The effect of globalization on wage inequality: an application to the European Union before the Great Recession

This paper aims at relating globalization with wage inequality, explaining if and how this relation is expected to hold differently for different-income countries. We intend to contribute to the literature with an empirical analysis for the countries of the European Union, before the Great Recession, by building and testing a panel data model on two distinct groups: the countries from the “North” (higher GDP per capita) and those from the “South” (lower GDP per capita). We found that trade has the effect of enhancing inequality in the “North” countries (confirming the Hecksher-Ohlin-Stopler-Samuelson mechanism), though we could not significantly conclude on its effect in the “South” group. Foreign Direct Investment inflows have the effect of diminishing inequality in the “North”, while FDI outflows have the same effect in the “South”. These results are not predicted by Feenstra-Hanson theory. We also tested for the effect of technology on inequality and, while we found mixed evidence on how the share of High Tech Exports affects inequality, Gross Expenditure on Research and Development, when significant, increases inequality in the “North” group of countries. By using a composite globalization index, we conclude that trade is dominant over FDI in affecting inequality. Moreover, when we tested for the non-economic aspects of globalization, we found that both political and social dimensions cause wage inequality to increase.