Globalisation Increases Wage Inequality By Rewarding Skills More Highly

Globalisation significantly increases the wages of high-skilled workers, according to new research by Paolo Epifani and Gino Gancia, published in the July 2008 issue of The Economic Journal.

As new markets (such as China) open up to international trade, this allows some industries to grow strongly. As these industries disproportionately employ skilled workers, the ''skill premium'' – the difference between the wages of skilled and unskilled workers – increases.

The effect of globalisation is substantial: the report estimates that doubling the market size will increase the ''skill premium'' by up to 30%. This suggests that the response to globalisation of many governments – urging the
need to pursue more and better education – is correct.

Since the mid-1970s, the wage gap between high-skilled and low-skilled workers has widened. At the same time, world trade has increased dramatically: between 1980 and the late 1990s, the share of countries ''open to trade'' rose from 35% to 95%, and the volume of trade of the average country rose from 59% of national income
to 74%.

The report explains how widening wage inequality and globalisation are connected. Globalisation increases the size of the market firms can access. Some industries can take advantage of a larger market more easily than others as they benefit from ''economies of scale''.

The study argues that those industries that take advantage of a larger market are more likely to employ skilled workers, and so the wages of skilled workers will rise faster than unskilled workers in a period of globalisation.

Why is this so? Consider computer programming. Once a program is written, it is cheap to make more copies of it – much of the cost is fixed (it is the cost of employing someone to write it). This means that the larger the market, the more valuable the program – and the programmer. The same reasoning applies to scientists researching new drugs and many other skilled industries.

What's more, big markets demand more differentiated products and product differentiation is a skill-intensive activity.

Given that ability is more important in large markets and that globalisation is creating a huge world market, skilled workers benefit relatively more from this process. The effects this study finds are big. The researchers'' calculations suggest that a 50% fall in trade costs between two countries can increase the skill premium (the extra
wage that skilled workers receive from having more skills) by 10%, and full trade integration can raise it by up to 30%.

Using data for 68 countries between the early 1960s and the late 1990s, the report estimates the effect of globalisation on the ''skill premium''. It finds that a doubling of market size can increase wage inequality by around 30%.

So a large fraction of the growing difference in the wage of high-skilled and lowskilled workers may be attributed to the growth of world markets due to globalisation.

"The Skill Bias of World Trade'' by Paolo Epifani and Gino Gancia is published in the July 2008 issue of The Economic Journal.