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Short and Long Run Decompositions of Wage Inequality Changes

T Huw Edwards & John Whalley

CSGR Working Paper No. 106/02

September 2002




This paper focuses on the causes of increased wage inequality in OECD

countries in recent years and its decomposition into the component factors of

trade surges in low wage products and technological change that has preoccupied

the trade and wages literature. It .argues that the length of production

run and degree of fixity of factors is crucial in such analyses. In particular,

if the observed wage inequality response to price and technology shocks re-

flects a short-run response in which factors and output have not adjusted

fully across industries, then decomposition analysis of the causes of the observed

increases in inequality is substantially altered relative to a long-run

factors mobile world. This conclusion applies both when one type of labour

has mobility costs and in the Ricardo-Viner case where there is an additional,

sectorally immobile factor. Furthermore, only small departures from

the fully mobile model can greatly change decompositions. This finding is

important because most data used in earlier work are interpreted as reflective

of a long-run full mobility response, when this may not be the case.

Incorrect conclusions as to how trade surges and technology contribute to

wage inequality can be easily drawn, if the data are in fact generated by a

short-run adjustment process.