Policy Implications of the Trade and Wages Debate

This paper examines the choice of policies to redistribute income in response to an increase in inequality caused by a rise in the differential wage paid to skilled labor compared with unskilled labor. The main issue is whether the appropriate policy response depends on whether the cause of the increased skill differential is ‘trade’—increased competition with low‐skilled workers abroad—or technological change. The analysis is conducted within the context of a two‐sector Heckscher–Ohlin trade model augmented to allow endogenous determination of the level of skill.