Effect of international trade on wage inequality with endogenous technology choice

Abstract

ABSTRACT This paper investigates how trade openness affects wage inequality within and between trading countries under a new framework that incorporates the endogenous technology choice assumption. This assumption implies that as well as making a labor choice, the firms in our model simultaneously choose to adopt different technology compositions, rather than simply utilizing the standard constant technology, as assumed in most previous researches. Theoretically, we find that the endogenous technology choice partially absorbs the negative effect of the unskilled-skilled labor supply ratio on the relative wage within a country. Furthermore, compared with the standard constant technology model, the calibration of the new framework using data from 52 countries yields qualitatively and quantitatively different results for the impacts of transport costs on the relative wage between the two countries. Specifically, there are cases in which this difference generates contradictory interpretations of the effect of a transport cost reduction on wage inequality. For several pairs of countries, the wage differential between two countries becomes more evident in response to trade openness in the standard constant technology model, whereas in the endogenous technology choice model, the gap becomes narrower.