UNITED NATIONS CONFERENCE ON TRADE AND DEVELOPMENT

POLICY ISSUES IN INTERNATIONAL TRADE AND COMMODITIES

STUDY SERIES No. 20

INTERNATIONAL TRADE AND LABOUR MARKET PERFORMANCE:

MAJOR FINDINGS AND OPEN QUESTIONS

by

Alessandro Turrini

Associate Economic Affairs Officer Trade Analysis Branch

Division on International Trade in Goods and Services, and Commodities United Nations Conference on Trade and Development

Geneva, Switzerland

UNITED NATIONS

New York and Geneva, 2002

ii

NOTE

The views expressed in this study are those of the author and do not necessarily reflect the views of the United Nations.

The designations employed and the presentation of the material do not imply the expression of any opinion whatsoever on the part of the United Nations Secretariat concerning the legal status of any country, territory, city or area, or of its authorities, or concerning the delimitation of its frontiers or boundaries.

Material in this publication may be freely quoted or reprinted, but acknowledgement is requested, together with a reference to the document number. A copy of the publication containing the quotation or reprint should be sent to the UNCTAD secretariat:

Chief Trade Analysis Branch

Division on International Trade in Goods and Services, and Commodities United Nations Conference on Trade and Development

Palais des Nations CH-1211 Geneva

UNCTAD/ITCD/TAB/21

UNITED NATIONS PUBLICATION

Sales No. E.02.II.D.10

ISBN 92-1-112558-8 ISSN 1607-8291

© Copyright United Nations 2002

All rights reserved

iii

ABSTRACT

This paper surveys the findings arising from existing research and suggests some directions for improving our understanding of the links between international trade and the labour market. Three routes for further research seem particularly promising. First, an effort should be made to put in relation labour market variables directly with trade policy measures. Second, there is a need to address the issue of trade and labour market outcomes from a consistent cross-country perspective. Finally, the role of labour market institutions and production internationalization (through outsourcing, international exchange of intermediate inputs or FDI) should be further explored.

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ACKNOWLEDGEMENTS

This paper was originally intended for a meeting of the ILO Working Party on the Social Dimension of Globalization. I would like to thank Sam Laird and Richard Kozul-Wright for helpful comments.

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CONTENTS

I. INTRODUCTION ................................................................................................1 II. THE FACTS .........................................................................................................3 A. Growing world trade: trends and determinants...............................................3

B. Trade integration and labour market dynamics: the broad picture ...................4 C. Trade liberalization and employment dynamics in developing countries ..........4 D. Growing labour market inequalities in developed countries ............................7

III. INTERPRETING THE FACTS...........................................................................9

A. Trade liberalization and the reallocation of labour from import-competing to export industries in developing countries....................................................9 B. Labour market inequality and growing North-South trade..............................9

IV. OPEN QUESTIONS AND PATHS FOR FURTHER RESEARCH ................11

A. Limitations in empirical implementation .......................................................11 1. Disentangling the effects of trade policy shocks ..................................11

2. How short is the short run, how long the long run? .............................12 3. Adopting a cross-country perspective .................................................12

B. Limitations in the model...............................................................................14 1. Trade-induced reductions in union mark-ups.......................................14 2. Trade in intermediate inputs, outsourcing and vertical specialization ...15 V. CONCLUSIONS ................................................................................................17 NOTES ....................................................................................................................18 REFERENCES ..............................................................................................................19

vi

Tables

1. Employment in manufacturing during episodes of liberalization...............................7 2. Wage inequality changes in OECD countries...........................................................8 3. Unemployment rates in the OECD ..........................................................................8 4. Effects of a 100% cut in textile and apparel tariff on real incomes .........................13 5. Effects of a 100% cut in agricultural tariff and export subsidies on real incomes ....14

Figures 1. Trade openness, by major country grouping ...........................................................3 2. Unemployment rates and trade openness .................................................................5 3. Wage shares and trade openness .............................................................................6

1

The wage and employment conditionsof unskilled workers in many developedcountries have deteriorated during the lastcouple of decades. Depending on whichcountries are considered, this tendency mayshow up either as a reduction in employmentperspectives for unskilled workers (continen-tal Europe) or as a reduction in their relative,and even absolute, earnings (United States).During the same period, the labour marketsin developing countries have been showingopposite tendencies, depending on the geo-graphical aggregates considered. Whiledisguised unemployment and wage inequal-ity have been falling in many Asian countries,labour market conditions have been sluggishin Latin America, and inequalities have beenincreasing.

At the beginning of the 1990s, the fo-cus of the analysis of labour marketdevelopments has shifted from a short-run,to a long-run, structural perspective. The per-sistence of growing unemployment or fallingwages in a number of developed countriesgave rise to the view that the deteriorationof the economic position of unskilled work-ers is to be attributed to a long-run tendencythat is driving the fundamentals of theeconomy.1 Two major structural changeshave characterized the last 20 years: the in-troduction of information technologies andthe growth in world trade and capital move-ments. Growing trade is, to a non-negligibleextent, attributable to liberal trade reformsadopted in many developing countries. Thecurrent worldwide developments parallelthose at the beginning of the 20th century,when rapid technical change and increasedinternational mobility for goods and produc-tion factors were coupled with increasing

inequality in the developed world. Duringthat period, however, labour migration seemsto have played a major role, whereas in thecurrent situation, the international movementof workers is not of a comparable magnitude(Baldwin and Martin, 1999). Research sug-gests that the explanation for thedeteriorating situation of unskilled workersis to be found in a tendency towards declin-ing demand for the services of unskilledlabour (Katz and Murphy, 1992; OECD,1997; World Bank, 1995; Slaughter andSwagel, 1997).

