Trade Liberalization, Firm Performance and Labour Market Outcomes in the Developing World: What Can We Learn from Micro-LevelData?

decades. It is less so, however, for much of trade-liberalizing Latin America, which did not receive
substantial FDI in the 1980s.

Intra-industry trade and wage inequality

Dinopoulos, Syropoulos and Xu (1999) are the first to investigate the potential role of intra-
industry trade for wage inequality. They build a one sector model which features monopolistic
competition and plant-level increasing returns to scale on the production side, and love for variety
on the consumption side. As in Krugman (1979), they assume that the price elasticity of demand
faced by each producer increases with the number of competitors. Further, they assume that the
skill-intensity of production increases with firm size. In this model, trade liberalization raises the
number of competitors, which implies that prices fall. As a consequence, some firms are forced to
exit, thereby raising the average size of surviving firms. The effect of trade on the skill premium
follows immediately from the assumption that firm size is skill-biased. This latter assumption finds
support in several plant-level empirical studies, e.g., in Idson and Oi (1999), who report that large
firms tend to employ a higher proportion of skilled workers.

Related work by Epifani and Gancia (2002) illustrates a new channel through which intra-
industry trade may increase wage inequality. The authors formulate a two-sector general equilib-
rium model which features monopolistic competition in both sectors to show that an elasticity of
substitution in consumption greater than one and higher scale economies in the skill-intensive sec-
tor imply that any increase in the volume of trade, even between identical countries, is skill-biased.
The intuition is simple. Trade expands the market size of the economy, which is beneficial because
of increasing returns. In relative terms, however, output increases by more in the skill-intensive
sector, since it is characterized by stronger economies of scale, and the relative price of the skill-
intensive good therefore falls. With an elasticity of substitution in consumption greater than one,
the demand for skill-intensive goods increases more than proportionally, raising their share of total
expenditure and therefore also the relative wage of skilled workers.

This result implies that, if the skill-biased scale effect is strong enough to overcome the standard

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