The impact of trade on wage inequality in developing countries: Technology vs. comparative advantage

Since the expansion of world trade in the 1980s, measures of inequality have risen not only in developed countries, but also throughout the developing world. This stylized fact is contrary to the predictions of classical trade theory that in countries with high endowments of unskilled labor, their wages should rise relative to those of skilled labor. This paper empirically tests the effects of trade on wage inequality in a differentiated panel framework where countries are classified according to their relative human capital endowments, constituting also the relevant comparative advantage in trade. Employing a newly constructed measure of technological change, an important source of omitted variable bias, not yet addressed in the literature, is removed. With the inclusion of this measure, several effects otherwise attributed to trade disappear, underscoring the importance of controlling for technological change. Technology transfer as well as technological change is found to take place particularly in industries and trade flows classified as medium-technology intensive. Evidence is also found for pure 'trade'- effects, supporting the Heckscher-Ohlin predictions of the effects of trade on wage inequality once the heterogeneity of the trading partners and the traded goods is taken into account.