Input trade liberalisation and wage-inequality with non-traded goods

This paper develops a multi-sector full-employment general equilibrium model with internationally non-traded goods and international fragmentation in skill-intensive production, to understand the mechanism how trade-induced growth in the skill-intensive sector is mediated to informal sector wages and employment through the existence of finished non-tradable and the corresponding domestic demand-supply forces. The underlying developing economy is characterised by dual unskilled labour market with unionised formal and non-unionised informal sectors, consistent with the empirical literature on developing economies India. Numerical analysis has also been performed to simulate how the changes in elasticities of factor substitution in production in different sectors account for the movement in informal wage and therefore the movement in skilled-unskilled wage gap. This paper challenges the view that the relative wage-inequality in a DC like India with rigid organised sector labour market has unequivocally been governed only by the increase in the skilled wages. An extension with involuntary unemployment of skilled labour using the fair wage hypothesis has also been presented that effectively demonstrates the robustness of the results obtained under full-employment model.