2003/04/EPS  

This paper analyzes the effect of globalization on wage premia by studying the interaction between trade costs, firms’ location decision, and relative demand for labor. It suggests that globalization, through vertical specialization and/or agglomeration, increases inequality in countries with a relative abundance of skilled workers in a way that is observationally equivalent to skilled-biased technological progress (i.e., joint increases in the wage premium and the within-industry skilled–unskilled employment ratio). This confirms the potential role of international trade in explaining the observed increase in wage inequality between skilled and unskilled workers that has occurred in most industrialized countries since the mid-1970s. Calibration of the model supports this result. It shows that NAFTA has contributed significantly to the observed increase in the US wage premium.