Abstract: The rise in income inequality in developing countries after trade liberalization has been a puzzle for trade theory, which predicts the opposite effect. The authors present a model with imported intermediate goods in which the relative wages of skilled labor can rise due to higher imports of inputs or due to skill-biased technological change. The evidence from Peru in the post-liberalization phase in the early 1990s supports the skilled-biased technological change hypothesis. The authors find that most of the decrease in the blue-collar wage share in the manufacturing industries can be explained by the increase in machinery imports that followed liberalization, suggesting that the skilled-biased technology is embodied in imported machinery.
JEL classification: F16, J31, 033, 054, 015
Key words: income distribution, machinery reports, trade liberalization, wage differentials, Peru
Since the 1980s, the occurrence of increasing wage inequality along with rising volume of trade in developed countries has led to a debate about the impact of international trade on the changing wage structure. While economists argue about the quantitative impact of trade, they agree that trade can lead to higher income inequality in a high-income nation (the Stolper-Samuelson theorem). On the other hand, conventional trade theory predicts that trade will lead to lower income inequality in developing countries. Unfortunately, that prediction has not been borne out. Studies of developing countries find that trade liberalization episodes have been accompanied by rising wage inequality.
There are fewer studies of developing countries compared to the literature on developed countries. Robbins (1996) in a study of developing countries in Latin America, East and South-East Asia finds that wage differentials have risen in many developing countries with high trade exposure. Using household data, he finds that trade liberalization has been accompanied by rising relative wages and demand for skilled-labor in Argentina, Chile, Costa Rica, Colombia, Malaysia, Mexico, the Philippines, Taiwan and Uruguay, contradicting the predictions of traditional trade theory. Robbins suggests that adoption of skill intensive technology via capital goods imports is responsible for rising inequality and finds some evidence for this using data on aggregate machinery imports.
Wood (1997) compares the experience of Latin America since the mid-1980s with that of East Asia in the 1960s and 1970s. He points out that while the wage gap between skilled labor and unskilled labor narrowed in the four tigers (Hong Kong, the Republic of Korea, Singapore, and Taiwan) in the initial decades of export-oriented industrialization, wage differentials have risen in many of Latin American countries following their trade liberalization episodes. He suggests that the difference in experience is due to the entry of China and other large developing countries into the world market and the introduction of skilled-biased technology since the 1980s. Davis (1996) makes a similar argument and shows in a model with multiple diversification cones that local factor abundance, instead of global factor abundance, is central to determining the income distributional effects of trade liberalization. Also, Hanson and Harrison (1999) provide evidence suggesting that rising wage inequality in Mexico may have been due to import competition in low skill intensive industries.
There are other possible explanations for this phenomenon. Feenstra and Hanson (1996, 1997) hypothesize that activities transferred from the north to the south are more skilled-labor intensive than those formerly produced in the south, but less skilled-labor intensive than those in the north. They argue that capital flows from the north to the south increase the relative demand for skilled labor in both the north and the south. They find evidence for this using regional data for Mexico. …