Technological change and the proc-ess of �globalization� � namely, institutionaland technical developments that are reduc-ing the mobility barriers for goods andproduction factors � may both be responsi-ble for causing a secular downturn in thedemand for unskilled labour. As for techno-logical change, it may cause a reduction inthe demand for unskilled labour if newly in-troduced technologies are sufficiently�skill-biased�. Trade-related developmentsare generally thought to affect the demandfor different types of labour through theintersectoral composition of the demand forgoods.

Globalization and technologicalchange differ in a fundamental sense. Whiletechnological progress is driven by innova-tions whose development and adoption canbe influenced by the policy environment onlyto some extent, the openness of markets ab-solutely depends on laws and regulationsimposed by sovereign Governments. Under-standing the origins of the developmentsobserved in the labour market has primaryimplications for economic policy. Not sur-

I. INTRODUCTION

2

prisingly, there has been a lively debate inrecent years, focused on the identification ofthe forces shaping the demand for labour inthe North. Empirical work has proliferated,and alternative techniques have been con-fronted with the aim of assessing the relativeimportance of technology and trade as alter-native explanations for the observedreduction in the demand for unskilled labour.

The aim of this paper is to summa-rize the results of recent research into theeffects of trade on labour demand, and toidentify some open questions and directionsfor further research. Three paths are identi-fied as particularly promising. First, an effortshould be made to relate labour market vari-ables directly to trade policy measures.Second, the links between trade and the la-

bour market should be addressed from a con-sistent cross-country perspective. Third, therole of labour market institutions and pro-duction internationalization (outsourcing,international exchange of intermediate in-puts, foreign direct investment) should befurther explored.

The next section summarizes somebasic facts about world trends in trade inte-gration, employment and wage inequality.Section III illustrates the explanations com-monly offered by labour and trade economiststo account for the effects of trade on employ-ment and wage dynamics, and assess thefindings of empirical research on that issue.Section IV identifies some open questionsand paths for further research. Section V con-cludes.

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A. Growing world trade: trends anddeterminants

Trade integration increased steadily inthe post-war period worldwide, with an up-swing in global openness during the 1970s,followed by a slight contraction in the mid-dle of the 1980s and an acceleration in the1990s (Krugman, 1995; Baldwin and Mar-tin, 1999). Not all countries have beensharing equally in the opportunities offeredby growing world trade. Figure 1 shows in-dex numbers for the ratio of total trade valueto GDP (as an indicator of trade openness)for different country aggregates and the worldas a whole for the period 1960-1998. Untilthe end of the 1970s, trade openness had been

increasing quite steadily for all country ag-gregates. Since then, the openness indicatorof Asian countries has accelerated sharply,while that of sub-Saharan Africa and LatinAmerica has experienced a deceleration.

A large part of the increase in tradeintegration and interdependence is due to along-term downward trend in transport andcommunication costs. Part of the greater in-terdependence is associated with reductionsin trade barriers as a result of autonomous,regional and multilateral trade liberalization.In the post-war period, manufacturing tariffsin industrialized countries have been cut toan average of 3-4 per cent as a result of thevarious GATT/WTO rounds. The conclusion

II. THE FACTS

0

0.5

1

1.5

2

2.5

3

3.5

1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998

East Asia & Pacific Latin America & CaribbeanSub-Saharan Africa High-incomeWorld

Figure 1. Trade openness, by major country grouping(total trade as a percentage of GDP, base 1970 = 1)

Source: UNCTAD computations based on World Bank, World Development Indicators, 2001.

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of the Uruguay Round contributed to a fur-ther multilateral reduction in manufacturingtariffs since the mid-1990s, to the elimina-tion of incumbent non-tariff measures, to thetariffication of agricultural protection and toits incipient reduction. Regional trade agree-ments have contributed to expanding tradewithin trade blocs, both as a result of the for-mation of new agreements (NAFTA,MERCOSUR, ASEAN, COMESA) and as aresult of the deepening and increased cover-age of existing agreements (EEC).2 Finally,a number of developing countries in LatinAmerica, North Africa, South Asia andSouth-East Asia have been reducing theirtrade barriers unilaterally, often in conjunc-tion with the adoption of structuraladjustment and stabilization policies. Over-all, the acceleration in trade integrationduring the 1990s was the result of trade lib-eralization, which was most marked incertain Asian developing and middle-incomecountries.

B. Trade integration and labour marketdynamics: the broad picture

During the last 20 years, a general-ized reduction in the aggregate demand forlabour paralleled the developments in inter-national trade.3 The unemployment rate hasbeen growing on average across countries.The increase in unemployment has been moresubstantial in developed countries. While inthe average OECD country the unemploy-ment rate grew by more than 2 per centbetween 1980 and 1997, in the average non-OECD country unemployment grew by lessthan half a percentage point.4 The share ofwage income in total income has also beenfalling on average. The fall, again, is moresubstantial in developed economies. Theseaggregate figures, however, mask importantdifferences across countries. Within devel-oped countries (aggregate) labour demandhas been falling more substantially in conti-nental Europe; within developing countries,Latin America and sub-Saharan Africa ex-perienced the major employment losses.

Figure 2 illustrates the cross-countryrelationship between changes in trade open-ness (as measured by the ratio of trade toGDP) and unemployment rates over the pe-riod 1980-1997. When the sample includesall countries, the relationship appears veryweak (the correlation coefficient between thetwo variables is close to zero). If the sampleis restricted, respectively, to OECD and non-OECD countries a clearer pattern emerges.In OECD countries there is a slight positivecorrelation between changes in trade open-ness and unemployment (with a correlationcoefficient of 0.16), whereas the correlationis negative for non-OECD countries (with acoefficient of -0.5). A similar pattern is ob-served with regard to the wage share in totalincome (figure 3). For the whole sample ofcountries, the correlation between changesin trade openness and wage share is veryweak, while for OECD countries it is nega-tive (-0.3) and for non-OECD countries it isslightly positive (0.11). Of course, this evi-dence is not indicative of any causalrelationship between trade liberalization andlabour demand. The co-evolution of unem-ployment rates and wage shares of incomecan be attributed to many different factors.Before drawing any conclusion concerningthe links between trade openness and thedemand for labour, one has to control for themain residual factors that may explain em-ployment and wage dynamics. However,there is a prima facie indication that the ef-fects of growing trade integration on labourdemand may have been quite different in de-veloped and developing countries � that isto say, while increased trade is coupled withfalling labour demand in developed coun-tries, this does not seem to be the case indeveloping countries.

