Information and Globalization: Wage Co-Movements, Labor Demand Elasticity, and Conventional Trade Liberalization

NBER WORKING PAPER SERIES

INFORMATION AND GLOBALIZATION:

WAGE CO-MOVEMENTS, LABOR DEMAND ELASTICITY, AND CONVENTIONAL TRADE LIBERALIZATION

James E. Rauch Vitor Trindade

Working Paper 7671

http://www.nber.org/papers/w7671

NATIONAL BUREAU OF ECONOMIC RESEARCH 1050 Massachusetts Avenue

Cambridge, MA 02138 April 2000

Financial support was provided by NSF grant #SBR-9709237 (Rauch). We thank Alessandra Casella, Mark Machina, Joel Sobel, and Joel Watson for very helpful discussions and Neville Francis and David Ryfe for research assistance. We are also grateful for the comments of participants in seminars at the Santa Cruz International Economics Conference, the University of Washington, Boston College, Dartmouth College, Boston University, Southern Methodist University, and the University of Texas. The views expressed herein are those of the authors and are not necessarily those of the National Bureau of Economic Research.

© 2000 by James E. Rauch and Vitor Trindade. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source.

Information and Globalization: Wage Co-Movements, Labor Demand Elasticity, and Conventional Trade Liberalization James E. Rauch and Vitor Trindade

NBER Working Paper No. 7671 April 2000

JEL No. F15, F16

ABSTRACT

We model home country familiarity with business opportunities in a foreign country as a parameter in a matching process between domestic and foreign firms. We show that as familiarity increases the effect of relative national labor supplies on relative national wages declines, the elasticity of domestic labor demand increases, and the extent of “pass-through” of trade tax changes to home wages increases. Since the volume of trade is increasing in familiarity, trade liberalization has a greater impact on wages when the initial volume of trade is greater, all else equal. As familiarity becomes complete, the results of the 2 x 2 Heckscher-Ohlin-Samuelson model are obtained: relative national wages are fixed by trade taxes independent of relative national labor supplies, domestic labor demand is infinitely elastic, and pass-through of tax changes to wages is “complete” in the sense that it is determined entirely by production technology and no arbitrage opportunities remain.

James E. Rauch Vitor Trindade

Department of Economics Department of Economics

University of California, San Diego University of California, San Diego

La Jolla, CA 92093 La Jolla, CA 92093

and NBER [email protected]

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