Wage Inequality and Unemployment in the Presence of Imported Intermediate Goods: A Theoretical Analysis

Date01 November 2021
Published date01 November 2021
AuthorNirjhar Ghosh,Priya Brata Dutta
Subject MatterArticles
Wage Inequality and
Unemployment in the
Presence of Imported
Intermediate Goods:
A Theoretical Analysis
Priya Brata Dutta1 and Nirjhar Ghosh1
This article develops a static three-sector and five-factor competitive general
equilibrium model of a small open economy: sector 1 is the rural agricultural
sector, which produces products using informal or unorganised unskilled labour
and land as inputs; sector 2 is the urban manufacturing, final-goods-producing sec-
tor that produces products with the help of unskilled labour, who get unionised
wages, and capital; and sector 3 is the service sector, which uses skilled labour
with formal wages, capital and sophisticated hi-technology-intensive imported
intermediate goods produced abroad as inputs. We show that an exogenous
increase in capital inflow or an increase in tariff on imported intermediate input
reduces the skilled–unskilled wage inequality and lowers unemployment as long
as the return to capital is unaltered and output adjustments absorb the entire
shock of the two policies. Such capital inflow increases rural wage and reduces
unemployment via the Harris Todaro mechanism but interestingly does not allow
the skilled wage to increase. Thus, two critical policy targets can be accommo-
dated at the same time.
JEL Codes: F13, J31, J46
Wage inequality, skilled labour, unskilled labour, input trade reform, general
equilibrium, unemployment
1 Economics and Politics Department, Visva-Bharati University, Santiniketan, Birbhum, West Bengal,
Corresponding author:
Priya Brata Dutta, Economics and Politics Department, Visva-Bharati University, Santiniketan, Birbhum,
West Bengal 731235, India.
E-mail: priyabratadutta@gmail.com
Foreign Trade Review
56(4) 375–399, 2021
© 2021 Indian Institute of
Foreign Trade
Reprints and permissions:
DOI: 10.1177/0015732520986893
376 Foreign Trade Review 56(4)
Globalisation, as it is popularly known, defines a process of integration with the
rest of the world. Such integration is routed through increasing volumes of foreign
trade and investment and is a widely discussed international policy issue in the
present era. The conventional belief is that globalisation is welfare improvement
both from the aggregative perspective and from the distributive perspective.
However, with regard to its distributive effects, various empirical works point out
that the skilled–unskilled wage inequality has grown in many developed1 and less
developed2 countries, and it has been one of the important issues of research in
development economics in recent years.
There exist numerous theoretical works in the context of developing countries
that attempt to determine the implications of globalisation or trade liberalisation
for the problem of growing wage inequality,3 and they are based on the theoretical
framework of static competitive general equilibrium models4 of small open econo-
mies, having a common property of introducing two different types of labour, that
is, skilled and unskilled. The ratio of the wage rate of the skilled worker to that of
the unskilled worker is taken as a measure of wage inequality in these models.
Some models assume full employment of both types of labour, including those in
the works of Mahata et al. (2020), Gupta and Dutta (2010a, 2010b, 2011), Yabuuchi
and Chadhuri (2007, 2009), Chaudhuri and Yabuuchi (2007, 2008), Marjit and
Acharyya (2003, 2006), Marjit and Kar (2005), Marjit et al. (2004) and Kar and
Beladi (2004). They analyse how the different international phenomena such as
emigration of skilled labour or unskilled labour, capital inflow, liberalisation poli-
cies, like a reduction in the import tariff rate, etc., affect wage inequality. However,
only Chaudhuri and Yabuuchi (2008) and Marjit and Acharyya (2003) introduced
non-traded goods in their models; Marjit (2003) considers only non-traded inter-
mediate goods, but Marjit and Acharyya (2003) and Chaudhuri and Yabuuchi
(2008) consider both non-traded intermediate goods and non-traded final goods.
Also, with respect to wage inequality in developing countries, traditional theories
on international trade, like the Ricardian theory of comparative advantage and the
Heckesher–Ohlin theory, deal primarily with trade in final goods.
Recently, the impact of trade in intermediate goods has received increased
attention (see Feenstra and Hanson [1996, 2001, 2004] in this context).
Liberalisation has facilitated greater access of imported intermediate goods, and it
has had a significant impact on the global wage gap. International trade benefits
consumers through lowering the prices of the goods they consume. An important
distinction between trade in final goods and trade in intermediate inputs is that
while the former benefits consumers directly, the latter operates only indirectly,
by allowing firms to lower their costs of production through using better, cheaper
or novel inputs from abroad, reducing firm’s production costs and thus the prices
of locally produced goods. Thus, imported inputs make an important source of
technology inflows, especially in developing economies that import significant
portions of their equipment, and they have been steadily growing over the last
decade facilitated by fragmentation of production. Studies on intermediate inputs
and value chains are therefore attracting more and more attention. According to an

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