Peterson Institute publications
The Peterson Institute for International Economics is a private, nonprofit, nonpartisan
research institution devoted to the study of international economic policy. More › ›
RSS News Feed Search

News Release

Trade Impact on US Wages: Modest in Past, Less in Future

November 6, 1997

Contact:    William R. Cline    (202) 857-3600

Washington, DC—Income distribution in the United States has become increasingly unequal over the past twenty-five years: wages of skilled workers, defined as those with some college or greater education, rose by almost 20 percent relative to wages of unskilled workers with high school or less education. The American economy became much more integrated with the world economy during this same period. A key policy issue, highlighted by the intense Congressional battle over NAFTA in 1993 and the current debate over fast track negotiating authority, is whether increased international trade has been responsible for the rise in wage inequality. Trade and Income Distribution by William R. Cline critically evaluates the voluminous literature on the subject and presents new estimates which conclude that:

  • the rise of the availability of skilled labor relative to unskilled in the United States and abroad, due to the sharp increase in the number of college graduates, should have caused a reduction in the US ratio of skilled to unskilled wages by as much as 40 percent;
  • hence the total unequalizing influences have been much greater than the observed net rise of about 20 percent in skilled wages;
  • the decline of transport and protection costs, and thus increased trade, may have increased the US skilled/unskilled wage ratio by about 6 percent over two decades and the composition of immigration may have added another 2 percent to this ratio; hence international factors may have contributed close to half the net rise in the wage ratio.
  • however, trade has mainly raised skilled wages, due to new export opportunities, rather than reduced unskilled wages. Increased efficiency through international trade and specialization has created a larger pie to share, largely compensating any downward pressure on unskilled wages.
  • moreover, the gross unequalizing forces were so much greater than the observed net rise in wage inequality that there were much larger effects from sources other than trade such as skill-biased technical change, a falling real minimum wage, and falling unionization. Trade and immigration contributed only about one-tenth of the total unequalizing influences (see attached table). About half of this trade impact can be attributed to a policy of lower protection; the rest is due to falling transport and communications costs.

Cline also projects future levels for the skilled and unskilled labor forces in the United States and abroad, along with production technology, to estimate the possible future effects of trade on wage differentials. He finds that the unequalizing pressure from this source is likely to be smaller than in the past. The reason is that the remaining levels of transport and protection barriers are relatively small so that the impact of additional integration of the United States into the world economy is unlikely to be as great as in the past two decades. In addition, the rising availability of skilled workers in developing countries is likely to diminish the pressure of North-South trade on unskilled US workers.

Cline finds that freezing trade protection at post-Uruguay Round levels, and failing to pursue the hemispheric Free Trade Agreement of the Americas and free trade in the Asia Pacific region as agreed by APEC, would thus have limited impact in reducing the US skilled/unskilled wage ratio. Moreover, any such impact would reduce US skilled wages much more than it would increase unskilled wages. When account is also taken of the concentrated impact of the costs of protection on lower income groups, the conclusion is that protection (or failure to extend open trade) is a highly inefficient way to moderate wage inequality.

Cline's model suggests that the underlying trend toward equalization of international "factor" (labor and capital) prices is far more likely to boost unskilled wages abroad toward US levels rather than the reverse. This trend is unlikely to go much further than approximating an international norm of relative skilled/unskilled wage ratios, however, at much higher absolute levels in the United States and other industrial countries than in developing countries because of the higher productivity of their labor forces.

Another key finding is that the large block of the US economy that is nontradable, mainly services, provides a major buffer that limits the potential of international trade to cause "factor price equalization" and lower US unskilled wages. A tendency toward "home orientation" in demand and production causes an approximately comparable buffer.

Another key policy implication of Cline's study is that further reconsideration of immigration strategy, to once again emphasize skills rather than family ties, could moderate the impact of immigration on wage inequality.

At the broadest level, the policy implication of Cline's study is that open trade is a key component of an efficient market economy. Its moderate, potentially unequalizing, side effects need to be addressed by a wide range of general economic policies rather than through the inefficient response of restricting trade. The basic challenge for the American public is to find ways to ensure that the benefits of trade are shared fairly.

Cline's volume also surveys about 50 previous studies of this issue. He finds that there is a sharp division among economists, spanning subdisciplines, on whether trade and immigration have played an important role in widening wage inequality. Among labor economists, one group argues there has been little impact of trade and that the nature of technical change"skill-biased" innovation such as computer advanceshas been the driving force boosting skilled wages and eroding unskilled wages. Another group of labor economists has, however, calculated the skilled and unskilled labor content of trade and immigration to estimate a significant adverse impact because imports and immigration have boosted the relative supply of unskilled labor.

Among trade economists, one group has severely criticized calculations of adverse distributional impact from trade on grounds that they do not focus on the evidence required by trade theory. Another, smaller, group has instead stressed the classic ("Stolper-Samuelson") forces whereby lower protection causes relative erosion of unskilled wages for a country such as the United States, where unskilled labor is "scarce" relative to international patterns, and so trade tends to erode its scarcity premium. By one extreme estimate, this effect has caused almost the entire rise in US wage inequality.

Cline rejects the extremes of this literature and places a balanced estimate from the various studies at about one-fifth as the share of the observed increase in wage inequality attributable to trade and immigration. He then provides two new models of his own to estimate not only the past effects of trade and immigration but their likely impact in the future. His "general equilibrium" models take explicit account of the growth of skilled and unskilled labor supply in the United States and in 12 other countries or regions. His estimates also gauge the decline of protection and of transportation and communications costs.

A key insight in Cline's study is that there have been two opposing forces. Falling transport and protection costs have meant greater global integration and thus greater pressure on US wage inequality. On the other hand, the stock of skilled labor relative to unskilled labor has risen much faster in developing countries, such as the East Asian "tigers," than in the United States. This has reduced the trade pressure on US unskilled wages for a given amount of global integration estimates. Cline arrives at the findings summarized above from the estimates of these models.