Tsukuba Economics Working Papers
No. 2010-007

A Survey of Trade and Wage Inequality: Anomalies, Resolutions, and New Trends
byYoshinori Kurokawa
September 2010
This version: November 2012

UNIVERSITY OF TSUKUBA
Department of Economics
1-1-1 Tennodai
Tsukuba, Ibaraki 305-8571
JAPAN

A Survey of Trade and Wage Inequality: Anomalies,
Resolutions, and New Trends
Yoshinori Kurokawa
University of Tsukuba
November 2, 2012
(Published in Journal of Economic Surveys, 28 (2014), 169-193.)

Abstract
This paper surveys recent studies on trade and wage inequality. We …rst introduce
some trade-based explanations for increased wage inequality. There are, however, anumber of criticisms of this line of thought based on the "trade-wage inequality anomaly," the "price-wage anomaly," and the small volume of trade. Mainly due to these
criticisms, trade-based explanations for rising wage inequality have been limited in theeconomic literature. Rather, the primary explanations for wage inequality have been
based on skill-biased technological change. Some trade models, however, have weakened the above criticisms, and more economists now argue that the e¤ect of trade,though relatively small compared to that of technological change, is more signi…cantthan generally believed. Finally, we attempt to link new trends in inequality, such asjob polarization and within-group inequality, to the trade and wage inequality literature.
Keywords: Trade, Wage inequality, Trade-wage inequality anomaly, Price-wage anomaly, Skill-biased technological change, Outsourcing, Variety-skill complementarity, Skill
intensity reversal, Job polarization, Within-group inequality
JEL Classi…cations: F12; F16

Tel.&Fax: +81-29-853-7426; E-mail address: kurokawa.yoshi.fw@u.tsukuba.ac.jp. I am very gratefulto Timothy Kehoe for his invaluable guidance and to Cristina Arellano, Michele Boldrin, and Terry Roefor their helpful advice. I am also grateful to two anonymous referees and Toru Aoki for their detailed
comments and suggestions and to Winston Chang, Koichi Hamada, Katsuhito Iwai, Michihiro Ohyama, andYoshimasa Shirai for their continuous encouragement. I wish to thank seminar participants at the Trade andDevelopment Workshop at the University of Minnesota for their useful comments. I also thank Kim Strain
and Andrew Cassey for their careful correction of my English and Daniel Chiquiar and Gordon Hanson for
their help with the Mexican data. However, the remaining errors are exclusively mine. This paper previously
circulated under the title "Possible Resolutions of the Trade-Wage Inequality Anomaly: A Survey of Tradeand Inequality."11

Increased Trade and Increased Wage Inequality

As Figure 1 shows, the relative wage of high-skilled to low-skilled workers began to increasein U.S. manufacturing industries in the late 1980s, and this phenomenon was also observedin Mexico.1 As can be seen, these two countries showed surprisingly similar movements inrelative wages in the late 1980s and early 1990s.2 What is the cause of this recent increasein wage inequality in these countries?
The data also indicate that, as shown in Figure 2, U.S.-Mexican trade as a percentageof U.S. GDP increased dramatically during the same period.3 Hence, this increased trade
might have contributed to the recent increase in skill premiums in both countries.4 Past
studies, such as Wood (1994), have investigated the possible relationship between trade andwage inequality. It is still a topic of interest and heated debate among economists.
However, there are a number of criticisms of trade-based explanations for increased wage
inequality. One criticism is based on the "trade-wage inequality anomaly"— a discrepancy
between the standard Heckscher-Ohlin (H-O) model and the data. According to the H-O
model, the relative wage of high-skilled to low-skilled workers should increase in the highskill abundant U.S. but decrease in low-skill abundant Mexico after trade liberalization.
However, as we have seen in Figures 1 and 2, the data show that the wage inequality
increased along with the increase in trade in both countries in the late 1980s and early
1990s. This is the "trade-wage inequality anomaly."
A second criticism is based on the "price-wage anomaly"— another discrepancy between
the standard H-O model and the data. In the H-O model, an increase in the relative wageof high-skilled to low-skilled workers should be driven by an increase in the relative price ofhigh-skill to low-skill intensive goods in the high-skill abundant U.S. This price-wage linkage
is known as the Stolper-Samuelson theorem of the H-O model. However, the data revealthat the relative prices of high-skill intensive goods were declining or constant during the
1980s, while the relative wage of high-skilled workers was increasing in the U.S. (Lawrence
and Slaughter, 1993).
1

Here, we use non-production and production workers as an index for high-skilled and low-skilled workers(Berman et al., 1994; Sachs and Shatz, 1994; Berman et al., 1998; Hanson and Harrison, 1999; Robertson,2004). We calculate the U.S. relative wage during the period 1980-2000 on the basis of the U.S. Annual
Survey of Manufactures (ASM). We calculate the Mexican relative wage on the basis of the Mexican Monthly
Industrial Survey (Encuesta Industrial Mensual, or EIM) by …rst calculating the average monthly wage of
non-production relative to production workers. The annual average is then produced by averaging thismonthly relative wage.
2
We note that the U.S. and Mexican relative wages are shown on di¤erent scales in Figure 1, as here weseek to emphasize the qualitative movements of these series. Kurokawa (2011a) emphasizes the quantitative
di¤erence between the same series during the period 1987-1994, when the North American Free Trade
Agreement (NAFTA) was enacted. Kurokawa (2011b) examines the data during the period 1994-2000.
3
Here, U.S.-Mexican trade is de…ned by the sum of U.S. exports to and U.S. imports from Mexico. The
data for trade and GDP are from the International Trade Administration and the Bureau of Economic
Analysis (BEA).
4
This paper mainly focuses on the U.S. and Mexico; however, the same increase in the relative wage ofhigh-skilled workers during the 1980s and into the 1990s can be found in Australia, Canada, Japan, Sweden,
and the United Kingdom (Feenstra and Hanson, 2003).

