The possible relationship between international trade and wage inequality in developed countries has been a very important and regularly debated topic for both academics and politicians in the last two decades. Unskilled workers in many developed countries and especially in the United States have seen a significant decline in their relative wages, while at the same time international trade increased considerably. Some have argued that the increase of international trade is likely to explain this decline of relative wages. Trade economists have approached this question using the Heckscher-Ohlin model, from various angles. The first is based on the Factor Content of Trade (FCT) theorem of Vanek (1968) and the work of Deardorff and Staiger (1988), where changes in the volume of net exports are transformed (via an input-output matrix) into changes in relative factor rewards (Borjas et al. 1992; Katz and Murphy 1992; Wood 1995); the second is based on the traditional Stolper-Samuelson theorem, where changes in product prices cause changes in factor rewards (Leamer 1998, 1994; Baldwin and Cain 2000; Harrigan and Balaban, 1999).
Furthermore, to analyze the increasing wage inequality in the United States, Feenstra and Hanson (1996, 1999) and Sitchinava (2007), among others, introduce outsourcing in a Stolper-Samuelson framework, while Michaels (2008), relying on the Heckscher-Ohlin framework, assesses the effects of trade on wage inequality in the U.S. states, by investigating the effects of highway infrastructure. Finally, there are recent papers that follow different theoretical frameworks in order to analyze the increasing wage inequality. For instance, Blum (2008) uses a Ricardo-Viner model, while Zhu and Trefler (2005) use a model that combines Heckscher-Ohlin and Ricardian environments.
The FCT approach has been heavily criticized on the ground that it lacks a solid theoretical foundation and especially that FCT is not related with factor prices. For instance, Panagariya (2000), Learner and Levinsohn (1995) and Learner (2000) argue that FCT calculates quantities of indirectly exported and imported factors via international trade, but according to the Stolper-Samuelson theorem, it is product prices and not factor quantities that are related with factor prices. Yet, by introducing the concept of the Equivalent Autarkic Equilibrium (EAE), Deardorff and Staiger (1988) provide the theoretical foundation and show under which assumptions the FCT and relative wages are related (see also, Deardorff 2000; Krugman 2000; Wood 1995).
In this paper, in contrast to all previous FCT studies which rely on the use of input-output matrices to calculate the FCT (see Borjas et al. 1992; Katz and Murphy 1992; Wood 1995), we calculate the FCT by directly estimating the endowments required to achieve the EAE. This is accomplished by estimating a revenue function similar to Harrigan and Balaban (1999). We assume the revenue function to be of the Symmetric Normalized Quadratic functional form, which is more attractive to other functional forms (like the Translog that has been used extensively), because it has the important property of flexibility when convexity and concavity are imposed. We also allow for a more general technology that is joint in output quantities. Under such technology the analysis departs from the hypothesis of Factor Price Equalization (FPE). (1) We find that the FCT for capital is positive, the FCT for skilled labor is negative, but quite close to zero, while the FCT of unskilled labor is negative and large in magnitude. Hence, there is no Leontief Paradox in the United States for the period 1965-1991 in our framework. This result is consistent with the findings of Bowen et al. (1987), Davis and Weinstein (2001), and Feenstra and Hanson (2000) in terms of relative factor abundance.
Then, by using the quadratic approximation lemma (Diewert 1976, 2002), we are able to decompose the growth rate of factor rewards of trade equilibria (TE) to the growth rate of FCT, the growth rate of endowments and technological change. …