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Capital Imports Composition, Complementarities, and the Skill Premium in Developing Countries

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Ohad Raveh and Ariell Reshef

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Many developing countries in the 1980s and 1990s went through a process of trade liberalization, allowing access to their domestic markets as well as gaining access to foreign ones. This led to an expansion of import and export activity. At the same time, many of these countries – albeit not all, and to different degrees – experienced increases in inequality. The concurrence of the rise in trade flows and increase in inequality has prompted many economists to ask: is there a causal relationship between the two? And if so, what is the mechanism? The counterfactual prediction of classic Heckscher-Ohlin theory, that developing countries should experience a decrease in wage differentials between skilled and unskilled workers – an important dimension of income inequality – has shifted the focus of research to other channels through which globalization may affect wages and other factor prices.

In this paper Ohad Raveh and Ariell Reshef do exactly that, and empirically study (1) a novel channel: variation in the composition of capital equipment imports. In face of the broadly-accepted capital-skill complementarity hypothesis, capital imports should drive up relative demand for skill and relative skilled wages (i.e. the skill premium) in developing countries, especially because they do not produce much capital equipment, and therefore imports are strongly indicative of (gross) investment. Previous work has taken this hypothesis for granted within structural quantitative trade models, without testing its validity or relevance. Raveh and Reshef explicitly test whether capital imports raise the skill premium, in a sample of developing countries. They find that capital imports per se do not affect the skill premium; rather, it is the composition of capital imports that matters. While imports of R&D-intensive capital equipment raise the skill premium, imports of less innovative capital equipment actually lower the skill premium.. The pattern of trade liberalization favors imports of the first type of capital more than the other. The authors calculate that in their sample of developing countries, trade liberalization can explain a substantial amount of the overall increase in the skill premium. The question remains, however, why do two types of capital have opposite effects? The authors estimate that only R&D-intensive capital equipment (for example, information and communications technology) is complementary to skilled labor in production; in contrast, less innovative capital equipment is more complementary to unskilled labor (for example, transportation equipment and machinery). Thus, only when the composition of imports tends towards more R&D-intensive and skill-complementary capital do we observe an increase in the skill premium and therefore in inequalities. In this way, developing countries import skill-biased technological change, that is embodied in their capital imports.

(1) That is 21 developing countries between 1983 and 2000

Original title of the article : “Capital Imports Composition, Complementarities, and the Skill Premium in Developing Countries”
Published in : Journal of Development Economics, 118, January 2016, pp. 183-206
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