Skill-Biased Technical Change, Trade Liberalization, and Wage Inequality between Skilled and Unskilled Labor: Cross-Country Evidence
Attempts to explain the determinants and the dynamics of wage differentials between skilled and unskilled labor have formed one of the most controversial topics in economics. The reason for such an intense interest in inequality in earnings between workers with different skill levels is the dramatic increase in wage inequality in the United States in the 1980s. However, the extent of wage differentials has substantially varied across countries over the recent decades. These different patterns across countries allow the factors contributing to wage inequality to be identified as a high priority research area. Skill-biased technical change is considered to be one of the factors contributing to wage inequality. This way of technical change favors highly skilled labor over less-skilled labor by increasing its relative demand and its earnings. This increase in the relative demand, as a rule, is caused by the appropriate increase in the relative productivity of more skilled workers. The other leading hypothesis that has emerged to explain the rapid changes in the wage inequality in the U.S. and some other countries over the recent decades is increased international trade between developed and developing countries. According to the standard Heckscher-Ohlin theory of international trade, countries endeavor to export goods that intensively use those resources they have in relative abundance. Thus, skill-abundant countries tend to be net exporters of those goods that intensively use skilled labor, while skill-scarce countries tend to be net exporters of those goods that intensively use unskilled labor. Furthermore, by virtue of the Stolper-Samuelson theorem, it increases the skill premium in developed countries and reduces it in developing countries. Therefore, the impact of increasing international trade with developing counties on the skill premium and welfare of unskilled labor in developed countries has been at the centre of a heated debate. This paper analyzes trends in wage inequality and returns to education in a number of OECD and non-OECD countries over the recent decades. A theoretical model is developed to explain empirical observations. The paper examines the impact of skill-biased technological change and trade liberalization on wage inequality across different countries.