2

A third criticism is based on the volume of trade. For example, as shown in Figure 2,
the share of U.S.-Mexican trade in U.S. GDP was only 2.5 percent in 2000. Trade-based
explanations for increased wage inequality have often been criticized due to this small
volume of trade. Krugman (1995) provides numerical examples to explain why the small
volume of trade in the U.S. makes it unlikely that trade can account for the change in wages.
Therefore, mainly due to these three criticisms, trade-based explanations for increased
wage inequality have been limited in the economic literature. Rather, the primary explanations have been based on skill-biased technological change. There are many possible reasonsfor skill bias. For example, Krusell et al. (2000) consider the possibility of capital-skill complementarity. A sharp decrease in equipment prices in the 1980s led to an increase in the
demand for high-skilled workers, who were complements for this equipment, and a decreasein the demand for low-skilled workers, who were substitutes. Hence, the relative demand
and thus the relative wage of high-skilled to low-skilled workers increased. This technologybased explanation is consistent with the decrease in the price of high-tech goods and theincrease in wage inequality both in the U.S. and in Mexico.
Using trade models, however, a few economists have successfully weakened all/some of
the above criticisms that are based on the trade-wage inequality anomaly, the price-wage
anomaly, and the small volume of trade. Feenstra and Hanson (1996), for example, showthat foreign direct investment shifts production activities from the North to the South andthus increases the North’s outsourcing of low-skill intensive goods to the South, and thesegoods are high-skill intensive goods by the South’s standards. Thus the skill intensity of
production rises in both the North and the South, raising the relative demand and thus therelative wage of high-skilled to low-skilled workers in both types of countries. In the North,this increase in the relative wage of high-skilled workers is accompanied by an increase in
the relative price of domestic production to imports, which is compatible with U.S. data.
They also …nd that 15-33 percent of the shifts towards high-skilled workers within U.S.
manufacturing industries during the period 1979-1985 can be explained by outsourcing.
As noted above, we focus on the wage inequality between high-skilled and low-skilledworkers. However, many recent studies reveal interesting new trends in wage inequality,
such as the inequality among high-, middle-, and low-wage workers (job polarization) or theinequality within the top 10 percent of the income distribution (within-group inequality).
Thus we also survey these new trends and attempt to link them to the trade and wage
inequality literature.
Of course, there are many papers that also survey trade and wage inequality (e.g.,
Burtless, 1995; Richardson, 1995; Cline, 1997; Williamson, 1997; Wol¤, 2000; Feenstra
and Hanson, 2003; Kremer and Maskin, 2006; Drews, 2007; Goldberg and Pavcnik, 2007;
Chusseau et al., 2008; Harrison et al., 2011; Chusseau and Dumont, 2012). Our survey
paper adds value as follows. First, our paper is not a mere chronological survey but focuseson the anomalies and their resolutions. Second, it also discusses new trends in inequality

3and attempts to link them to the trade and wage inequality literature.
The rest of this paper is as follows. In Section 2, we …rst survey some trade-based
explanations of wage inequality and then discuss three major criticisms based on the tradewage inequality anomaly, the price-wage anomaly, and the small volume of trade. In Section
3, we describe some technology-based explanations. Section 4 reviews a few trade models
weakening the above criticisms. Our alternative trade models are introduced in Section 5.
In Section 6, we discuss new trends in inequality, such as job polarization and within-groupinequality. Finally, Section 7 concludes the paper.

2

Trade-Based Explanations

What is the cause of the recent increase in wage inequality in the U.S. and developing
countries such as Mexico? Some studies argue that by using di¤erent assumptions and by
examining di¤erent data, it is possible to …nd a signi…cant e¤ect of trade on wage inequality.

2.1

Theoretical and Empirical Arguments by Wood (1994)

Among these studies, Wood (1994) is one of the …rst economists to systematically examine
wage inequality trends across developed and developing countries.5 He argues that thelabor-market e¤ects of North-South trade in manufactured goods can be analyzed in thestandard H-O model, with North and South countries as the two countries, and highskilled and low-skilled workers as the two factors.6 The H-O model predicts that after
trade liberalization, the relative wage of high-skilled to low-skilled workers will rise in thehigh-skill abundant North, as production shifts toward high-skill intensive goods, raising
the relative demand and thus the relative wage of high-skilled workers. In the low-skill
abundant South, on the other hand, the relative wage of high-skilled workers will fall, as
production shifts toward low-skill intensive goods, raising the relative demand and thus therelative wage of low-skilled workers.
In the H-O model, this rise in the relative wage of high-skilled to low-skilled workers in
the North should be driven by the rise in the relative price of high-skill to low-skill intensive
goods. This price-wage linkage is known as the Stolper-Samuelson theorem of the H-O
model.
Wood next estimates the degree to which trade with the South can account for thedecreased demand for low-skilled workers in manufacturing in the North in 1990. Primarily
using OECD sources, he develops the factor content approach to calculate the numbersof high-skilled and low-skilled workers used to produce the goods that are exported andthe numbers that would have been used to produce the goods that are imported. The
5

We note that Leamer (1993) is also notable and makes a similar argument.
In Wood (1994), the "North" usually approximates most closely what the World Bank calls "high-income
OECD-member economies" (before 1989 called "industrial market economies"), and the "South" is usually
the UN’s "developing market economies," plus China.
64di¤erence between these values is used to determine the e¤ect of trade on the demand forhigh-skilled and low-skilled workers. He …nds that trade with the South reduced the demand
for low-skilled workers in manufacturing in the North by 22 percent.
His theoretical and empirical arguments thus indicate a signi…cant e¤ect of trade on
wage inequality. However Wol¤ (2000) notes that one strong assumption used by Woodis that goods imported from the South are "non-competing" imports— most of the manufactured goods imported from the South are types that are not produced in the North.
It might be probable that, due to this assumption, the e¤ects on low-skilled employmentof trade expansion are overestimated. This is because under this assumption, competition
can occur on the price di¤erences between imported and domestic goods; for example, one
50 dollar pair of domestic pants is substituted by one 20 dollar pair of imported pants.
By the standard factor content approach, however, one 20 dollar pair of domestic pants issubstituted by one 20 dollar pair of imported pants. Thus the former e¤ect is 2.5 times aslarge as the latter. However, as noted by Burtless (1995), Wood himself suggests that evenhis estimate presented above understates the impact of North-South trade on the relative
demand for low-skilled Northern workers because it ignores unskilled labor saving technology that Northern …rms are forced to adopt to remain competitive with …rms based in theSouth.

2.2

Other Empirical Studies on Trade and the Skill Premium

Although they use di¤erent models and examine di¤erent data, there are many empiricalstudies that also …nd a signi…cant e¤ect of trade on wage inequality as in Wood (1994). For
the U.S., Borjas and Ramey (1994), for example, show how trade volumes can be linked
to wage inequality in the U.S. By using time series analysis, they conclude that the only
variable that consistently shares the same long-run trend with their wage-inequality series
is the durable-goods de…cit as a percentage of GDP. Harrigan and Balaban (1999) estimate
an econometric general equilibrium model of U.S. wages as a function of prices, technology,
and factor supplies. They …nd that capital accumulation and the fall in the price of traded
goods increased returns to education.
For Mexico, Revenga (1997) and Hanson and Harrison (1999), for example, link changes
in Mexican wage inequality to changes in trade policy. Revenga (1997) argues that tradereform had a negative e¤ect on …rm-level employment and wages in the Mexican manufacturing sector both by shifting down industry product and labor demand and by reducing therents available to be captured by …rms and workers. Hanson and Harrison (1999) …nd thatthe reduction in tari¤ protection in 1985 disproportionately a¤ected low-skilled industries
and that the goods from that sector may have fallen in price and wage because of competition from economies with reserves of less expensive low-skilled labor than that available
in Mexico. Verhoogen (2008) also focuses on Mexico, linking quality upgrading for export
to the skill premium. He shows that only the most productive plants in Mexico enter the5

export market and produce higher-quality goods for export than for the domestic market,
thus requiring the payment of high wages to both white-collar and blue-collar employees,
but especially to white-collar employees.7
There are also many empirical studies for countries other than the U.S. and Mexico, particularly for Latin America.8 For Chile, Robbins (1996), for example, …nds that, although
the content of high-skilled labor in imports exceeds the content in exports, the returns tohigh-skilled labor grew after trade liberalization. Using a time series approach, Beyer etal. (1999) also …nd a long-term correlation between openness and wage inequality in Chile.
For Costa Rica, Gindling and Robbins (1999) …nd that the skill premium rose after liberalization as a result of changes in the structure of labor demand. For Brazil, Green etal. (2001) …nd an increase in the returns to college education following trade liberalization. For Argentina, Galiani and Sanguinetti (2003) …nd that import penetration explainsa small part of the skill premium in Argentina. For Colombia, Attanasio et al. (2004) showthat trade liberalization increases inequality through technology, and the growing informal
sector. Goldberg and Pavcnik (2005) show that tari¤ cuts decreased low-skilled wages inColombia because the most protected workers were low-skilled.

