Developed and developing economies

Has global integration of factor and product markets since the 1970's had a significant impact on wages in either developed or developing countries? The integration of goods, technology, labour and capital has been an on going process over the past century. This has led to the phenomenon now known as globalisation. 

For several developed economies the most imperative decade for globalisation since World War II was the 1970s, when the proportion of trade to output increased in both developed and developing economies in the wake of the two oil shocks. Technological evolution has improved transport and communications, enhanced information awareness and information processing, and has set the stage for novel products and innovations. These developments make it much easier for national markets to be globally integrated. 

Conversely, Feenstra (1998), states that 'the rising integration of world markets has brought with it a disintegration of the production process, in which manufacturing or services activities done abroad are combined with those performed at home'.1 Consequently, we observe contradictory arguments discussing the impact of global integration of factor and product markets. 

A study carried out by Katz and Murphy (1992), argues that 'wage inequality among both men and women increased substantially in the United States during the 1980's'.2 'In addition, employment shares of manual and production workers have declined in favour of skilled workers, and structural unemployment has risen'.3 

By focusing on developed countries, primarily the United States (U.S), evidence will be extracted to deduce whether the occurrence of global integration has had a significant impact on wages since the 1970's.

It is understood that global integration of factor and product markets has led to increases in quantity of trade between countries in the last forty years. This is due to easier capital mobility, improved infrastructure as well as innovation of new technology. Moreover, it is later confirmed by a traditional trade model known as the Heckscher-Ohlin model.

According to economic theory, free trade affects the prices of factors through the change of relative prices of goods. Trade initiates a reduction of the relative price of products intensive in unskilled labour, as well as increasing the relative prices of products intensive in skilled labour. Consequently, the relative wage of skilled labour increases, while that of unskilled labour decreases. As a result, wage inequality becomes apparent. What's more, economic theory is confirmed by studies carried out by several economists.

Economic theory has been further developed over the past century to best explain the impact of global integration of factor and product markets on wages. The prime economic model employed to explain the existence and pattern of international trade based on a comparative cost advantage between countries producing different goods is the Heckscher-Ohlin (H-O) trade model. This model is built on the primary Ricardian model.

Heckscher and Ohlin affirm that this advantage exists because of the relative resource endowments of the countries trading. Moreover, the model predicts that the impact of being skilled or unskilled on attitudes towards trade and immigration should depend on a country's skill endowments, with the skilled being less anti-trade and anti-immigration in more skill-abundant countries (here taken to be developed countries) than in more unskilled-labour-abundant countries (here taken to be developing countries).The customary Heckscher-Ohlin model begins by escalating the number of factors of production from one to two. The model assumes that labour and capital are used in the production of two final goods.

The Heckscher-Ohlin model assumes that the solitary distinction between countries is these differences in the relative endowments of factors of production. It is in due course made known that trade will arise, trade will be nationally beneficial, and trade will have numerous effects upon prices, wages and rents, when the nations vary in their relative factor endowments and when different industries exploit factors in different proportions. 

Both the Heckscher-Ohlin model and the Ricardian model have distinct features. The Ricardian model assumes that production technologies diverge among countries; the Heckscher-Ohlin model assumes that production technologies are equivalent. There are four main theorems as a result of the Heckscher-Ohlin model; the Heckscher-Ohlin theorem, the Stolper-Samuelson Theorem, the Rybczynski theorem, and the factor-price equalization theorem. The Stolper-Samuelson and Rybczynski theorems illustrate relationships amid variables in the model while the Heckscher-Ohlin and factor-price equalization theorems present some of the key results of the model.

Wood (1995) employs Heckscher-Ohlin theory to explain the relationship between trade and wages. Trade and wages are coupled solely via changes in product prices. For example, 'an externally induced fall in the domestic producer price of apparel, relative to the price of machinery, reduces the wage of unskilled, relative to skilled workers'.4 Moreover, this is known as the Stolper-Samuelson theorem. Evidence portrays trade effects on wages in the developed world according to these theorems. 

Throughout the past few decades several economists have carried out regressions, along with data analysis to illustrate the impact to which, global integration of factor and product markets have had on wages in the U.S Factor content of trade was employed by Sachs and Shatz (1994) and Wood (1994) to measure the effects of trade on labour. Sachs and Shatz (1994) implement factor content of trade to estimate the impact of trade on employment of skilled and unskilled workers in the U.S. manufacturing sector. Figure 1 – Factor Content Estimates of Impact of Trade with Developing Countries on Demand for Labor in Manufacturing in 1990 [Wood (1995)]

Empirical evidence carried out by Sachs and Shatz (1994) and Wood (1994, ch.4) illustrate that trade with developing countries reduced the demand for manufacturing workers in general, revealed by the negative figures of all workers. Sachs and Shatz conclude that 'trade reduced the demand for skilled workers nearly as much for unskilled worker'.5 This is shown by the -1.9 percent, unskilled minus skilled. Hence, it is proven in Wood (1994) that trade increased the demand for skilled workers, with reducing the demand for unskilled workers. Thus, according to the theory of the labour supply curve, wages for the unskilled workers will fall, giving further rise to those whom are more skilled. Reasons arisen have been due to greater production of skill-intensive exports.

While such results have been illustrated, the validity of them has been debatable. Such estimates fail to take into account technical progress. In addition, the factor content estimates are restricted to manufacturing considering the growth of the service sector over the past decade. In addition Wood goes on to say that 'defensive innovation may seem inconsistent with economic theory: if labour-saving, cost-reducing technologies existed, why weren't profit-maximising firms already using them?'6 Consequently, it is believed that factor content calculations are misguided.

A further imperative measurement is the use of product price movements. Wood (1995) goes on to pronounce 'it is true that Heckscher-Ohlin forces have reduced the relative wages of unskilled workers, then there must have been accompanying reductions in the relative prices of labour-intensive goods'.7 Nevertheless, Lawrence and Slaughter (1993) deduce that the statement is inaccurate via empirical studies. They learn that the changes in prices are far too small to confirm the effects on relative wages in the U.S. 

Wood (1994) discusses skill differentials in his literature on north-south trade employment and inequality. The north representing developed countries, and the south, developing countries. At this point, he divided the labour force into easier observed categories and used NO-ED for workers with no education, BAS-ED for workers with a basic level of education and SKILD for educated workers.

SKILD and BAS-ED are taken as the two main categories representing the north as Wood makes evident that the north have fewer NO-ED than the south. Wood suggests that with manufacturing changes throughout the 1970s, trade with the south had decreased the demand for BAS-ED labour relative to SKILD labour. Evidence confirms that trade in manufacturing with the south had abridged the relative demand for unskilled labour. Consequently, this shift in demand raised the wages of SKILD compared to that of BAS-ED workers.