To Integrate with a High- Or Low-Wage Country: That is the Question

This paper considers the question of whether a country with the intermediate capital–laborratio is better off forming a free trade area with the higher or lower wage country. Typicalanalyses of gains from trade ignore the effects of free trade on factor prices. When Europe formsa free trade area with a high-wage economy, the equalized wage rises and rent declines, whilethe price of the importable declines. Workers unambiguously benefit, but integration has anambiguous effect on capitalists. However, consumers as a whole benefit from the integrationand workers can more than offset the losses of the capitalists. On the other hand, Europe'sintegration with a low-wage economy raises rent but lowers the wage and the price of thelabor-intensive good. Accordingly, capitalists unambiguously benefit, but integration has anambiguous effect on workers. Again, welfare of all consumers rises and the capitalists can morethan offset the losses of workers.