Firms’ location decision across asymmetric countries and employment inequality

European Economic Review 49 (2005) 299 – 320 www.elsevier.com/locate/econbase

Firms’ location decision across asymmetric countries and employment inequality Vanessa Strauss-Kahn∗ Economics and Political Science, INSEAD, Bd de Constance, Fontainebleau 77305, France Received 1 December 2002; accepted 10 December 2003

Abstract This paper analyzes the e-ect of globalization (lower trade costs) on production and trade patterns if, 1rms are vertically linked, stages of production di-er in labor-factors intensity and countries di-er in labor-factors prices. In order to re4ect the “Continental Europe” experience, relative wages are assumed 1xed and spatial changes in production are translated into changes in relative (skilled to unskilled) employment levels. The asymmetry in factors prices across countries results in a unique agglomeration equilibrium for a broad range of trade costs. At low trade costs, 1rms’ location depends on production costs—vertical specialization occurs. This paper also provides a consistent explanation of the observed increase in employment inequality between skilled and unskilled workers in relatively high-unskilled wage countries. c 2004 Elsevier B.V. All rights reserved.  JEL classi cation: F12; F15; J31 Keywords: Agglomeration; Intermediate inputs; Skilled/unskilled workers; Trade liberalization; Vertical specialization

1. Introduction Recent theoretical research on new economic geography, synthesized in Fujita et al. (1999), studies the interactions between trade costs levels (e.g., tari-s, transportation costs, information costs and/or communication costs) and 1rms’ location decision. It also helps understanding cross-countries income disparities as spatial shifts in production translate to shifts in labor demand across locations (Krugman and Venables, 1995). Most of these studies focus on symmetric countries and assume a single factor of production. In a context of international economic integration, where small di-erences ∗

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c 2004 Elsevier B.V. All rights reserved. 0014-2921/$ - see front matter
doi:10.1016/j.euroecorev.2003.12.008

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Table 1 Trends in earnings dispersion Country

Time period

% change in earnings D9/D5

Austria Belgium Denmark Finland France Germany Italy Netherlands Norway Sweden United Kingdom United States

1980–1994 1985–1993 1980–1990 1980–1994 1981–1994 1983–1993 1980–1993 1985–1994 1980–1991 1981–1993 1981–1994 1981–1994

0.7 0.0 2.6 1.8 3.9 0.6 15.4 2.5 2.7 3.8 10.7 15.5

% change in earnings D5/D1 2.5 −1:4 −2:1 −1:4 −2:4 −6:2 −1:8 0.6 −6:4 2.3 11.5 10.9

Sources: Author calculations; Data are from the OECD Employment Outlook (Organisation for Economic Cooperation and Development (OECD), 1996–1997). Notes: D1 and D9 refer to the upper earnings limits of, respectively, the 1rst and the ninth deciles of employees ranked in order of their earnings from lowest to highest, i.e., D1 corresponds to the 10% workers earning the least. D5 is de1ned similarly. It corresponds to median earnings.

among countries may in4uence a 1rm’s location decision, it is however interesting to study location decisions when countries di-er. If such di-erences originate from disparities within the labor market (e.g., di-erences in labor-factors endowments or in labor-factors prices), then analyzing 1rms’ location also provides information on within-country inequality between labor-factors. Existing models of the e-ect of trade on within-country inequality between skilled and unskilled workers focus on wage inequality. They aim at explaining the increase in relative wage that occurred in the United States and the United Kingdom since the late 1970s. 1 In some Continental Europe countries, however, the evidence points that inequality in employment has increased while relative wage remained stable. Labor market in Continental Europe countries is more rigid than that in the U.S. and the U.K. Strong unions, high minimum wages and unemployment bene1ts have probably helped compressed wage dispersion and have induced increasing employment di-erentials (de1ned as the di-erence between the share of skilled employed in skilled population and the share of unskilled employed in unskilled population). In fact, recent works from Blanchard (e.g., Blanchard and Wolfers, 2000) suggest that both macroeconomic shocks and rigid labor market institutions contribute to European unemployment. 2 Table 1 provides evidence on earnings inequality for the United States, the United Kingdom and several Continental Europe countries. Earnings dispersion signi1cantly increased in 1

See Feenstra and Hanson (2001) for an interesting survey. In Blanchard and Wolfers (2000), panel data evidence the interaction between macroeconomic shocks and rigid labor market institutions in explaining European unemployment. This result helps explaining the large di-erence in employment trends across European countries (e.g., the employment di-erential in Germany decreased by 23% between 1989 and 1994). 2