2.3

Criticisms of Trade-Based Explanations

As was discussed in the previous sections, increased trade might have contributed to therecent increase in skill premiums. However, trade-based explanations for increased wage
inequality have been criticized. The major criticisms lie not in the theories but in the data.
2.3.1"Trade-Wage Inequality Anomaly"

One criticism is based on a "trade-wage inequality anomaly"— a discrepancy between thestandard H-O model and the data. As we discussed in Section 2.1, according to the H-O
model, the relative wage of high-skilled to low-skilled workers should increase in the highskill abundant U.S. but decrease in low-skill abundant Mexico after trade liberalization. The
H-O model thus generates a positive relationship between trade and wage inequality in the
U.S. but generates a negative relationship in Mexico. However, as we have seen in Figures 1
and 2, the data generated a positive relationship between trade and wage inequality in bothcountries in the late 1980s and early 1990s. This is the "trade-wage inequality anomaly."Note, however, that this anomaly is not particular to the U.S. and Mexico during the
1980s and 1990s. As pointed out by Williamson (1997), the anomaly was actually found by
Krueger (1978), who studied ten developing countries covering the period through 1972. As
7

Cragg and Epelbaum (1996), Feliciano (2001), and Robertson (2004) also highlight trade and wage
inequality in Mexico.
8
Gourdon (2011) surveys empirical studies on trade and wage inequality in developing countries. There arealso theoretical studies for Latin America. For example, Atolia (2007) shows, using numerical simulations,that the rise in wage inequality in Latin America can be rationalized as a short-run response to tradeliberalization.

6

we noted in Section 2.2, many studies for Latin America also …nd that wage inequality rose
following trade liberalization. Moreover, a review by Davis (1996) reports a study of sevencountries in Latin America and East Asia that shows that wage inequality typically did
not decrease after trade liberalization but rather increased (Robbins, 1996). More recently,
Berman et al. (1998) and Goldberg and Pavcnik (2007) present evidence of rising wage
inequality in developing countries. These results are again at odds with the H-O prediction.
2.3.2"Price-Wage Anomaly"

A second criticism is based on a "price-wage anomaly"— another discrepancy between thestandard H-O model and the data. As we mentioned in Section 2.1, the Stolper-Samuelson
theorem of the H-O model predicts the same direction of movement in the relative priceof high-skill to low-skill intensive goods and the relative wage of high-skilled to low-skilledworkers because the rise in the relative wage of high-skilled workers should be driven by
the rise in the relative price of high-skill intensive goods in the high-skill abundant U.S.
However, the data show that the relative prices of high-skill intensive goods were decliningor constant during the 1980s, while the relative wage of high-skilled workers was increasingin the U.S.
Lawrence and Slaughter (1993), the most cited work on this criticism, …nd little e¤ect ofchanges in output prices on wages during the 1980s. The measured wage inequality between
high-skilled and low-skilled workers (non-production and production workers) increased by
10 percent during the period 1979-1989. Thus they argue that, according to the StolperSamuelson theorem, the rising relative wage of high-skilled to low-skilled workers after tradeliberalization must have been accompanied by the rising relative price of high-skill to lowskill intensive goods.
However, using data on prices and quantities of inputs and outputs from the Trade andImmigration Data Base of the National Bureau of Economic Research (NBER) and data on
U.S. terms of trade from the export and import price indices produced by the Bureau of Labor Statistics (BLS), they …nd no evidence that the price of low-skill intensive manufactured
goods fell relative to that of high-skill intensive manufactured goods in U.S. manufacturingindustries during the period 1979-1989. They examine percent changes during the 1980s in
the import and export prices of industries against the ratio of high-skilled (non-production)
to low-skilled (production) workers employed in these industries during the same period. In
each unit, these industries are disaggregated at the two- and three-digit Standard Industrial
Classi…cation (SIC) levels. Regardless of the level of disaggregation, however, they …nd thatthese price changes do not indicate that the international prices of high-skill intensive goods
increased relative to the international prices of low-skill intensive goods. In fact, the relative
prices of high-skill to low-skill intensive goods declined.
To corroborate their conclusion, Lawrence and Slaughter (1993) also calculate the percent changes in U.S. import and export prices during the period 1980-1989 as a weighted
7

sum of the 3-digit SIC price changes using the employment of either high-skilled (nonproduction) or low-skilled (production) workers as weights. They …nd that the average
import price change using high-skilled workers as weights is 26.0 percent, while the changeusing low-skilled workers as weights is 28.1 percent. However, the average export pricechange using high-skilled workers as weights is 26.3 percent, while the change using lowskilled workers as weights is 30.0 percent. Thus, in both cases of import and export prices,
the average price change using high-skilled workers as weights is lower than the change using
low-skilled workers as weights. This result again indicates that the international prices of
low-skill intensive goods slightly increased relative to the international prices of high-skill
intensive goods.
This decrease in the relative international prices of high-skill intensive goods allowed
the authors to conclude with con…dence that the Stolper-Samuelson mechanism did nothave much in‡uence on U.S. relative wages during the 1980s and that no regression analysis
is necessary for this conclusion. Needless to say, a regression analysis would have beennecessary if the relative international prices of high-skill intensive goods had instead increased, to determine the degree to which the Stolper-Samuelson mechanism contributed tothe increased U.S. skill premium compared to other possible factors.
It should be noted that some economists disagree with Lawrence and Slaughter’s …ndingthat imports have not contributed much to rising wage inequality in the U.S. Davis andTopel comment on in Lawrence and Slaughter (1993) as follows: "Those disagreeing with theauthors’results suggested that their treatment of technological change in the U.S. economy
as exogenous may be hiding the e¤ects of trade on wages. Paul Romer, John Helliwell,and Martin Baily all argued that technological change cannot be considered exogenous
because some portion of apparent technological change in the United States is driven by
the globalization of production, as low-skilled, labor-intensive manufacturing tasks gradually
move from the United States to low-wage countries, such as Mexico, while the most skillintensive jobs continue to be performed in the United States." (Lawrence and Slaughter,
1993, p. 221)
2.3.3

