Trade Liberalisation and the Wage Skill Premium in Korean Manufacturing Plants: Do Plants’ R&D and Investment Matter?

• Published date: 01 June 2017
• Author: Yong‐Seok Choi,Chin Hee Hahn
• DOI: http://doi.org/10.1111/twec.12438
• Date: 01 June 2017

Trade Liberalisation and the Wage Skill

Premium in Korean Manufacturing Plants:

Do Plants’ R&D and Investment Matter?

Chin Hee Hahn

1

and Yong-Seok Choi

2

1

Department of Economics, Gachon University, Sujeong-gu, Seongnam-si, Gyeonggi-do, Korea and

2

Department of Economics, Kyung Hee University, Dongdaemun-gu, Seoul, Korea

1. BACKGROUND AND OBJECTIVE

FOR the past several decades, the impact of globalisation on wage inequality between

skilled and unskilled workers (wage skill premium) has drawn much attention in the aca-

demic and policy circles. Earlier studies based on the traditional Heckscher–Ohlin theory were

generally sceptical to the view that trade is an important cause for the rising wage inequality.

Recent theories, however, highlight several new mechanisms –interaction between skill-

biased technological progress (SBTC) and trade (Wood, 1995; Thoenig and Verdier, 2003;

Bustos 2011a, 2011b), complementarity between imported capital goods and skilled workers

(Acemoglu, 2003), or trade-induced compositional change in firm’s product portfolio (Ver-

hoogen, 2008), for example by which trade liberalisation increases wage skill premium.

Although there are a growing number of empirical studies finding that globalisation increases

wage skill premium,

1

whether and how globalisation increases wage skill premium is an issue

which deserves further scrutiny.

In this paper, we examine empirically the effect of trade liberalisation on within-plant

wage inequality between skilled and unskilled workers

2

utilising plant-level data set in the

Korean manufacturing sector. As in Amiti and Davis (2012) and Amiti and Cameron (2012),

3

we examine separate roles of output and input tariffs and consider possibly differential effects

among plants. The latter approach is broadly in line with the spirit of the recent heteroge-

neous firm trade theories which predict differential responses of firms to trade liberalisati on

depending on the firm characteristics.

In this paper, we focus on plants’ R&D and investment behaviour as the key plant charac-

teristics determining the effect of import tariff reductions on within-plant wage skill premium.

So, our paper can be broadly related to the literature examining the possible interaction

This research was financially supported by Economic Research Institute for ASEAN and East Asia under

the project entitled ‘Impact of Globalization on Labor Market’. We are grateful to Professor Chris Mil-

ner and an anonymous referee for many detailed comments on this paper. The revision of this paper was

made when Choi visited Division of Politics and Economics at Claremont Graduate University as a visit-

ing scholar. Choi would like to thank Professor Thomas Willett for his generous hospitality. All remain-

ing errors are our own.

1

See Goldberg and Pavcnik (2007) for an extensive review of the related literature.

2

Our focus on within-plant wage skill premium is motivated by Hahn and Park (2013), which shows

that around half of the increase in the aggregate share of the skilled employment and wages is accounted

for by the within-plant effect in Korean manufacturing during the period of our analysis.

3

While Amiti and Cameron (2012) focus on the effects on within firm wage inequality between skilled

and unskilled workers as in this paper, Amiti and Davis (2012) analyse the effects on between-firm wage

inequality.

©2016 John Wiley & Sons Ltd

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The World Economy (2017)

doi: 10.1111/twec.12438

The World Economy

between trade and SBTC as a mechanism through which trade affects wage skill premium.

While there is a growing interest in this subject, empirical studies which examine this mecha-

nism explicitly are surprisingly scant.

4

The following is a brief sketch of the story that explains our focus on plant’s R&D and

investment behaviour. According to the well-known heterogeneous firm trade theories, such

as those developed and reviewed by Amiti and Davis (2012), trade liberalisation or reductions

of trade costs increases the revenue and profit of firms with higher productivity while decreas-

ing them with lower productivity. The increase (decrease) of the revenue and profit, or the

prospect of it, will enhance (reduce) the incentive to do R&D

5

and/or to make investments in

production facilities since these are basically investment activities motivated by profit oppor-

tunities. However, the effect of import tariff reductions on within-plant wage skill premium

might differ depending on firms’ behaviours in R&D and facility investment in response to

import tariff reductions. Above all, R&D itself is likely to be a skilled labour-intensive activ-

ity. Thus, if a firm increases R&D activity in response to trade liberalisation, it will increase

the relative demand for the skilled workers, leading to an increase of the wage skill premium

when wages are determined at the firm level. Furthermore, R&D might be aimed at more

skill-intensive products or processes under the increased import competition.

6

Alternatively, if

a firm decides to increase its production capacity by investing in equipment and production

lines given existing technologies, it is likely to increase relative demand for the production or

unskilled workers or at least their increase of relative demand for the non-production workers

will be weaker than R&D-doing firms. So, firms that increase production capacities in

response to trade liberalisation may experience a reduction in wage skill premium or a weaker

increase in wage skill premium than R&D-doing firms.

7

So, our analysis allows for differen-

tial effects of tariff reductions among plants engaged in R&D, plants making facility inve st-

ments and those that do neither. We find evidence consistent with the above conjecture. We

think that this is a novel feature of our paper.

As mentioned above, we are interested in estimating the separate effects of output and

input tariff reductions on wage skill premium as in Amiti and Cameron (2012). We think that

conducting similar analyses for Korea’s case is a meaningful exercise per se. Amiti and

Cameron find that the reduction in intermediate input tariffs lowers wage skill premium in

Indonesian manufacturing, while they find no significant effect from the output tariff reduc-

tions. Their interpretation of the wage-inequality-reducing effect of input tariff reductions is

as follows. As Indonesian manufacturing plants import more skill-intensive intermediate

inputs mostly from developed countries, the reduction in input tariffs induces firms to switch

from in-house production of skill-intensive intermediate inputs to importing, which decreases

4

Bustos (2011a, 2011b) are a couple of exceptions.

5

Costantini and Melitz (2008) and Aw et al. (2011) theoretically analyse this mechanism in the context

of heterogeneous firms and trade.

6

Thoenig and Verdier (2003) theoretically show that firms respond to globalisation by engaging in ‘de-

fensive innovation’, that is by biasing the direction of their innovations towards skilled labour-intensive

technologies.

7

It is well known that only a small fraction of plants are engaged in R&D and a much higher fraction

of plants, although not all plants, are making positive investments at a point in time. This pattern is also

observed for Korean manufacturing, as we will show below. Thus, focusing on R&D alone in response

to trade liberalisation might not be sufficient to understand the effect of import tariff reductions on

within-plant wage skill premium and might lead to an omitted variable bias problem.

©2016 John Wiley & Sons Ltd

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