Low-wage competition: pains from trade for medium-wage countries

Abstract

The entry of a low-wage country into a world economy with preexisting wage differentials puts the gains from trade in a former low-wage and then medium-wage country under pressure. If negotiations over the formation of a free trade area cover international transfers, there is a strong presumption that they bring about global free trade and compensation of the medium-wage country if necessary. In the absence of international transfers, by contrast, the medium-wage country is not compensated when global free trade causes a reduction in its gains from trade, and it may even happen that it is not part of the equilibrium free trade area.

Keywords:

• gains from trade
• low-wage competition
• North-South trade
• free trade area
• core
• wage inequality

JEL classifications:

• F11
• F61

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 See https://www.economist.com/asia/2018/04/12/why-samsung-of-south-korea-is-the-biggest-firm-in-vietnam.

2 See https://www.jetro.go.jp/en/news/releases/2019/6980a2e6ad84b745.html.

3 This might also help explain why ‘[T]he composition of antidumping using economies has … changed dramatically, shifting from mostly advanced economies such as Canada, the United States and the European Union to developing economies nowadays’ (Kang and Ramizo 2020, 336).

4 Krugman 1979, Sec. III also considers a dynamic version of his model. Grossman and Helpman 1991 extend this dynamic model to endogenous growth (see also Arnold 2002, 2003). These dynamic models focus on growth effects, as it is not possible to obtain analytical welfare results (an important exception is Helpman 1993). We build on the static Krugman 1979 model because our focus is on welfare effects.

5 Countries are classified as middle-income if their gross national income per capita is between $1,036 and $12,535 (see https://datahelpdesk.worldbank.org/knowledgebase/articles/906519).

6 In what follows, whenever inequality constraints are used to distinguish cases, examples of parameters for each possible case are given either in the running text or in online Appendix B.

7 Here and in what follows we omit the qualification ‘except for a set of varieties of measure zero’.

8 The core principle and bargaining games are the standard approaches to the endogenous formation of regional trade agreements among a small number of countries. The multi-country network approach (cf. Goyal and Joshi 2006) does not lend itself well to our three-country setup. See Limão 2016, 348 ff..

9 We skip Nash bargaining here, as the convexity property underlying its axiomatization is not satisfied with the present discrete choice set.

10 Exclusion of the South can also be the outcome of the maximization of a social welfare functional with sufficiently heavy weight on equality if one modifies (3(3) $\frac{a^i}{L^i}{\overline{A}}^i<\frac{a^{i^{\prime }}}{L^{i^{\prime }}}({\overline{A}}^{i^{\prime }}-{\overline{A}}^i),(i,i^{\prime })\in \left\{\right(E,S),(E,N),(S,N\left)\right\}.$(3) ) in such a way that unit cost equalizes in E and S (see online Appendix C).

11 See https://wits.worldbank.org/CountryProfile/en/Country/WLD/StartYear/2019/EndYear/2019/TradeFlow/Import/Indicator/MFN-WGHTD-AVRG/Partner/WLD/Product/all-groups.

12 A differentiable function $f\left(x\right)$ with $f^{″}\left(x\right)>0$ satisfies $f(a+c)<f\left(a\right)+\left[f\right(b)-f(a\left)\right]c/(b-a)$ and $f(b-c)<f\left(b\right)-\left[f\right(b)-f(a\left)\right]c/(b-a)$ and, therefore, $f(a+c)+f(b-c)<f\left(a\right)+f\left(b\right)$ for $a+c<b$ and $c>0$. Setting $f\left(x\right)=x^{1/\alpha }$, $a=x_S$, $b=x_E+x_{ES}+x_{SN}$, and $c=x_{SN}$ yields the result. The inequality $a+c<b$ becomes $x_S<x_E+x_{ES}$.