The Small Volume of Trade

A third criticism is based on the volume of trade. As we have seen in Section 2.1, Wood
(1994) empirically argues that there is a signi…cant e¤ect of trade on wage inequality. Tradebased explanations for increased wage inequality, however, have often been criticized dueto the small volume of trade, as shown in Figure 2.
Krugman (1995) provides numerical examples to explain why the small volume of tradein the U.S. makes it unlikely that trade can account for the change in wages. He develops
a computable general equilibrium model of world trade to determine the degree to which
the growing exports of newly industrializing economies (NIEs) a¤ect OECD labor markets.
The model has the two countries (the aggregate OECD and the aggregate NIEs), two goods8(high-skill intensive good 1 and low-skill intensive good 2), and two factors (high- andlow-skilled workers). The markets are perfectly competitive. The production and utility
functions are Cobb-Douglas.
The e¤ects of opening trade between the OECD and the NIEs can be represented by
Figure 3. Point A shows OECD autarky. After opening to trade, the relative price of highskill intensive good 1 to low-skill intensive good 2 increases, and, as a result, production
moves to Q while consumption moves to C. In world equilibrium, the NIEs’ o¤er curve(drawn backward with its origin at Q) passes through C — OECD exports are equal to
NIEs imports, and vice versa.
To make the model computable, he uses past empirical results to set parameter values,
and by using the Cobb-Douglas production and utility functions he also speci…es elasticities(unitary elasticities for simplicity) in production and consumption. He then asks whatchanges in relative wages and prices would be consistent with the observed NIEs trade.
His answer is that NIEs trade on the scale actually seen should be associated with afairly small change in the relative wage of high-skilled to low-skilled workers and a verysmall change in the relative price of high-skill to low-skill intensive goods. In fact, his
exercise shows that a 3 percent increase in the relative wage of high-skilled workers from its
autarky level is large enough to imply NIEs exports of 2.2 percent of OECD gross product,
which is greater than the actual share of NIEs manufactures in OECD spending. It is also
shown that this wage increase is associated with a rise of only 1 percent in the relative
price of the high-skill intensive good. He thus concludes that for plausible parameters,
the change in relative prices associated with the size of NIEs trade should be well within
measurement error. In other words, actual changes in relative prices should re‡ect a whole
host of characteristics besides trade.9
In summary, as commented on by Cooper in Krugman (1995), Krugman’s results nicely
show the e¤ects of import competition on the basis of simple traditional trade theory andthen identify why the plausible e¤ects are small. It seems that the simplicity of his theory
makes his research more notable. As will be shown in Section 5, the model by Kurokawa(2011a) shares this simplicity with Krugman’s model. Contrary to Krugman’s simple model,
however, Kurokawa’s simple model will show the theoretical possibility that trade, evenwhen small in volume, signi…cantly contributes to an increase in the skill premium.
Here, it should be noted that Krugman (2008) recently argues that, due to the increasein U.S. trade with low income countries and the growing fragmentation of production, it is
no longer safe to assume that the e¤ect of trade on wage inequality is miniscule, although
he admits that it is hard to prove the actual e¤ect.
It should also be noted that trade seems small in volume in terms of U.S. GDP; however,
it is not small from the Mexican perspective. U.S.-Mexican trade as a fraction of Mexican
GDP, for example, was 23.9 percent in 1994 and 42.6 percent in 2000, although it was 1.4
9

We note that, for alternative views, see Deardor¤ (2000), Leamer (2000), and Panagariya (2000).

9percent in 1994 and 2.5 percent in 2000 as a percentage of U.S. GDP. It thus seems thatpeople tend to look at the volume of trade only in terms of U.S. national income.

3

Technology-Based Explanations

Mainly due to these three criticisms, as shown in Section 2.3, trade-based explanations
for rising wage inequality have been limited among economists. Conversely, the primary
explanations have been based on skill-biased technological change.10

3.1

Capital-Skill Complementarity

A variety of explanations for skill bias are possible. For instance, Krusell et al. (2000)
consider the possibility of capital-skill complementarity and provide a technology-based
explanation for increased wage inequality that …ts the theory and data.
They develop the following four-factor aggregate production function that distinguishes
among capital structures (kst ), capital equipment (ket ), low-skilled workers (ut ), and highskilled workers (st ) and allows for di¤erent elasticities of substitution among factors:
G (kst ; ket ; ut ; st ) = ksthut + (1) ( ket + (1) st )

=

i(1

)=

:

In this speci…cation, the elasticity of substitution between equipment and low-skilledworkers is given by 1= (1), and the elasticity of substitution between equipment and).11high-skilled workers is given by 1= (1To assess how the skill premium has been a¤ected by changes in factor inputs, they
estimate the parameters of their model using U.S. time series data during the period 19631992. They …nd that

= 0:401 and=

0:495:> . Thus the elasticity of substitution

between capital equipment and low-skilled workers, 1= (1) = 1:67, is higher than thatbetween capital equipment and high-skilled workers, 1= (1) = 0:67: capital-skill com-plementarity. With this empirically plausible di¤erence in substitution elasticities, changes
in observed factor inputs can account for most of the variation in the skill premium during
the period.
They thus conclude that a sharp decrease in equipment prices in the 1980s led to anincrease in the demand for high-skilled workers, who were complements for this equipment,
and a decrease in the demand for low-skilled workers, who were substitutes. Hence, the relative demand for and thus the relative wage of high-skilled to low-skilled workers increased.
This technology-based explanation is consistent with the decrease in the price of high-techgoods and the increase in wage inequality both in the U.S. and in Mexico. It is thus implied10

For example, see Katz and Autor (1999), Acemoglu (2002), and Acemoglu and Autor (2011) for a survey
on technological change and wage inequality.
11
See Saito (forthcoming) for the history of the constant elasticity of substitution (CES) function.

10

that the most signi…cant competition that low-skilled workers in the U.S. face is not foreign
workers but the combination of high-tech equipment and high-skilled workers in the U.S.12
It should be noted that the hypothesis of capital-skill complementarity was …rst formalized by Griliches (1969). As documented by Mendez (2002), there is now a vast literature
on capital-skill complementarity initiated by Griliches. Most studies before the mid 1990s
are skeptical about the empirical relevance at the aggregate level of this capital-skill complementarity. Using di¤erent methodologies, however, recent studies take the opposite viewand explicitly link capital equipment to rising wage inequality. Goldin and Katz (1998), forexample, document the importance of capital-skill complementarity during the period 19091929. This period has two features that make it comparable to the 1980s and the 1990s.
The 1909-1929 period experienced both signi…cant technological change and a substantial
increase in wage inequality. Compared to these past studies, Krusell et al. (2000) go evenfurther and …nd that most of the wage inequality shift during the 1960s-1980s in the U.S.
can be accounted for by the capital-skill complementarity hypothesis. Their mechanism isstraightforward, as we have seen in the above discussion. Lindquist (2005) is a Swedish
version of the Krusell et al. (2000) study.

