, suggesting that countries (or regions) with access to larger markets have higher wages. In this paper, we unite these two strands of the literature by developing a model that examines whether the wage increases attributed to access to larger markets are non-neutral.
Redding and Venables (2004), henceforth RV, develop a structural model of trade relating access to larger markets to per capita incomes. They estimate a generalized gravity equation using world trade data to construct empirical proxies for market and supplier access. These are trade cost weighted measures of export demand and import supply, respectively, that take into account the geographical distribution of trade flows. Market access measures the size of the market that can be reached by firms positioned in a given country. Supplier access measures the ease at which firms in a given country can acquire intermediate inputs. RV show that per capita incomes are increasing in both of these measures. Their model, however, does not differentiate between labor types and therefore does not address the issue of whether market access has different influences on skilled workers and unskilled workers. There is a good reason to believe that the wage increases attributed to market and supplier access would be non-neutral across both skill groups and industries. First, a number of recent theoretical contributions demonstrate a positive relationship between market size and the skill premium. Epifani and Gancia (2006, 2008) show that in the context of a new trade model scale itself is skilled biased under very reasonable assumptions, and they provide supporting empirical evidence. In addition, the New Economic Geography models of Epifani (2005) and Amiti (2005), which explicitly account for factor endowment differences between countries, suggest that the forward and backward linkages provided by agglomeration exacerbate the Stolper-Samuelson Effect, leading to relative wages that overshoot the values that would be observed in the absence of such linkages. Second, Redding and Schott (2003) provide empirical evidence, suggesting that in countries with higher values of market and supplier access individuals have greater incentive to invest in skills, leading to a higher return to education and a larger skill premium. And third, as Feenstra and Hanson (1999), henceforth FH, demonstrate, if production is fragmented, changes in the parameters of the production function over time can shift the composition of activities that are performed abroad in a given industry, leading to non-neutral effects on productivity and factor prices. Countries and industries with better access to overseas production activities, that is, larger levels of supplier access, would be more likely to observe such changes.
In this paper, we augment the methodology in RV to examine the relationship between market and supplier access and the skill premium in U.S. manufacturing industries. Our analysis differs from RV in two principal ways. First, we develop a model that relates market and supplier access to value added prices rather than to wages. This is the natural generalization to a model with more than one internationally immobile factor of production. Second, we use industries as our unit of analysis rather than countries. An industry-level analysis allows us to gauge the effects of market and supplier access on industry value added prices which we can then decompose into mandated factor price adjustments. …