A Noteon Terms of Trade Shocks and the Wage Gap

IMF Working Papers, December 1, 2010

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Using Chilean data, the paper documents that for resource-rich small open economies the effects of terms of trade shocks on the wage gap (between skilled and unskilled workers) depend on factor intensities in the non-tradable sector, following the model in Galiani, Heymann, and Magud (2010).
For a skilled-intensive non-tradable sector the authors show that improvements in the terms of trade benefit skilled workers.
The relation holds at the industry level: the wage gap widens in skilled-intensive sectors while it shrinks in unskilled-intensive ones, the more so as terms of trade volatility decreases.

Empirical analysis uses Chilean data.
The analysis follows the theoretical model in Galiani, Heymann, and Magud (2010).
Focus is on resource-rich small open economies and the interaction between terms of trade shocks and factor intensities in the non-tradable sector.

Wage gap dynamics vary by industry factor intensity:
- Skilled-intensive sectors: wage gap widens with improvements in terms of trade.
- Unskilled-intensive sectors: wage gap shrinks with improvements in terms of trade.
The magnitude of these industry-level effects increases as terms of trade volatility decreases.

The distributional impact of terms of trade shocks is mediated by the factor intensity composition of the non-tradable sector.
Policymakers in resource-rich small open economies should consider sectoral factor intensities when assessing the distributional effects of external price movements and when designing labor-market and social policies to mitigate adverse effects on unskilled workers.