Chapter 8: International Trade and Wage Inequality: The Role of Economies of Scale and Relative Factor Endowments
INTRODUCTION 8.1 Although the issue of wage inequality has held centre stage in policy discussions in recent years, it is arguable that it is not the inequality per se that is the major problem. In any market economy, a certain amount of wage inequality necessarily exists, which corresponds to an equilibrium wage premium that a skilled worker can earn over an unskilled worker, thus providing the needed incentive for the latter to acquire skills. Instead, it is the fact that rising wage inequality has been accompanied by absolute declines in real earnings of workers at the low end of the wage distribution that is a matter for serious policy concern. This is the view expressed, for example, by Feldstein (1998) who sees poverty among workers in the bottom decile or quintile as the real problem. Whether the rise in wage dispersion corresponds to an absolute decline in real earnings or real gains for the bottom decile has, indeed, important social implications. For example, Freeman (1994) has linked the high rate of crime in the United States despite massive incarceration to the rise in earnings inequality accompanied by a fall in the real earnings of the less skilled. The fall in real earnings from work relative to the returns to crime such as from dealing in illegal drug business served to provide a job market push into crime. Phelps (1997) has also made a strong argument that the decline in net wages relative to median pay makes it impossible for lowskilled...
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