C. Trade liberalization and employmentdynamics in developing countries

During the last couple of decades, ma-jor trade liberalization reforms have beencarried out in developing countries, espe-cially in Latin America, North Africa and

5

Figure 2. Unemployment rates and trade openness (changes 1980-1997)

Source: UNCTAD computations based on World Bank, World Development Indicators, 2001.

Unemployment rates and trade shares

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Trade shares over GDP (diff. 1997-1980)

Une

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Unemployment rates and trade shares: Non-OECD countries

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Trade shares over GDP (diff. 1997-1980)

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Unemployment rates and trade shares: OECD countries

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Trade shares over GDP (diff 1997-1980)

Une

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Figure 3. Wage shares and trade openness (changes 1980-1997)

Source: UNCTAD computations based on World Bank, World Development Indicators, 2001.

Wage and trade shares

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Trade shares over GDP (diff. 1997-1980)

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Wage and trade shares: OECD countries

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Trade shares over GDP (diff. 1997-1980)

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Wage and trade shares: Non-OECD countries

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South and South-East Asia. Available evi-dence shows that, during and after most ofthe trade liberalization episodes, there wasnot a major contraction in manufacturingemployment.5 Papageorgiou, Choksi andMichaely (1990), in a cross-country analysisof a series of case studies, conclude that tradeliberalization in developing countries in gen-eral does not result in employment losseseven in the short run. The results of theiranalysis are summarized in table 1. Manu-facturing employment was higher afterliberalization in 12 out of the 13 cases re-ported, the exception being Chile. Parker,Riopelle and Steel (1995) focus on employ-ment changes in small firms following tradeliberalization in a number of African coun-tries. In general, there is evidence of asustained growth in employment after liber-alization in all African countries examined.Harrison and Revenga (1995) studied theexperience of 16 low- and medium-incomeeconomies in which there was significanttrade liberalization in the last 20 years. Theyreported the results concerning employmentdynamics for six of them. While employ-

ment was growing in Latin American coun-tries (Costa Rica, Peru and Uruguay)throughout the whole period of liberalizationand after, in transition economies (Czecho-slovakia, Poland and Romania) there weresubstantial employment losses.

With regard to the evolution of in-come inequalities in liberalizing developingcountries, the picture varies widely acrossregions. While wage inequality has been con-stant or narrowing in most Asian countriesover the past two decades (Fields, 1994;World Bank, 1995), in a number of LatinAmerican countries that underwent signifi-cant episodes of trade liberalizationinequality has been increasing markedly(Revenga, 1995; Wood, 1997; Robbins,1996; UNCTAD, 1997).

D. Growing labour market inequalities indeveloped countries

In developed countries, trade liberali-zation reforms in the last two decades havebeen less radical, except perhaps in Australia

Year before Average for Year afterEpisode liberalization liberalization period liberalization

Argentina 1 (1967-1970) 1 836 1 847 1 914Argentina 2 (1976-1980) 1 863 2 099 2 132Brazil (1965-1973) 1 780 2 182 3 397Chile 2 (1974-1981) 515 487 351Peru (1979-1980) 675 717 736Philippines 1 (1960-1965) 1 456 1 647 1 825Philippines 2 (1970-1974) 2 056 2 313 2 596Rep. of Korea 2 (1978-1979) 2 000 2 196 2 099Singapore (1968-1973) 61 139 210Sri Lanka 1(1968-1970) 74 108 97Sri Lanka 2 (1977-1979) 112 134 155Turkey 1 (1970-1973) 485 551 651Turkey 2 (1980-1984) 799 829 n.a.

Source: Table 10 in Papageorgiou, Choksi and Michaely (1990). Note: Periods of liberalization are in parentheses.

Table 1. Employment in manufacturing during episodes of liberalization(Thousands of workers)

8

and New Zealand. Increased trade opennessin developed countries was mainly the resultof a long-run decline in transport and com-munication costs. For many industrializedcountries, what characterizes recent decadesis an acceleration of trade with high-growthdeveloping countries (especially Asian coun-tries). Trade with developing countries,however, remains quite small in absolutevalues in all industrialized countries (wellbelow 5 per cent in the United States and theEuropean Union).

The labour market developments in anumber of developed countries have beencharacterized by increasing inequality, espe-cially with regard to skills (table 2). Theaverage wage for unskilled workers in theUnited States was declining from the early1980s in comparison with the average wagefor skilled workers, thus reversing a trendtowards decreasing income inequality acrosseducational levels observed in previous dec-

ades (Bound and Johnson, 1992; Katz andMurphy, 1992; Berman, Bound and Griliches,1994). Since the relative supply of skilledlabour has been increasing throughout thepost-war period, increasing income differ-ences between skilled and unskilled workershave been attributed to changes in relativedemand. Similar yet less clear-cut develop-ments occurred in the same period in otherdeveloped countries (Davis, 1992; Freemanand Katz, 1996; OECD, 1997). In Europe,with the notable exception of the UnitedKingdom the decline in relative demand forskilled workers did not result in increasingincome differences, but rather in slower em-ployment growth for the less educated (table3). There is agreement that this different la-bour market performance for continentalEurope is due to institutional factors, suchas union policies, centralized wage settingand binding minimum wage laws (Freemanand Katz, 1996).