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the U.S. and the U.K. in the 1981–1994 period, while it slightly varied in most continental European countries. In contrast, for equivalent periods, employment di-erentials drastically rose in several Continental Europe countries (e.g., by 83% in Finland, 95% in France and 110% in Norway), while it only increased by 28% in the U.S. and 48% in the U.K. 3 To account for these patterns, one needs to investigate the role of trade in explaining employment inequality in a context of 1xed factors prices. In this paper, I analyze how a decrease in trade costs modi1es the international structures of production and trade patterns when countries are asymmetric and there are several factors of production. Firms are vertically linked, stages of production di-er in labor-factor intensity and countries di-er in labor-factor prices. Because changes in 1rms’ location a-ect relative labor demand, I also investigate the e-ects of globalization (decreased trade costs) on within-country inequality between skilled and unskilled workers. In order to capture the Continental Europe experience, I build a general equilibrium model of new economic geography with 1xed wages, where spatial changes in production patterns are re4ected into changes in relative (skilled to unskilled) employment levels. 2. Description of theoretical background and results 2.1. Relevant literature The method used in this paper is in line with the new economic geographic literature which examines the e-ect of a decrease in the cost of trade on 1rms’ location decisions and trade patterns. The following results are now standard in the literature: 1rms distribute evenly across locations if trade costs are either high (1rms must be close to consumers) or low (production costs are decisive). At intermediate levels of trade costs, there is agglomeration of the economic activity in one location. Endogenous agglomeration occurs because 1rms in imperfectly competitive industries bene1t from locating in the same location as they take advantage of increased competitiveness and greater demand. Such agglomeration of 1rms requires either that labor be mobile across countries, as in Krugman (1991), or that 1rms be vertically linked, as in Venables (1996). 4 The literature on 1rms’ location decisions also includes other work that is relevant for this paper. Notably, and in contrast with previous research, recent studies from Holmes (1998) and Pfann and Van Kranenburg (2003) provide evidence that government incentives in4uence 1rms’ location decision. Both papers carefully study the e-ects of di-erences in taxation across locations (or times) on strategic business location decisions. They suggest that government policies that a-ect production costs play a dramatic role on 1rms’ location choices. European governments institutionally in4uence wages determination as well as entry and exit legal costs. Thus, in the present 3

Data on employment di-erentials come from the OECD Employment Outlook (1997). Skill levels correspond to education levels. 4 See Ottaviano and Puga (1997) for a survey.

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paper, the di-erence in labor-factor cost could easily be a consequence of labor-market government policy. Results of this paper sustain the idea that government policies matter. 2.2. Forces at work In this paper, three forces in4uence a 1rm’s location decision: vertical linkages, factor prices and access to market. Firms in the downstream (i.e., 1nal goods) sector gain on production costs if they locate where relatively many upstream (i.e., intermediate goods) 1rms are based because it results in lower intermediate goods’ price—this is the cost linkage. Firms in the upstream sector 1nd it pro1table to locate where relatively many downstream 1rms are based because it results in high demand for their goods— this is the demand linkage. These vertical linkages create forces that may give rise to agglomeration of the industrial production in a single location. Di-erences in factors price and immobility of 1nal demand are dispersion forces which may give rise to vertical specialization (i.e., each location specializes in the production of one type (i.e., 1nal or intermediate) of goods). The relative strength of these concentration and dispersion forces depends on the level of trade costs. 2.3. Results As standard in the new economic geography literature, there is agglomeration at intermediate trade costs levels. Speci1c to the assumption of asymmetric countries, the agglomeration equilibrium is unique for a broad range of trade costs. Such agglomeration may occur in either country depending on the relative magnitude of the di-erence in factors prices. At low trade costs, 1rms’ location decision depends on production costs. Di-erent stages along the process of production locate in di-erent countries— international trade and production become increasingly vertically specialized. Under vertical specialization and most agglomeration equilibria, the employment differential between skilled and unskilled workers widens in the relatively high unskilled-wage country. Such result is consistent with observed increase in skilled– unskilled inequality. The rest of the paper is organized as follows. Section 3 sets out the formal model; Section 4, the general equilibrium. Sections 5–7 analyze 1rms’ location decision and employment di-erential for di-erent levels of trade costs. Section 8 presents simulations of the model and discusses the main results. Section 9 concludes. (Section 10 comprises the Appendix.) 3. The model In order to analyze the e-ect of globalization on asymmetric countries and to derive conclusions regarding employment inequality, I extend Venables’ (1996) model by introducing a second factor of production and by assuming factors price di-erences across locations.