3.2

Other Technology-Based Explanations

Several other studies also relate skill-biased technological change to wage inequality (Katzand Murphy, 1992; Berman et al., 1994; Berndt and Morrison, 1995; Autor et al., 1998;
Berman et al., 1998; Machin and van Reenen, 1998; Katz and Autor, 1999). For example,
Berman et al. (1998) …nd strong evidence for pervasive skill-biased technological change
in developed countries— the same manufacturing industries simultaneously increased demand for skills in di¤erent countries. They also show evidence consistent with skill-biased
technological change in developing countries. Katz and Autor (1999) argue that the only
explanation consistent with the increase in the relative wage and employment of high-skilled
to low-skilled workers is that there has been an outward shift in the demand for high-skilledworkers since the mid-1980s. Berman et al. (1994) and Krugman and Lawrence (1994) also
document that the relative employment of high-skilled to low-skilled workers increased in
U.S. manufacturing sectors during the 1980s.
Although technology-based explanations have been supported by most economists, there
were also a few criticisms. Recall Wood (1994), who blamed growing trade for increased
inequality, as we have seen in Section 2. As noted by Williamson (1997), Wood dismissed
skill-biased technological change as a potential explanation for increased wage inequality
because labor and total factor productivity growth both slowed during the 1980s. Woodalso argued that the pattern of increasing wage inequality in the North favored a trade12
Alvalez-Cuadrado and Van Long (2011) focus on sectoral di¤erences in the elasticity of substitution
between capital and labor to provide an alternative source for technology-driven structural change consistent
with balanced growth at the aggregate level.

11

explanation because there was no cross-country association between wage inequality trends
and technological progress. That is, technological progress did not necessarily occur in every
developed country in which wage inequality increased.
It should also be noted that many empirical studies have investigated skill-biased technological change at the worker-, …rm-, and sector-level, but linkages across sectors have been
ignored, despite the fact that more than half of a …nal product’s value is embedded in intermediates. Voigtländer (2012) shows that skill upgrading in one sector goes hand-in-handwith increasing skill demand in many other sectors because of linkages that operate throughthe use of intermediate products (an intersectoral technology-skill complementarity).

4

Resolutions of the Anomalies

With very few exceptions, economists have tended to disagree with trade-based explanations
for increased wage inequality on the basis of the anomalies— the gaps between the data
and the standard H-O model— and thus blame skill-biased technological change. A few
economists, however, have been successful in resolving the anomalies on the basis of trademodels.

4.1

Foreign Direct Investment and Outsourcing

One of the notable resolutions of the anomalies is based on foreign direct investment andoutsourcing. Feenstra and Hanson (1996) show that foreign direct investment shifts production activities from the North to the South and thus increases the North’s outsourcing
of low-skill intensive goods to the South, and these goods are high-skill intensive goods
by the South’s standards. Thus the skill intensity of production rises in both the Northand the South. This globalization, interpreted as foreign direct investment from the Northto the South, increases the relative demand and thus the relative wage of high-skilled to
low-skilled workers in both the North and the South.13
To explain this mechanism, they provide a model with a continuum of intermediate
goods indexed by z 2 [0; 1]. Higher z re‡ects higher skill intensity of production. Capital iscomplementary with high-skilled workers, and the North has more capital and more highskilled workers than the South. Figure 4 shows the locus of minimum costs for intermediate
goods produced in the North and South denoted CN CN and CS CS , respectively. It can beshown that in equilibrium there is a cuto¤ z such that the South produces intermediate
goods in [0; z ] while the North produces intermediate goods in [z ; 1].
Consider a capital ‡ow— foreign direct investment— from the North to the South. This
capital ‡ow lowers the return to capital in the South and raises it in the North. This will13
We note that, by introducing southern technological catch-up, Zhu and Tre‡er (2005) also employ amechanism closely related to the mechanism developed by Feenstra and Hanson (1996). There are more
recent papers that focus on the role of outsourcing/o¤shoring. For example, see Blinder (2006, 2009), Sayek
and Sener (2006), Grossman and Rossi-Hansberg (2008), and Liu and Tre‡er (2008).

12

lower the Southern costs locus CS CS in Figure 4, and raise the Northern locus CN CN , thus
00increasing the cuto¤ value of z to z . Thus the activities in [z ; z ] now take place in the0South rather than in the North. The activities in [z ; z ] are more high-skill intensive thanany previously performed in the South. They are, however, less high-skill intensive than
any that now occur in the North. As a result, this increases the average skill intensivenessof production in both countries, which raises the relative demand and thus the relative wageof high-skilled to low-skilled workers in both countries.
In the North, this increase in the relative wage of high-skilled workers is accompanied by
the increase in the relative price of domestic production to imports. Feenstra and Hanson(1996) empirically con…rm that domestic prices actually rose by more than import prices
in the U.S. during the 1980s.
They next ask whether outsourcing due to growth in the South’s relative capital stock
can explain a signi…cant part of the shift towards high-skilled workers in the U.S. To answer
this question, using a panel data of 450 four-digit SIC U.S. industries, they perform regressions in which the share of high-skilled workers in the total wage bill should be explainedon the basis of various industry variables including the change in the import share. They
…nd that 15-33 percent of shifts towards high-skilled workers within U.S. manufacturingindustries during the period 1979-1985 can be explained by the increasing import share.

4.2

Role of Non-Traded Goods

Kremer and Maskin (2006) note that the model of Feenstra and Hanson (1996) shareswith the other standard trade models the prediction that trade should be greatest between
countries with the most di¤erent factor endowments; this is not observed. Related to thispoint, Xu (2003), for example, shows that in a model with endogenously determined nontraded goods, tari¤ rates in the South can have a U-shaped relationship with inequality,
reducing wage inequality when tari¤ rates start at a high level and increasing it when they
are initially lower.
To demonstrate this relationship, he formulates a model with two countries (Northand South countries), two factors (high-skilled and low-skilled workers), a continuum of
manufactured goods indexed by z 2 [0; 1] that both countries produce using high-skilledworkers, and an agricultural good that only the South produces using low-skilled workers.
The South has a relative productivity advantage in low-index manufactures, and the North
has such an advantage in high-index manufactures. In equilibrium, there will be cuto¤
indices 0 < z x < z m < 1 such that southern export goods in [0; z x ] are produced only in
the South, southern import goods in [z m ; 1] are produced only in the North, and goods in[z x ; z m ] are produced in both countries and are not traded. Southern trade liberalization
due to a tari¤ reduction in this model decreases the range of non-traded goods throughthe import expansion e¤ect and the export expansion e¤ect. The import expansion e¤ectdecreases z m , thus decreasing the demand for high-skilled workers in the South. The export
13

expansion e¤ect, however, increases z x , thus increasing the demand for high-skilled workers
in the South as in the model of Feenstra and Hanson (1996). He shows that the export
expansion e¤ect dominates for low initial tari¤ rates, while the import expansion e¤ect
dominates for high initial tari¤ rates. Trade liberalization due to a tari¤ reduction thus
produces a U-shaped e¤ect on inequality in the South. A similar argument shows that thesame is true for the North.
It should also be noted that Feenstra and Hanson (1996) resolve the anomalies on thebasis of a "skill intensity reversal": intermediate goods that are produced in the South andrelatively high-skill intensive within the South are relatively low-skill intensive within the
North.14 As will be discussed in Section 5.3, however, this assumption poses an empiricalchallenge, as past research has found little evidence for the so-called "factor intensity reversal." In fact, as documented by Kurokawa (2011b), we could not observe any clear-cut skill
intensity reversal in the late 1980s when the skill premiums in the U.S. and Mexico actuallybegan to rise. Kurokawa (2011a), however, successfully provides a simple resolution of theanomalies observed in the late 1980s and early 1990s without assuming this skill intensity
reversal, unlike Feenstra and Hanson (1996).

