US Trade and Wages: The Misleading Implications of Conventional Trade Theory

Conventional trade theory, which combines the Heckscher-Ohlin theory and the Stolper-Samuelson theorem, implies that expanded trade between developed and developing countries will increase wage equality in the former. Th is theory is widely applied. It serves as the basis for estimating the impact of trade on wages using two-sector simulation models and the net factor content of trade. It leads naturally to the presumption that the rapid growth and declining relative prices of US manufactured imports from developing countries since the 1990s have been a powerful source of increased US wage inequality. In this study we present evidence that suggests the presumption is not warranted. We highlight the sensitivity of conventional theory to the assumption of incomplete specialization and fi nd evidence that is not consistent with it. Since 1987, although US domestic relative eff ective prices in industries with relatively high shares of manufactured goods imports from developing countries have declined, eff ective unskilled worker–weighted prices have actually risen relative to skilled worker–weighted prices. If anything, this suggests pressures for increased wage equality. Also in apparent contradiction to theory, the (six-digit North American Industry Classifi cation System [NAICS]) US manufacturing industries with high shares of manufactured imports from developing countries are actually more skill intensive than the industries with high shares of imports from developed countries. Finally, applying a two-stage regression procedure, we fi nd that developing-country import price changes have not mandated increased US wage inequality. While these results confl ict with standard theory, they are easily explained if the United States and developing countries have specialized in products and tasks that are highly imperfect substitutes. If this is the case, the impact of increased trade with developing countries on US wage inequality is far more muted than standard theory suggests. Also methodologies such as the net factor content of trade using US production coeffi cients and simulation models assuming perfect substitution between imports and domestic products could be highly misleading. JEL Codes: F11, F16, J30