Paul Krugman explains here why he thinks trade may be now a much larger factor behind rising U.S. inequality, compared to the 1980s and early 1990s. The reasons have to do with China and production fragmentation.
During the 1980s and 1990s, there was considerable concern about the possible role of globalisation in contributing to rising income inequality, especially in the United States. This concern was based on standard economic theory: since the 1941 Stolper-Samuelson paper, we’ve known that growing trade can have large effects on income distribution, and can easily leave broad groups, such as less-skilled workers, worse off.
After economists looked hard at the numbers, however, the consensus was that the effect of trade on inequality was probably modest. Recently, Ben Bernanke cited these results – but he recognised a problem: “Unfortunately, much of the available empirical research on the influence of trade on earnings inequality dates from the 1980s and 1990s and thus does not address later developments. Whether studies of the more recent period will reveal effects of trade on the distribution of earnings that differ from those observed earlier is to some degree an open question.”
But the question isn’t really that open. It’s clear that applying the same models to current data that, for example, led William Cline of the Peterson Institute to conclude in 1997 that trade was responsible for a 6% widening in the college-high school gap would lead to a much larger estimate today. Furthermore, some of the considerations that once seemed to set limits on the possible inequality-promoting effects of trade now seem much less constraining.
There are really two key points here: the rise of China, and the growing fragmentation of production.
Krugman was the co-author of a well-known 1994 paper (called "Trade, Jobs, and Wages") which laid out the case for trade's relative insignificance. Interestingly, his co-author on that paper, Robert Lawrence, does not see much of a footprint of trade behind the recent rise in inequality. In fact, he argues the case is even less compelling now than it was a decade ago.
How to reconcile the two perspectives? I think Lawrence is right to the extent that the skill premium has stopped rising since 2000, and therefore the type of approach that Cline and others used and which Krugman thinks would yield larger estimates of trade's contribution today, would not actually explain current inequality (which derives from the rise in incomes at the very top and from the increase in the profit share). But there are other (non-Stolper-Samuelson) models, based on bargaining for example, that could.
In any case, the trade-versus-technology debate of a decade ago is not worth reliving. What is remarkable is that a growing number of prominent economists--Bernanke, Summers, Krugman--are now willing to give globalization a starring rather than supporting role in the recent rise on inequality.