Preferential Trading and Real Wages

Abstract

Following the Stolper–Samuelson type of logic, the general impression is that freeing up trade, whether preferentially as in the North American Free Trade Agreement (NAFTA) or on a nondiscriminatory basis as in the Uruguay Round, must lower real wages in one set of countries and raise them in the other set of countries. An increase in the real wage in all countries as a result of freeing up of trade either relies on gains via an improvement in the terms of trade or requires special assumptions such as increasing returns, complete specialization or asymmetries in production technology. This paper shows that even within a standard three‐country, three‐good, small‐union model, preferential trade liberalization can lead to increased real wages in both partner countries without necessarily relying on terms‐of‐trade improvements, increasing returns, complete specialization, or asymmetries in production technology.