A new column at VoxEU.org looks at Trade and inequality: From theory to estimation. The column, by Elhanan Helpman, Oleg Itskhoki, Marc Muendler and Stephen Redding, utilises data from Brazil to consider the effects of trade on inequality. The column presents a unique study examining wage inequality in Brazil after trade liberalisation. Starting from a closed economy, the column finds that wage inequality will initially rise as only some firms take advantage of the new opportunities. But as trade costs continue to fall and more firms start to trade, wage inequality peaks and begins to fall back.
A key prediction of the Helpman, Itskhoki and Redding approach is an inverted U-shape relationship between wage inequality and trade openness.
Starting from the closed economy, reductions in trade costs necessarily increase wage inequality. But as trade costs continue to fall, wage inequality reaches a peak and starts to fall back. The intuition for this result stems from the discrete jump in a firm's wages that occurs when a firm enters the export market. When some firms export, while others do not, then the additional revenue generated at exporters is shared with only the workers at exporters so that export-market access contributes to wage inequality. When no firm exports, a small reduction in trade costs increases wage inequality, because it induces some firms to export and raises the wages paid by these exporting firms relative to domestic firms. At the other extreme, when all firms export, a small increase in trade costs raises wage inequality, because it induces some firms to cease exporting and reduces the wages paid by those domestic firms relative to exporting firms.