Trade liberalization, export quality, and three dimensions of wage inequality

In the context of quality content of export baskets becoming the most important determinant of export growth for developing countries, we show that reduction in tariff on final import goods asymmetrically affects the quality of skill‐based export goods that differ with respect to the relative skill intensity of their higher‐quality varieties. This offers a plausible explanation for asymmetric quality variations across product groups observed for Brazil and India since the 1980s. On the contrary, tariff‐reduction‐induced quality variations, regardless of their asymmetry, accentuate wage inequality in all dimensions by depressing the informal unskilled wage through displacement of unskilled workers from the formal sector and the consequent informalization of the economy. This suggests that tariff reductions accentuating wage inequality, as shown in the existing literature, may be underestimated if induced variations in the quality of export goods are unaccounted for. A quality‐content production subsidy or a subsidy targeting the use of skilled labor, given to producers of the export good whose quality is downgraded as a consequence of tariff reduction, can be used as a concurrent policy to mitigate such effect. The wage inequality will also decline to some extent following such subsidies. A proportional factor income tax may be a quality‐neutral way to finance the subsidies.