1979-1989 1989-1994/5D9/D5 D5/D1 D9/D5 D5/D1

Australia 0.02 0.02 0.06 -0.04Canada 0.03 0.08 -0.01 -0.13France 0.02 -0.01 0.01 0.00Germany 0.01 -0.12 -0.03 -0.08Italy -0.03 -0.23 0.19 0.32Japan 0.05 0.00 -0.02 -0.07Netherlands 0.03 0.00 0.02 0.01United Kingdom 0.09 0.05 0.03 0.02United States 0.12 0.11 0.06 0.07

Source: OECD Employment Outlook, July 1996, table 3.1.Note: D9/D5 is the value of the ninth decile over the first; D5/D1 is the value of the fifth decileover the first decile.

Table 2. Wage inequality changes in OECD countries

1973 1979 1985 1989 1993

OECD 3.3 5.1 7.8 6.4 8.0OECD Europe 3.0 5.6 9.9 8.5 10.4Of which EU 2.7 5.4 10.5 8.7 11.0

Source: OECD Labour Force Statistics, 1973-1993, 1995.Note: Table entries are unemployment rates expressed as percentages.

Table 3. Unemployment rates in the OECD

9

wages in most developing countries. Currieand Harrison (1997) find that in Morocco theimpact of tariff and quota removal has beenquite limited, both on employment and onwages. Milner and Wright (1998) obtainsimilar results for Mauritius. Revenga (1995)shows that during trade liberalization inMexico manufacturing employment did notfall much, whereas wages declined substan-tially. Rama (1994) is one of the few studiesin which reported employment effects (esti-mated for Uruguay) are quite considerable.These results contrast with those obtained inanalogous studies for the United States andCanada: after trade liberalization in NorthAmerica job flows were found to be quitesubstantial (Revenga, 1992; Gaston andTrefler, 1997).

What is more puzzling is that the ex-pectation that employment should increasein export-oriented sectors and decline in im-port-competing industries is disproved in anumber of studies. Milner and Wright (1998)analyse the case of Mauritius and find that,after some time lags, trade liberalization re-sulted in expanded labour demand in exportindustries. More surprisingly, labour demandappears to increase even in import-compet-ing industries. Similar positive employmenteffects in import-competing industries arereported in Ghose (2000) for a number ofAsian countries and in Dessing (2000) for 18developing countries in Latin America, Af-rica and Asia.

B. Labour market inequality andgrowing North-South trade

The increase in labour market in-equalities in developed countries has been

III. INTERPRETING THE FACTS

A. Trade liberalization and the reallocationof labour from import-competing to ex-port industries in developing countries

The employment effects associatedwith trade liberalization in developing coun-tries have often been interpreted in the lightof a �specific factors� trade model. Thismodel assumes that some production factors(e.g. capital equipment) are immobile acrosssectors, and is suited for a short-run appraisalof the effects of trade policy shocks on la-bour demand. After trade liberalization,labour shifts from the shrinking import-com-peting sectors to the expandingexport-oriented ones. At the end of the real-location process, overall labour demand mayeither rise or fall, depending on the relativelabour intensity of import-competing andexport-oriented industries. The common apriori assumption is that in developing coun-tries the labour intensity of export industriesis higher than that of import-competing sec-tors (since the comparative advantage ofthese countries lies in their labour endow-ments), so that, overall, trade liberalizationshould bring about an increase in overall la-bour demand.6 Some empirical work aimedat assessing this hypothesis has been carriedout in the past decade. In this work, the rela-tionship between sectoral measures of wagesand employment on the one hand, andsectoral trade variables such as trade flows,trade prices or, more rarely, trade policy vari-ables on the other hand, is tested.

Overall, the econometric work doneso far roughly confirms the finding obtainedfrom the simple count of job flows duringliberalization: trade liberalization did notresult in major changes in employment or

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associated with increased trade through along-run trend towards the substitution of un-skilled labour for skilled labour. This viewis rooted in the neoclassical model of com-parative advantage. The Stolper-Samuelsontheorem indicates that falling demand forunskilled labour in developed countries iscaused by the fact that those goods that re-quire intensive use of unskilled labourservices are increasingly produced and ex-ported by unskilled labour-abundantdeveloping countries.

Empirical analysis aimed at testingwhether growing trade is responsible for thelabour market developments in the North hasbeen abundant in recent years. The method-ologies employed by trade and laboureconomists differ.7 Labour economists lookat the impact of trade volumes on the earn-ings of workers with different skills(examples are given in Wood, 1994, andBorjas, Freeman and Katz, 1992). The logicof this analysis is that trade in goods pro-duces effects analogous to those of changesin the relative supply of labour. By comput-ing the �factor content of trade� (i.e. thedirect and indirect amount of factor inputsnecessary for producing a given amount oftraded output) it is possible to assess by howmuch domestic unskilled labour is displacedby the unskilled labour �incorporated� in netimports. Trade economists followed a differ-ent approach. In their view, trade flows

cannot be used directly as explanatory fac-tors of factor rewards, since they areendogenous � that is, determined togetherwith factor earnings. According to that view,relative wages are to be related to price vari-ables. The expectation is that falling pricesof imports will lead to a contraction of im-port-competing industries, and then to fallingdemand for the factors employed intensivelythere. This path has been followed in severalstudies. For example, Lawrence and Slaugh-ter (1993) and Sachs and Shatz (1994) simplyrelate the change in import prices to employ-ment levels in the United States. Leamer(1996), Feenstra and Hanson (1999), andHaskel and Slaughter (2001) analyse whichchange in factor prices would have been nec-essary in order to reproduce, consistentlywith the Stolper-Samuelson theorem, theobserved changes in import prices and pro-ductivity, and compare these �mandated�wage changes with the actual changes in theUnited States economy.

In spite of the differences in the ana-lytical approach, the message emerging fromrecent work aimed at assessing the impact oftrade on labour market inequalities is quiteunanimous: trade integration had only a mar-ginal role in shaping the structuraldevelopments in labour markets over the last20 years.8 The conventional wisdom is thatthese trends have rather to be attributed toskill-biased technological change.

