An empirical investigation of the relations among wage differentials, productivity growth, and trade

Basudeb Biswas (*) This article investigates the relations among productivity growth, wage differentials, and net exports in the United States. The time periods considered are the long run and the short run. Cointegration test results indicate that all the test variables are cointegrated. Therefore, productivity growth, wage differentials, and trade are all related in the long run. A short-run investigation of the relations among productivity growth, wage differentials, and trade is conducted within a vector error correction (VEC) estimation structure. The VEC tests indicate that, contrary to the prevailing view, productivity growth and trade have no impact on wage differentials in the short run. At the same time, it is apparent that wage differentials and trade have a positive and statistically significant impact on productivity growth in the United States in the short run. (JEL F16) I. INTRODUCTION The U.S. economy has experienced unprecedented economic growth in recent years. However, an analysis of its labor markets indicates that despite this strong economic growth, the wage gap between skilled and unskilled workers has been widening. An explanation of this apparent paradox has attracted much empirical interest. Essentially, two competing hypotheses have been used to explain this growing gap. One hypothesis is advanced by trade economists who assert that trade impacts wage inequality through the prices of imports and exports. Their argument primarily rests on the notion that when rich (high-wage) countries trade with poor (low-wage) countries, import competition forces down the relative prices of the low-skill-content goods produced in the rich countries. Stolper and Samuelson's (1941) theorem suggests that a reduction in the price of these labor-intensive products leads to a decrease in the return to the factor (unskilled labor) used in the manufacture of these goods. A simultaneous increase in the price of U.S. exports of skill-intensive products leads to increased returns to the factor (skilled labor). This change in circumstances results in a decline in the relative wages of the less skilled workers in the rich country. Considerable controversy exists over the estimates of trade's impact on wage inequality. (1) For example, Wood (1994) attributed almost two-thirds of the wage differential to trade, whereas Lawrence and Slaughter (1993) argued that none of the wage differential can be explained by trade. Other studies by Krugman (1994, 1995), Murphy and Welch (1991), and Karoly and Klerman (1994) suggested that trade may have had a modest impact on the wage gap in the United States. In a recent study, Borjas and Ramey (1994) analyzed the impact of trade deficits on wage differentials in the United States. The authors found a link between wage differentials and trade. They claimed that trade deficits may lead to increasing wage inequality in the United States Ghosh et al. (2000) found no empirical evidence in support of the Borjas and Ramey (1994) hypothesis. Their test results indicated that wage inequality had a negative impact on U.S. net exports. Empirical evidence concerning which factors cause the wage gap between skilled and unskilled labor in the United States remains inconclusive, with several labor economists offering an alternative explanation attributing the wage gap to technological advance. This analysis emphasizes that within the Heckscher-Ohlin (1933) framework, the lowering of trade barriers leads to an expansion of the skill-intensive sector and a contraction of the labor-intensive sector. A decline in the relative wage of the unskilled workers should then lead to the adoption of less skill-intensive technologies across all sectors. Several empirical studies, however, indicate an increase in the proportion of skilled workers within most sectors despite the rise in their relative wage. This observation led Berman et al. (1994) to reach the conclusion that it is technology rather than trade that is widening the wage differential. …