Heckscher-Ohlin Model to Debunk Wage Inequality's Popular Theory

This article by Arvind Panagariya discusses the Heckscher-Ohlin model and how it can be used to describe the reasoning behind the increase in wage inequality between skilled and unskilled workers in recent years.  Between the late 70’s and early 90’s the ratio of skilled-to-unskilled wages rose almost 30% in the United States. At this time, trade between developed and developing countries rapidly expanded. Panagariya explores the causes for this gap in this article.

The H-O model is suitable for this analysis because it allows us to focus solely on the income distribution effects without having to take into account differences in technology as does the Ricardian model. Panagariya begins the article by thoroughly explaining the Heckscher-Ohlin model, just as we have in class. The primary conclusion drawn from the H-O model is that each country open to free trade will export the goods that use its abundant factor more intensively and import the goods that use its scarce factor more intensively. After many calculations and graphs we can further conclude that the relative and real factor returns, specifically the wage-rental rate, of countries open to free trade eventually equalize. Therefore, we can discredit the theory that the wage inequality is caused by trade with developing countries.

Panagariya draws on further research to support his opposition. He cites Krugman (1995) to have stated that the 2% of total expenditure occupied by imports from developing countries is too small to explain such a large increase in wage inequality. Finally, Panagariya declares his theory for the increased wage inequality to have been caused by a shift in technology in favor of skilled labor. Technological advances have been shown to shift demand to support skilled labor and an increase in wages while leaving unskilled labor to suffer. The Heckscher-Ohlin model has offered a viable explanation as to why trade is simply not to blame for the increase in wage inequality.


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