4.3

Schumpeterian Mechanism

Another notable resolution of the anomalies is based on the Schumpeterian mechanism.
Dinopoulos and Segerstrom (1999) show that trade increases the relative price of innovation(the reward for innovation relative to the current level of R&D di¢ culty), thus encouraging
high-skill intensive R&D investment in each country. They also show that a contemporaneous correlation between an index of the relative price of innovation and an index of the
U.S. skill premium was 0.80 during the period 1963-1989. Acemoglu (2003) shows that
trade "induces" skill-biased technological change in the U.S., and this improved technology
can be transferred to other countries by spillover e¤ects.15 Thus these explanations also
demonstrate the rise in relative demand and, hence, the relative wage of high-skilled to
low-skilled workers in each of the trading countries. This can occur without a rise in therelative price of high-skill to low-skill intensive goods.
We, however, note that Acemoglu (2003) might not be successful in explaining the factthat the U.S. and Mexico exhibited surprisingly similar timing in the increase in the skill
premium. This is because the increase in the skill premium in Mexico should be driven by
the spillover e¤ects in his model, but this spillover process usually takes many years.
We also note that, while emphasizing that trade can increase the skill premium in each14

We note that, even if a good has the same skill intensity in both the North and the South, this good canbe relatively low-skill intensive compared to other goods within the North but relatively high-skill intensive
within the South. In the following discussion, the word "skill intensity reversal" refers to the reversal of
relative skill intensities between the two countries.
15
Using a heterogeneous-…rm trade model a la Melitz (2003), Bas (2012) links …rms’export to skill-biased
technology to show a within-industry increase in the skill premium. Burstein et al. (2012) link trade to theskill premium through capital-skill complementarity (skill-biased technology).

14

of the trading countries, all the studies presented above do not disagree that technologicalchange has played an important role.

5

Our Alternative Resolutions

5.1

Variety-Skill Complementarity

Compared to the previous studies discussed in Section 4, Kurokawa (2011a) provides asimpler resolution of the anomalies. The resolution is based on a straightforward applicationof the well-known model of variety trade in intermediate goods developed by Ethier (1982).16
The variety trade in di¤erentiated intermediate goods increases the variety of intermediate
goods used by the …nal good in both countries. The increased variety of intermediate goods
then can increase the variety of tasks to be handled and thus corresponds to higher demandfor high-skilled workers. Through this variety-skill complementarity, the relative demand
and thus the relative wage of high-skilled to low-skilled workers— the skill premium— rises inboth countries.17 This can occur without a rise in the relative price of high-skill to low-skill
intensive goods. Using the data from the period prior to the implementation of NAFTA,
he also provides several numerical examples that illustrate that small amounts of variety
trade can produce a signi…cant increase in the relative wage.
This linking of imports of new foreign varieties— increases in the extensive margin ofimports— to wage inequality is compatible with available empirical evidence. Figure 5 plots
the 1980–2000 data on growth in what Kehoe and Ruhl (2009) call the "least traded goods"
in U.S. manufacturing imports from Mexico for 1980 and on the growth in the relative wageof high-skilled to low-skilled workers in U.S. manufacturing industries. Figure 6, however,plots the growth in the "least traded goods" in Mexican manufacturing imports from the
U.S. for 1980 and the growth in the relative wage in Mexican manufacturing industries
during the same period.
Kehoe and Ruhl (2009) classify the set of goods that accounts for only 10 percent oftrade as the "least traded goods." Here, the growth in the least traded goods is employed
to measure the increase in the extensive margin of trade. The data for the growth in least
traded goods are the Standard International Trade Classi…cation (SITC) (revision 2) 3digit manufacturing data from the OECD International Trade by Commodities Statistics(ITCS).18 The source of data for the U.S. and Mexican relative wages is the same as for16
Ethier’s (1982) model is an intermediate-goods version of Krugman’s (1979) model of variety trade in…nal goods.
17
Dinopoulos et al. (2011) also link variety trade to wage inequality. Their model, however, modi…es theone-sector Krugman (1979) model of variety trade in …nal goods by introducing quasi-homothetic preferencesfor varieties and non-homothetic technology in the production of each variety, thus relating an increase in
the output of each variety— not an increase in the number of variety— to an increase in the relative demandfor high-skilled workers by each variety (output-skill complementarity). Sato and Yamamoto (forthcoming)
also link variety trade in …nal goods to the skill premium. Zhang (2012) links variety trade in services tothe skill premium.
18
See Kehoe and Ruhl (2009) for the detailed procedure used to construct …gures 5 and 6. Note that the15

Figure 1.
As can be seen in …gures 5 and 6, the least traded goods that account for 10 percent
of U.S. manufacturing imports from Mexico in 1980 account for 42.5 percent in 2000, andthe least traded goods that account for 10 percent of Mexican manufacturing imports fromthe U.S. in 1980 account for 17.5 percent in 2000. This indicates that each country started
importing goods that it had not imported previously or had only imported in small quantities, thus indicating that the variety of manufactured imports increased in each country.
Moreover, these …gures reveal that this growth in the least traded goods was highly correlated with the growth in the relative wage in each country over 1980–2000. In fact, thecorrelation between these two series was high in each country: it was 0.932 and 0.947 in
the U.S. and Mexico, respectively. Thus linking the extensive margin of imports to the skill
premium is compatible with this evidence in both countries.
Here, it is worth noting that the method developed by Kehoe and Ruhl (2009) used in
Kurokawa (2011a) for measuring the extensive margin is di¤erent from methods used in the
few previous studies of the extensive margin.
Hummels and Klenow (2005) and Broda and Weinstein (2006), for example, classify agood as not traded if the value of trade is zero, and Evenett and Venables (2002) classify
a good as not traded if its yearly value of trade is less than or equal to 50,000 1985 U.S.
dollars, regardless of the country being studied. In Kehoe and Ruhl’s (2009) de…nition of a
non-traded good, however, goods with very small but nonzero amounts of trade can also be
considered, and the actual dollar value of the 10 percent cuto¤ can di¤er across countries.
Hence, non-traded goods in a country are determined based on the relative importanceof goods in the country’s trade. This country-variant method developed by Kehoe andRuhl has been widely used. Sandrey and van Seventer (2004), Mukerji (2009), Amarsanaa
and Kurokawa (2012), and Atolia and Kurokawa (2012a), for example, use the method tomeasure the extensive margin of trade, as does Kurokawa (2011a).

5.2

A Quantitative Analysis of Import Variety and Skill Premium

As we discussed in Section 5.1, Kurokawa (2011a) has provided a simple resolution of theanomalies. However, this poses a quantitative challenge. This is because no past studies
have quanti…ed how much of the increase in the skill premium can be accounted for by
the change in the extensive margin of imports. Atolia and Kurokawa (2012a) formulate astatic applied general equilibrium model and then calibrate it to Mexican data for 1987.19
manufacturing imports in these …gures include imports of both …nal and intermediate goods. Fortunately,
however, much of the increase in trade has been in intermediate goods (Feenstra, 1998).
19
Here, applied general equilibrium analysis is de…ned to be the numerical implementation of generalequilibrium models calibrated to data (Kehoe and Kehoe, 1994; Kehoe and Prescott, 1995). Recently, Choand Díaz (forthcoming) also apply applied general equilibrium analysis to trade and wage inequality in
Slovenia. Note that some authors (e.g., Richardson, 1995; Bhagwati, 1998; Francois and Nelson, 1998)
convincingly point out that a general equilibrium approach is the appropriate tool for analyzing the e¤ectsof trade on wage inequality.