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enous, determined together with the value oflabour market variables. This is a major con-cern which trade economists have about thework undertaken by labour economists. Asfor import prices, they can be considered en-dogenous only on the assumption that thecountry being analysed is a �small� one, andis therefore not in a position to affect worldprices. While this assumption can be justi-fied for some countries, it is not appropriatefor countries such as the United States thatcan hardly be defined as price-takers in mostproducts.

Developments in trade quantities andprices can be the result of changes in tech-nology, factor endowments, tastes or policy.It is important to disentangle the differenteffects of such determinants � for two mainreasons. First, while factor endowments areessentially fixed and technology can hardlybe stopped or reversed by government inter-vention, the changes in labour marketoutcomes that stem from trade policy reformare under the control of national authorities.Second, depending on which sectors are sub-ject to trade liberalization, the effects onlabour demand can differ substantially. Dis-entangling the role of actual trade policyreforms from that played by other determi-nants of trade flows adds importantinformation to evaluate the effects of tradeex post.

Studies that analyse the impact oftrade on the labour market, evaluating whatshare of import price changes is attributableto trade policy, have so far been very few innumber.9 Further research should address thisissue.

The existing research has been usefulin giving a broad assessment of the order ofmagnitude of the impact of trade integrationon labour demand. However, several puzzlesand open questions remain. Why have the es-timated effects of trade liberalizationgenerally been so slight in developing coun-tries? Why does the empirical evidence notclearly confirm the expectation that, after lib-eralization, employment will expand inexport sectors and fall in import industries?How do we explain the fact that labour mar-ket inequalities have been increasing in LatinAmerica and decreasing in many Asian coun-tries?

A better understanding of these andother open issues requires that some of thelimitations that persist in existing researchbe tackled. Some are related to the empiricalimplementation of the models currently em-ployed to study the effects of trade on thelabour market, while others are rooted in themodels themselves.

A. Limitations in empirical implementa-tion

1. Disentangling the effects of tradepolicy shocks

The studies aimed at evaluating theeffects of trade on labour demand in devel-oping countries in a fixed-factor modelframework, as well as those using the neo-classical comparative advantage model toexplain developments in industrialized coun-tries, relate labour market variables(employment, wages) to trade flows or im-port prices. There is a problem with thisapproach. Trade flows are clearly endog-

IV. OPEN QUESTIONS AND PATHSFOR FURTHER RESEARCH

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2. How short is the short run, howlong the long run?

Most of the work focusing on the la-bour market impact of trade in developingcountries adopts a short-run perspective, im-plicit in the fixed-factor model ofinternational trade. Conversely, most of thestudies focusing on industrialized countriesare based on the long-run framework of theneoclassical model of comparative advan-tage. The idea beyond this difference in thechosen perspective is that while most of thetrade-related changes in developing countriesare associated with one-time reforms in tradepolicy, most of the trade developments inadvanced countries reflect long-run tenden-cies in transport and communication costs,technology and factor endowments.

Though useful for conceptual pur-poses, the distinction between the short andthe long run is blurred in practice. How longdoes it take for �mobile� workers to shiftfrom import-competing to export-orientedsectors? How long does it take for all pro-duction factors (capital, skilled and unskilledlabour) to shift to a sector paying relativelyhigher rewards for their services? Most prob-ably, the answers to these questions dependa great deal on the peculiarities of specificcases. However, the common practice ofadopting a short-run perspective when ana-lysing developing countries and a long-runone when studying developed countriesseems more dictated by a priori considera-tions than by a careful examination of thecountry characteristics.

As noted in Slaughter (1998), it isquite surprising that almost all the workbased on estimating the contribution of tradeto changes in developed countries� labourmarkets relate trade variables to labour mar-ket variables measured at the same point intime. This is comparable to assuming thatproduction factors can reallocate immedi-ately after the occurrence of trade shocks. Butwhat if we admit that for labour market ad-

justment to occur may require some time? Inthis case, one may argue that the conclusionthat trade played actually a minor role in ex-plaining United States wage inequality needsfurther exploration. In fact, the data show thatincreasing inequality in the United Statesstarted only at the beginning of the 1980s,but that trade integration produced markedchanges in import prices only in the 1970s,and not in the 1980s.10 There is a suspicionthat, owing to frictions that slow down theintersectoral reallocation of workers, thetrade shocks characterizing the United Stateseconomy during the 1970s may have startedto play a role in the labour market only inthe 1980s.

Overall, there is a need for a system-atic investigation of which perspective (long-or short-run) should inspire the empiricalwork in different countries and of which as-sumptions should be made concerning thelags with which the reallocation of labouracross sectors takes place.

3. Adopting a cross-country perspective

One basic fact that seems to contra-dict explanations based on the neoclassicalmodel of comparative advantage for thegrowing labour market inequalities in indus-trialized countries is that income inequalityhas been increasing also in a number of de-veloping countries. In most Latin Americancountries, in fact, wage inequality betweenskilled and unskilled workers was increas-ing in the same period as that in which risingwage differentials in the United States wereappearing. This would seem to be at oddswith the predictions of the Stolper-Samuelson theorem, according to which weshould expect income inequalities betweenthe skilled and the unskilled to fall as a re-sult of trade in developing countries. Thereason is that the stock of human capital indeveloping countries is smaller than that indeveloped countries, so that the comparativeadvantage of the former should lie in un-skilled labour, which will benefit from

13

increased trade integration. As suggested inWood (1997), this puzzle can be solved byabandoning the textbook version of the neo-classical model of comparative advantage.11

