Heterogeneous trade costs and wage inequality: A model of two globalizations

We develop a model for analyzing the distributional effects of two globalizations and their interdependence. We distinguish between two trade cost reductions, (i) trade liberalizations in the 1980s, which increased trade in low-skill-intensive goods (denoted L-globalization) and (ii) reductions in communication costs due to the IT revolution, which raised trade in middle-skill-intensive goods during the 1990s (denoted C-globalization). We consider a North-south trade economy in which the North is skill abundant. A freely traded final good is produced using high-skill services and a bundle of inputs. Inputs differ on the intensity of middle- and low-skill workers required to be produced, and are subject to heterogeneous trade costs. In the North, we find that wage inequality increases in the L-globalization. During the C-globalization, wage polarization emerges. The relative wage of high- to middle-skill workers increases, while the relative wage of middle- to low-skill workers is hump-shaped. We find a complementarity between the two globalizations. Wage polarization is delayed by the extent of trade in the L-globalization. In the South, we find that wage inequality increases in both globalizations. Finally, we show how asymmetric participation in the C-globalization of two southern countries generates a discontinuous pattern of specialization. The southern country participating in the C-globalization specializes in the least and most skill-intensive traded inputs.