Impact of Trade Liberalisation on Wage Inequality and Skill Formation: A Theoretical Analysis

We consider a small open economy with three sector and four factors. Agricultural sector produces output with unskilled labour and land. Manufacturing sector and skill formation sector produce output with skilled labour and capital. Skill formation sector transforms the unskilled labour into skilled labour. We also consider an extended version of this model where agricultural sector also uses capital. So capital is mobile between all three sectors. Both change in the price of manufacturing sector and capital stock alter skill formation in a similar direction. But change in the price of manufacturing sector leads to change in skilled–unskilled wage inequality in the same direction whereas due to change in capital stock it changes in opposite direction. In our extended study, where capital is mobile between all three sectors, the results of the basic model are unaltered. JEL Codes: F13, J31