The Stolper-Samuelson theorem permits avery straightforward prediction: in a givencountry, the factor benefiting from trade lib-eralization is the one that is relativelyabundant in comparison with the world av-erage. Two caveats must be entered regardingthis proposition: the first concerns the re-quirements for the validity of this result, andthe second concerns its operational use andits interpretative power. The Stolper-Samuelson theorem requires that all countrieseffectively produce all the feasible goods.Should any country appear to be specializedin the production of a subset of the goodsonly, the relation between good and factorprices fails to follow the predictions of theStolper-Samuelson theorem. When the coun-tries, the sectors and the relevant productionfactors are many, as they are in the real world,it may be quite difficult to understand em-pirically in which production factor a givencountry is relatively abundant and in whichtrade liberalization context this factor is go-ing to benefit from increased tradeintegration. Latin America, for instance, caneasily be considered an unskilled labour-abundant country according to a restrictiverepresentation of the world in which the onlyfactors are skilled and unskilled and sectorsare to be distinguished between those inten-

sive in skilled labour and those intensive inunskilled labour. Allowing for a more com-plex picture with several production factors,Latin America may more properly be definedas a land-intensive region. The effects oftrade liberalization on income inequality insuch a perspective may be less straightfor-ward.

To illustrate this point, tables 4 and 5show computable general equilibrium (CGE)simulations of the effects on factor earningsarising from the full liberalization of textilesand clothing and agricultural trade. Thesimulations are obtained from the GTAPmodel.12 In this experiment, the world is di-vided into 12 geographical regions; there aresix sectors and five production factors (seetables 4 and 5 and related footnotes).13 Whenthe textiles and clothing sector is liberalized(table 4), skilled/unskilled wage differentialsincrease in North America and Western Eu-rope, fall in Asian countries and stayrelatively constant in Latin America. Thisscenario is roughly consistent with the pre-dictions of the Stolper-Samuelson theoremand conveys quite closely the a priori as-sumption underlying many recent empiricalstudies. Textiles and apparel products are,overall, intensive in unskilled labour. Devel-oping countries are relatively abundant inunskilled labour, and developed countries inskilled labour. As a consequence, trade lib-eralization in textiles and clothing results in

Western North Oceania Japan Trans. Sub- North Latin Asian China South Rest ofEurope America countries Saharan Africa America NICs Asia the

Africa and worldMiddle East

Land 0.56 1.50 2.12 0.46 0.44 0.99 1.16 1.13 -0.44 2.68 0.64 0.24Unskilled labour 0.13 0.10 0.24 0.14 0.77 0.37 1.08 0.13 0.99 1.29 0.54 0.66Skilled labour 0.19 0.16 0.25 0.14 0.75 0.45 0.93 0.13 0.72 1.09 0.54 0.56Capital 0.17 0.15 0.29 0.14 0.73 0.45 0.92 0.10 0.78 1.1 0.52 0.58Natural resources 1.26 2.29 1.72 0.54 -0.75 2.28 -2.51 3.24 -4.20 -4.97 -1.77 -2.68

Source: UNCTAD simulations from GTAP 5. Note: Sectoral disaggregation: Natural Resources, Primary Agriculture, Food, Manufacturing, Services.

Table 4. Effects of a 100% cut in textile and apparel tariff on real incomes(Percentage changes)

14

increased exports from developing to devel-oped countries in these sectors; it entailsincreased demand for unskilled labour in the�South� and reduces the demand for un-skilled labour in the �North�. The results arequite different when agriculture is liberalized.In this case, wage differentials shrink in land-abundant countries (North and LatinAmerica, Oceania) and grow in land-scarcecountries (Western Europe, Japan, Asiannewly industrializing countries). The resultcan be interpreted as follows: agriculturalgoods are intensive in land, and unskilledlabour is complementary with land in agri-cultural production; as trade is liberalized inagriculture, land-abundant countries startexporting more agricultural products, and thedemand for both land and unskilled labourincreases. The opposite occurs in land-scarcecountries.

This exercise is instructive in under-standing the importance of adopting amulti-country, multi-factor perspective whenevaluating the effects of trade liberalizationon employment and income inequality.Moreover, it shows that, as pointed out pre-viously, labour demand is affected quitedifferently depending on the sector bias oftrade liberalization reforms.14 The results il-lustrate the need to shift from asingle-country to a consistent cross-countryperspective in ex-post econometric analysis.Coordinated action by academia and inter-

national institutions may provide the momen-tum required to undertake such an effort.

B. Limitations in the model

The unsatisfactory performance ofcommon trade models in empirical analysisaimed at identifying the role of trade in ex-plaining labour market outcomes may not bedue to limitations in the empirical strategy,but, more basically, to a misrepresentationof the main mechanisms through which tradeaffects labour demand. In other words, theproblem may be in the models themselves,rather than in the implementation of the em-pirical tests.

1. Trade-induced reductions in unionmark-ups

When the product market is imper-fectly competitive, rents are generated thatcan be shared by organized labour. It iswidely known that, among the effects en-tailed by the opening of trade, there is areduction in the degree of market power ofimperfectly competitive firms. Since theworkers that are most commonly covered byunion protection are the unskilled, there isthe possibility that the erosion of oligopolyrents associated with trade may also resultin a deterioration of relative wages for theunskilled. This is the line of research pur-sued, for instance, by Abowd and Lemieux

Western North Oceania Japan Trans. Sub- North Latin Asian China South Rest ofEurope America countries Saharan Africa America NICs Asia the

Africa and worldMiddle East

Land -21.98 33.9 62.53 -78.70 -0.69 7.54 -24.37 20.22 -21.11 4.68 0.22 5.72Unskilled labour 0.51 0.06 1.37 1.38 1.35 1.21 2.97 0.27 3.48 1.00 0.64 0.17Skilled labour 0.70 -0.01 0.55 1.68 1.41 0.94 3.81 -0.10 4.02 0.85 0.70 0.001Capital 0.55 0.09 0.79 1.46 1.40 0.99 3.50 0.11 4.06 0.82 0.64 0.02Natural resources -4.81 -1.17 -17.10 -47.87 0.06 -0.68 10.63 -4.88 -9 2.40 1.74 0.61

Source: UNCTAD simulations from GTAP 5. Note: Sectoral disaggregation: Natural Resources, Primary Agriculture, Food, Manufacturing, Services.

