Regional Integration and Wage Inequality

There is little disagreement among most economists that countries benefit from trade liberalization. Yet, whether unilateral, multilateral (through the World Trade Organization) or through regional integration agreements (RIAs), trade liberalization has been one of the most controversial economic issues of our time. It is the focus of everyone from politicians to union leaders and anti-globalization forces because, while there are overall welfare gains from liberalization, these gains are not evenly distributed. What's more, in addition to some groups actually hurt by trade liberalization, there are others who have the perception at the very least that it has led to increased inequality, that is—that the burden of trade liberalization falls mainly on the poor. Latin America has come a long way in terms of liberalization, reducing barriers to trade and eliminating restrictions to capital flows. While much of the liberalization occurred at the unilateral level, during the 1990s most countries deepened trade links at the subregional level as well (see Chapter 2), entering into a variety of South-South and North-South RIAs within the Americas. Several countries are currently negotiating trade arrangements with the European Union, and the hemisphere as a whole is moving toward the Free Trade Area of the Americas (FTAA). South-South and North-North integration may have very different effects on wage inequality. In the context of the wave of trade liberalization sweeping Latin America—and all the perceptions and controversies surrounding it—this chapter will examine its impact on wage inequality in the region, with a focus on how wage inequality is affected by different forms of regional integration. The effects on poverty are examined as well (see Box 12.1), although the link between trade and poverty is less direct than that between trade and wage inequality, since in the former , factors such as labor force participation decisions among household members and the price of the consumption basket intervene. The chapter first explores trends in relative wages across skill groups, then moves on to examine the theory behind how trade and labor markets are related. We begin with the neoclassical Heckscher-Ohlin model in which countries differ in the relative endowment of factors. In its strictest form, this model offers relatively straightforward predictions of how trade and wages—especially wage inequality—should be related. This model is perhaps most relevant for countries with large differences in relative endowments (North-South trade). Relaxing some assumptions allows for considering the effects of North-North and South-South trade, …