16

In the calibrated model, their numerical experiments show how much of the increase in the
Mexican skill premium can be accounted for by the extensive margin growth in Mexican
manufactured imports from the U.S.
As in Kurokawa (2011a), Atolia and Kurokawa (2012a) also measure the growth in
the extensive margin of imports by the growth in the share of the least traded goods inimports. Figure 7 plots the 1987-2000 data on the growth in the least traded goods in
Mexican manufactured imports from the U.S. for 1987 and on the growth in the relative
wage of high-skilled to low-skilled workers in Mexican manufacturing industries. The data
for the share of the least traded goods are the SITC (revision 2) 4-digit manufacturing datafrom the OECD ITCS, and the data source for the relative wages is the same as that of
Figure 1.
Figure 7 reveals that the least traded goods that account for 10 percent of Mexican
manufactured imports from the U.S. in 1987 account for 19.5 percent in 1994. This indicatesthat over this period, Mexico started importing U.S. manufactured goods that it had notimported before or had only imported in small quantities, thus indicating that the varietyof Mexican manufactured imports from the U.S. increased. The …gure also reveals thatthe growth in the least traded goods was highly correlated with the growth in the relative
wage in Mexico over 1987-2000. The correlation between these two series was high, 0.926,
over the period. As can be seen, the extensive margin of manufactured imports was growing
substantially before NAFTA was enacted in 1994, and it became stable thereafter. Similarly,
the Mexican skill premium was also growing substantially before NAFTA and became stable(with a slight decrease) thereafter.
Their numerical experiments focus on the period 1987-1994, when both the extensive
margin of manufactured imports and the skill premium were growing dramatically as shownin Figure 7. The numerical experiments show that the extensive margin growth in Mexican
manufactured imports from the U.S. over 1987-1994 can raise Mexican skill premium by
up to approximately 6.5 percent. However, the data show that the Mexican skill premiumincreased by 43.4 percent during the same period. Thus the results indicate that the growthin the extensive margin of manufactured imports can account for up to approximately 15
percent of the change in the Mexican skill premium over 1987-1994.
Atolia and Kurokawa (2012a), therefore, have quantitatively illustrated that the extensive margin of manufactured imports may be a channel that has a substantial e¤ect on theincrease in wage inequality in Mexico.
It should be noted that one of the most salient characteristics of the Mexican economy ismaquiladoras. This export-processing sector imports intermediate inputs and then assembles them into …nal goods in a way that is similar to that modeled in Atolia and Kurokawa(2012a). Of course, low-skilled workers would be used more intensively than high-skilledworkers in maquiladoras (intensity), but it is still possible that the demand for high-skilledworkers increases more than that for low-skilled workers (complementarity). In fact, as

17

emphasized by Feenstra and Hanson (1997), the demand for high-skilled workers increased
along with the increase in imports from the U.S. in maquiladoras. Atolia and Kurokawa’s
experiments successfully capture both the intensity and the complementarity.

5.3

Skill Intensity Reversal

Using data from the period following the implementation of NAFTA, Kurokawa (2011b)
also presents an alternative simple resolution of the trade-wage inequality anomaly. As also
documented by Reshef (2007), a rising skill premium in two countries can be explained
simply by the H-O model assuming a "skill intensity reversal."20 That is, U.S. exports to
Mexico of goods that are relatively high-skill intensive compared to other goods in the
U.S. but relatively low-skill intensive in Mexico will increase demand for U.S. high-skilledworkers but decrease demand for Mexican low-skilled workers. Conversely, U.S. imports
from Mexico of goods that are relatively low-skill intensive in the U.S. but relatively highskill intensive in Mexico will decrease demand for U.S. low-skilled workers but increasedemand for Mexican high-skilled workers. Therefore, the relative demand and thus therelative wage of high-skilled to low-skilled workers will increase in both countries.
This assumption, however, poses a serious empirical challenge because little evidence forthe so-called "factor intensity reversal" has been found in manufacturing industries in past
empirical studies (Leontief, 1964; Ball, 1966; Moroney, 1967), thus supporting Samuelson’s(1951-1952) impression that a factor intensity reversal has much less empirical importancethan theoretical interest.
Should we thus conclude that the H-O explanation with factor intensity reversal istheoretically interesting but empirically unimportant? The answer is no. This is because
the so-called factor intensity reversal has so far referred only to a capital/labor intensity
reversal. However, our focus is now on a skill intensity reversal. Unfortunately, no serious
empirical work on skill intensity reversal has been done until now. Thus it is time to revive
the factor intensity reversal controversy of the 1960s with the fresh viewpoint of a skill
division among labor.
Kurokawa (2011b) shows clear-cut evidence for the existence of skill intensity reversal.
U.S. net exports to Mexico of electronics products increased from 1994 to 2000.21 As shownin …gures 8 and 9, the electronics products were relatively high-skill intensive compared to
the non-electronics products in the U.S. but relatively low-skill intensive in Mexico both in1994 and in 2000.22 U.S. net imports from Mexico of non-electronics products also increased
20

Using simulations, Reshef (2007) shows that tari¤ reductions can substantially increase the skill premium
under the existence of skill intensity reversals.
21
In Kurokawa (2011b), the electronics industry is de…ned by the 2-digit SITC (revision 3) category 77,
and the non-electronics industry is de…ned by all the other 2-digit SITC categories of U.S. manufacturingindustries.
22
Kurokawa (2011b) de…nes the 2-digit SIC 1987 category 36 and the 3-digit International Standard
Industrial Classi…cation (ISIC) (revision 2) category 383 as the U.S. and Mexican electronics industries,
respectively. These approximately correspond to the 2-digit SITC (revision 3) category 77. He de…nes skill

18

from 1994 to 2000. As shown in …gures 8 and 9, non-electronics products were relatively
low-skill intensive in the U.S. but relatively high-skill intensive in Mexico both in 1994 andin 2000. As shown in Figure 1, the skill premium also increased in both countries. Thus thetwo-good H-O model with the reversal of relative skill intensities can be compatible withthe data presented above.
It is worth noting that the skill intensity reversal in the electronics industry displayedin these …gures is compatible with the structure of technologies in Feenstra and Hanson(1996, 1999), whereby the low-skill abundant country specializes in the low-skill intensive
operations within a given industry, and similarly the high-skill abundant country specializes
in the high-skill intensive operations.
Note also that what Sampson (2011) recently calls an "assignment reversal" is analogous
to a skill intensity reversal in the H-O model. Sampson considers an "assignment reversal"
to exist whenever the ranking of sectors by skill level di¤ers either over time or acrosscountries.
As above, this section has focused on our alternative resolutions. However, it is worth
noting that by modifying the H-O model and focusing on structural features within developing economies as in Marjit (2003), Razmi (2009) also successfully demonstrates anincrease in wage inequality along with the informalization of the labor force observed inmany developing countries.