Table 5. Effects of a 100% cut in agricultural tariff and export subsidies on real incomes(Percentage changes)

15

(1993) and by Borjas and Ramey (1995).Focusing on particular industries, character-ized by strong unionization, both papers finda significant correlation between imports andwage reductions for unskilled workers. Thisexplanation has also been proposed to ex-plain why trade liberalization in Mexico hada minor impact on employment and a majorone on wages: unions have been reducingtheir wage demands in formerly protectedsectors (Harrison and Hanson, 1999).

The economic theory of trade unionstells us that, in setting (or negotiating) wages,unions tend to behave (to some extent) asmonopolists. Consistently, they will achievea higher wage for their members the lowerthe elasticity of labour demand they face. Asglobalization proceeds (i.e. as technical andlegal barriers to trade and factor movementsare reduced), firms will more and more rap-idly seek across space (regions, States or evencontinents) the labour force with the bestcharacteristics, both in terms of quality andof cost. The consequence of this process is atendency towards a higher elasticity of labourdemand. As soon as wage pressures increase,firms may start looking at better opportuni-ties in markets that are more and more global.Consequently, even very small wage in-creases may entail sharp cuts in labourdemand and employment. This, in turn, re-duces the monopolistic power of unions, andtheir wage premiums. Examining labour de-mand elasticities, as an alternative channelthrough which globalization may operateagainst labour, has been proposed by Rodrik(1997).

Recent empirical research startedlooking at the effects of trade on labour mar-ket outcomes, investigating the impact ofgrowing trade flows on labour demandelasticities. However, the evidence so farshows that the impact has probably beensmall both in developed (Slaughter, 2001;Bruno, Falzoni and Helg, 2001) and devel-oping countries (Fajnzylber and Maloney,2000; Krishna, Mitra and Chinoy, 2001).

Overall, a deeper insight into labourmarket characteristics would help to explainthe different response of wages and employ-ment to trade integration observed acrosscountries.

2. Trade in intermediate inputs,outsourcing and vertical specialization

The relative importance of trade andtechnological change in explaining employ-ment and wages is not easy to disentangle inempirical analysis, or conceptually. Tradepolicy reforms or long-run developments intransport costs reduce the obstacles faced byfirms in �slicing up the value chain� interna-tionally. Owing to lower trade barriers, firmsare better able to locate different stages oftheir production process across countries,searching for the production factors with thebest quality and price characteristics. At thesame time, technological developments (e.g.reduction in communication costs) make iteasier to split the production process inter-nationally (through FDI or outsourcingpractices), thus fostering trade in intermedi-ate inputs along the value chain. Recentevidence shows that the extent of this �ver-tical specialization� across developed andsome middle-income countries is substantial,and has been growing rapidly in the last 20years (Hummels, Ishii and Yi, 2001).

Such developments are relevant forunderstanding the labour market impact oftrade reform. Feenstra and Hanson (1995)explore the role of outsourcing by UnitedStates firms in Mexico in explaining wageinequality. They show that outsourcing helpsto explain rising wage inequality both in theUnited States and in Mexico.15 This resultis explained as follows. With outsourcing,what is traded is not final output, but outputat different stages of production. Some stagesof production are conveniently located inMexico, while others remain in the UnitedStates. As outsourcing takes place, the de-mand for unskilled labour in the UnitedStates falls, because tasks are increasingly

16

carried out by workers in Mexico. At thesame time, however, an increase in wage in-equality may also be observed in Mexico,since the workers that are engaged inoutsourcing practices appear skilled com-pared with other Mexican workers.

This result can help explain the ap-parent puzzle of the simultaneous increasein wage inequality in the United States andseveral Latin American countries. Resortingto trade in intermediate inputs can also helpin finding an explanation for the often ob-served apparently inconsistent dynamics ofemployment in import-competing sectors inliberalizing countries. Instead of falling,employment appears to rise after some time

lags in import-competing industries. The rea-son may lie in productivity gains associatedwith imports of intermediate inputs.16 Thispossible explanation is consistent with recentevidence (Levinsohn, 1999) showing that alarge part of the job reallocation occurringin countries engaged in extensive trade lib-eralization (such as Chile) takes place withinindustries, and not between industries as sup-posed by standard trade models.17

A systematic cross-country analysisof the trade and labour links occurringthrough the exchange of intermediate inputsis likely to shed light on aspects of trade re-forms that are still poorly understood.

17

The relationship between trade inte-gration and labour market outcomes has beenat the centre of a lively debate among ex-perts and policy makers in recent years andis also the source of a number of concernsabout the effects of globalization. Liberaliz-ing developing countries fear that tradeliberalization may result in job losses in im-port-competing sectors. Governments and thelabour movements in industrialized countriesare concerned about a possible link betweenrising import penetration from developingcountries and growing labour-market in-equalities. So far, both these concerns seemcontradicted by the empirical evidence. How-ever, open questions remain and there isscope for substantially improving our under-standing of the links between internationaltrade and the labour market. Three routes forfurther research seem particularly promising.First, an effort should be made to relate la-bour market variables directly to trade policymeasures. Second, there is a need to addressthe issue of trade and labour market outcomesfrom a consistent cross-country perspective.Third, the role of labour market institutionsand production internationalization (throughoutsourcing, international exchange of inter-mediate inputs or FDI) should be further

explored. Significant advances along thesepaths require a substantial improvement indata availability and data quality, especiallyas far as trade policy measures, FDI flowsand trade in intermediates are concerned. Ajoint effort by Governments, academia andinternational organizations may be requiredfor this purpose.

A better understanding of the links be-tween trade integration and the performanceof labour markets is crucial for the imple-mentation of sound policy responses to thegeneralized trend towards falling demand forunskilled labour. However, irrespective of theresults of the research on this topic, it is likelythat interest groups in many countries willcontinue to resist further liberalization insensitive sectors because of concerns aboutemployment, and that interest groups in de-veloped countries will ask that liberal tradepolicies be made conditional on respect forlabour standards, as they did in the recentpast. The implementation of labour marketpolicies targeted at reducing adjustment coststhrough social safety nets and at narrowingthe skill gap may help contain such pressures,which are among the major threats to effortsto further liberalize trade.

V. CONCLUSIONS

18

1 However, as emphasized for instance inUNCTAD (1995), macroeconomic factors affect-ing aggregate investment still played a crucialrole in explaining the income performance ofunskilled workers in many developed countriesin the past two decades.

2 See Crawford and Laird (2001) for an overview.

3 See ILO (1995, 1998-1999) for an overview.

4 UNCTAD computations from World Bank,World Development Indicators 2001.

5 Recent surveys are to be found in Matusz andTarr (1999) and Bacchetta and Jansen (2001).

6 This hypothesis inspired abundant case-studywork at the beginning of the 1990s aimed atmeasuring the different labour intensity of im-port and export industries in a number ofdeveloping economies (Krueger, 1983).

7 For a discussion, see for example, Slaughter(1999).

8 For instance, the results of a poll among emi-nent economists doing research in this area,reported in the 1997 Economic Report of thePresident of the United States, show that the av-erage respondent attributed only 10 per cent ofthe increase in the United States labour marketinequalities to international trade (reported inSlaughter, 1999).

9 An exception is to be found in Haskel andSlaughter (2000), who analyse the effect ofchanges in tariff and transportation costs onUnited States labour market inequalities. Theyconclude that the impact of tariff changes on

United States skilled/unskilled wage differentialshas been very limited.

10 According to Leamer (1996), indeed, if there wasa �Stolper-Samuelson decade�, it was the 1970s,and not the 1980s as widely supposed.

11 See also Slaughter and Swagel (1997) andFrancois and Nelson (1998) on this point.

12 For a description of the GTAP model see Hertel(1997).

13 Benchmark data refer to 1997. The model usedin the simulations assumes costless and instan-taneous sectoral reallocation of productionfactors and full employment. Changes in labourdemand are fully reflected in wage changes.

14 It was noted in Wood (1997) and UNCTAD(1997) that the opposite trends observed in lib-eralizing Latin American and Asian countriesmay be partly explained by taking into accountthe fact that Latin American countries are to beconsidered land-abundant rather than unskilled-labour-abundant, and that in the past decadestrade liberalization has taken place only to a lim-ited extent in agriculture.

15 According to their findings, between 15 and 33per cent of the decline in the share of wage in-come accruing to unskilled workers in the UnitedStates can be attributed to outsourcing practices.

16 See Harrison and Hanson (1999) on this point.

17 See Trefler (2001), who obtains similar resultsanalysing the United States and Canada after theimplementation of the North American FreeTrade Agreement.

NOTES

19

Abowd, J. and T. Lemieux (1993), �The effects of product-market competition on collective-bargaining agreements: the case of foreign competition in Canada�, Quarterly Journal ofEconomics, 108, 983-1014.

Bacchetta, M. and M. Jansen (2001), �Adjusting to trade liberalization�, mimeo, WTO.

Baldwin, R. and P. Martin (1999), �Two waves of globalization: superficial similarities, fun-damental differences�, NBER Working Paper No. W6904, NBER, Cambridge Mass.

Berman, E., J. Bound and Z. Griliches (1994), �Changes in the demand for skilled labor withinUS manufacturing: evidence from the annual survey of manufacturers�, Quarterly Jour-nal of Economics, 109, 367-397.

Borjas, G., R. Freeman and L. Katz (1992), �On the labor-market effects of immigration andtrade�, in G. Borjas and R. Freeman (eds.), Immigration and the Work Force, Universityof Chicago Press, Chicago.

Borjas, G. and V. Ramey (1995), �Foreign competition, market power, and wage inequality�,Quarterly Journal of Economics, 110, 1075-1110.

Bound, J. and G. Johnson (1992), �Changes in the structure of wages in the 1980�s: An evalu-ation of alternative explanations�, American Economic Review, 82, 371-392.

Bruno, G., A. M. Falzoni and R. Helg (2001), �Measuring the effect of globalization on labordemand elasticity: An empirical application to OECD countries�, mimeo, UniversitàBocconi.

Crawford, J.-A. and S. Laird (2001), �Regional trade agreements and the WTO�, North Ameri-can Journal of Economics and Finance, 12, 193-211.

Currie, J. and A. Harrison (1997), �Trade reform and labor market adjustment in Morocco�,Journal of Labour Economics, 15, 44-71.

Davis, S., J. (1992), �Cross-country patterns of change in relative wages�, NBER Macroeco-nomics Annual, NBER, Cambridge Mass.

Dessing, M. (2000), �The impact of trade on employment on 18 Less Industrialized Coun-tries�, UNCTAD, mimeo.

Fajnzylber, P. and W. F. Maloney (2000), �Labor demand and trade reform in Latin America�,World Bank Discussion Paper No. 2491.

Feenstra, R. and G. Hanson (1995), �Globalization, outsourcing, and wage inequality�, Ameri-can Economic Review (May), 240-245.

____________ (1999), �The impact of outsourcing and high-technology capital on wages: es-timates for the US, 1972-1990, Quarterly Journal of Economics, 114, 907-40.

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20

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Matusz, S. J. and D. Tarr (1999), �Adjusting to trade policy reform�, World Bank DiscussionPaper No. 2142.

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23

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