6

New Trends

Thus far we have examined the wage inequality between high-skilled and low-skilled workers.
However, many recent studies now reveal interesting new trends in wage inequality suchas the inequality among high-, middle-, and low-wage workers (job polarization) or theinequality within the top 10 percent of the income distribution (within-group inequality).
This section brie‡y surveys these new trends and attempts to link them to the trade andwage inequality literature.

6.1

Job Polarization

Recent work in labor economics analyzes the diverging development of di¤erent sectors of
the labor market. Autor et al. (2003), Autor et al. (2006, 2008), Goldin and Katz (2007),
Goos and Manning (2007), Falvay et al. (2008), and Goos et al. (2009), for example,
document that employment growth has been non-monotonic across sectors in that it ispositive at the low and high ends of the labor market, but negative in the middle. This
employment shifts into high- and low-wage jobs at the expense of the middle is referred toas job polarization.
intensity by the number of non-production workers (NPD) relative to that of production workers (PD). The
broken lines represent the averages of skill intensity within each country.

19Increased trade might be a factor a¤ecting this job polarization. In fact, Blanchard andWillmann (2011), for example, construct a model that captures the observed job polarizationand then derive policy implications on the potential di¤erential impacts of strengthening
educational institutions versus trade protection. They …nd that targeted education subsidies
are more e¤ective than tari¤s as a means to preserve middle-wage jobs, while uniform
educational subsidies are less e¤ective.

6.2

Within-group Inequality

Dew-Becker and Gordon (2005) document new …ndings on U.S. income inequality over 19662001 from Internal Revenue Service (IRS) micro data.23 The mean real income has grown
faster than the median real income. This is because half of the income gains went to the
top 10 percent of the income distribution. Half of this inequality e¤ect is attributable to thegains of the 90th percentile over the 10th percentile (between-group inequality); the otherhalf is due to increased skewness within the top 10 percent (within-group inequality). These
results cast doubt on past studies that have paid substantial attention to between-groupinequality such as 90th/10th percentile ratio but little attention to within-group inequality
such as inequality within the top 10 percent.
Of course, technological change would be a major source of this income distributionchange. In fact, the hypothesis of skill-biased technological change is central to the labor
economics literature on inequality. As Dew-Becker and Gordon (2005, 2008) argue, however,
the evolution of the income distribution re‡ects multiple causes, not a single cause.
Thus increased trade might be also a cause. Atolia and Kurokawa (2012b), for example,
formulate a simple model that can provide a uni…ed explanation of the Dew-Becker and
Gordon (2005) …ndings on both between- and within-group inequality. Using a numericalexample, they show that under di¤erences in the ‡exibility of skills, an increase in input/task
variety due to technological change can be a source of these income changes. Their model
also implies that trade and entry policy can also be catalysts for these income changes.
Therefore, while technological change (which is similar everywhere) may increase income
inequality similarly in all countries, cross-country di¤erences in the top skewness can arisein the presence of cross-country di¤erences in trade and entry policy. This could weaken
an objection to the skill-biased technological change hypothesis. For example, Piketty andSaez (2006) object that technological changes have been similar everywhere while changes
in top income shares have not.

7

Conclusion and Next Steps

This paper has primarily discussed anomalies (the gaps between the standard H-O modeland the data) and their possible resolutions. It is true that the H-O model is confronted
23

See also Dew-Becker and Gordon (2008) for a survey of several aspects of rising inequality.

20with the anomalies, but the models that we have discussed in this paper are successful
in resolving the anomalies, weakening the criticisms of trade-based explanations of wage
inequality. An increasing number of economists now argue that the e¤ect of trade, thoughrelatively small compared to that of technological change, is more signi…cant than generally
believed.24 Even Krugman (2008) argues that, due to the increase in U.S. trade with low
income countries and the growing fragmentation of production, it is no longer safe to assume
that the e¤ect of trade on wage inequality is miniscule.
However, it should be noted that the result that trade can theoretically increase wage
inequality is not necessarily negative. This is because Kurokawa’s (2011a) model, for example, shows that the real wage of both high-skilled and low-skilled workers can rise. However,inequality increases because the former rises disproportionately more than the latter. In
fact, the real wage of non-production workers has increased, and, furthermore, the real wageof production workers has slightly increased in the U.S. since the 1980s.
Finally, we suggest some additional steps for future research. A next step is to carefully
monitor whether the wage e¤ect of trade will become increasingly signi…cant. To do so,
it would be more convincing to analyze the relative in‡uences of trade and technologicalchange on wage inequality within a uni…ed framework as in Feenstra and Hanson (1999),
Esquivel and Rodríguez-López (2003), and Parro (2012).25
Another next step is to study trade and wage inequality on the new trends that we havebrie‡y surveyed above. It would be interesting to theoretically and empirically investigate
the possible e¤ects of trade on the …ner details of income distribution such as job polarization
and within-group inequality.26
24
For example, see Feenstra and Hanson (1996, 1999), Acemoglu (2003), Burstein and Vogel (2010), andAtolia and Kurokawa (2012a).
25
Feenstra and Hanson (1999) …nd, using regression analysis, that computers explain approximately 35
percent of the increase in wage inequality in the U.S. during the period 1979-1990 while outsourcing explainsapproximately 15 percent. Esquivel and Rodríguez-López (2003) …nd, using regression analysis, that tradeliberalization would have led to a reduction in the wage gap in Mexico during the period 1988-1994 but thise¤ect was o¤set by the large impact of technological progress. They also …nd that during the period 19942000, the e¤ect of trade liberalization on Mexican wage inequality was nil and thus the slight increase in wage
inequality during this period was driven by technological progress. Using a general equilibrium trade modelwith capital-skill complementarity, Parro (2012) shows that the impacts of trade costs and technologicalchange on the skill premium during 1990-2007 are comparable, especially in developing countries.
26
On a di¤erent note, Caponi (2011) examines the inequality between generations of Mexican immigrants
in the U.S., while Takahashi et al. (forthcoming) demonstrate the equivalence of spatial inequalities inincome and in industrial location.

21

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30

FIGURE 1. Relative Wage of High-Skilled to Low-Skilled Workers in
U.S. and Mexican Manufacturing Industries, 1980-2000

FIGURE 2. U.S.-Mexican Trade as Percent of U.S. GDP, 1980-2000

31

Q2

C

A

Q

Q1

FIGURE 3. Adjustment of OECD Production and Consumption

32

FIGURE 4. Feenstra and Hanson (1996)

33

FIGURE 5. Least Traded Goods Growth: U.S. Manufacturing Imports
from Mexico, 1980-2000

FIGURE 6. Least Traded Goods Growth: Mexican Manufacturing
Imports from U.S., 1980-2000
34

FIGURE 7. Least Traded Goods Growth in Mexican Manufactured
Imports from U.S. and Mexican Skill Premium, 1987-2000

35

FIGURE 8. Skill Intensity in U.S. and Mexican Manufactures, 1994

FIGURE 9. Skill Intensity in U.S. and Mexican Manufactures, 2000

36