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Each economy (domestic and foreign) faces the same technology and has three sectors. One of them is perfectly competitive and produces a homogenous good which is assumed freely tradeable. The other two are imperfectly competitive industries (or stages of production) linked through an input–output structure. A good physically produced in the upstream sector—which acquires most of its value added in the downstream sector (where the managing, marketing, designing and wholesaling activities are processed)—is assumed to be an intermediate good for the downstream 1rm. This justi1es a framework in which the upstream sector is unskilled-labor intensive and the downstream sector is skilled-labor intensive. 5 In order to obtain analytical results, I assume that sectors are labor-speci1c. Considering relative labor intensities would not modify the qualitative results as agglomeration and vertical specialization would occur, but with less magnitude (i.e., the number of 1rms that relocate in equilibrium would be smaller). Workers are either employed in one of the two manufacturing sectors of the economy or considered unemployed. If unemployed, they produce at home the homogenous good to which we will refer as the home production good. One unit of skilled (resp., unskilled) labor produces vH (resp., vL ) unit of the home production good. Since the sector is perfectly competitive and the price of the output is normalized to one, home production provides an income of vH to skilled workers and of vL to their unskilled counterparts. I assume that unions in the manufacturing sector set wages to provide a 1xed markup  over the value of home production. Thus, skilled workers in the downstream sector receive a wage wH = vH and unskilled workers in the upstream sector receive a wage wL = vL where  ¿ 1. 6 In order to study the e-ects of globalization on employment inequality, I assume that (i) wages are 1xed—which implies that employment adjusts to production needs, and (ii) endowments are of such a magnitude that unemployment occurs in both sectors. Using the home production assumption allows me to have a simple general equilibrium framework with an outside option for workers who are not employed in the manufacturing sector. Such assumption seems more appropriate than alternative frameworks (e.g., government taxation and unemployment bene1ts framework) because (i) it keeps the focus of the paper on manufacturing 1rms’ location and its induced e-ect on manufacturing employment, (ii) it allows consumers to have preference over other goods than manufactured one and (iii) it gives some insights on the wage setting process. Also, estimates reported in Benhabib et al. (1991) suggest that home production may be as much as half that of the market sector and that labor input in such production is almost as large as in the market sector. I also make the assumption that wages di-er across countries, wH ¡ wH∗ and wL ¿ wL∗ , and that countries are otherwise similar with equivalent levels of endowment, HP = HP ∗ and LP = LP∗ , where HP is the endowment in skilled labor, LP the endowment in unskilled labor and variables with a * superscript correspond to foreign 5 Recent work from Burstein et al. (2003) suggests that distribution costs (including wholesale and retail services, marketing, etc.) represent about half of 1nal goods’ prices. Such evidence is in accordance with the framework presented hereby. Feenstra (1998)’s Barbie Doll example is also relevant as production costs of the doll (made in foreign countries) represent only 10% of such doll’s retail price. 6 For simplicity,  is assumed the same across types. Allowing it to di-er would not change the qualitative results as long as wH ¿ wL .

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variables. 7 These assumptions are speci1c to this model. To my knowledge, this is one of the 1rst general equilibrium model of new economic geography that considers more than one factor of production and hence analyzes geographic location across asymmetric countries. 8 There is trade in both intermediate and 1nal goods, labor is assumed to be immobile across countries and, within this framework, 1rms may choose to locate either in a relatively low skilled wage country or in a relatively low unskilled wage country. 3.1. Preferences Consumers in the domestic and foreign countries have Cobb–Douglas preferences over the home production good and manufactured goods. 9 1−  U = Chp Cd ;

0 ¡  ¡ 1;

(3.1)

where Chp is the demand for the home produced good whose price is used as numeraire and Cd represents a composite good made up of varieties of downstream goods. Consumers have identical preferences among varieties aR la Dixit–Stiglitz–Spence, i.e.,    (−1)= =(−1) n∗ nd d   m dj (−1)=  + cdi ; (3.2) Cd =   d j i where cdi is the domestic demand for downstream good i produced domestically and mdj is the domestic demand for downstream good j produced abroad; nd (resp., n∗d ) is the number of downstream 1rms located in the domestic (resp., foreign) country and , the elasticity of substitution between varieties, is greater than one. We refer to Cd as the aggregate downstream good. As typical, shipment of the manufactured goods incurs “iceberg” trade costs. The manufacturing price index of the aggregate downstream good, Pd , is hence de1ned by 1=(1−)  n∗ nd d   1− ∗ pdi + (pdj d )1−  ; (3.3) Pd =  i

j

where pdi is the producer price of downstream good i. 7 The di-erence in absolute wages follows the factor speci1c structure of the model. Considering relative factor intensities would result in a framework where cross-countries di-erences in relative factors prices matters. 8 Ricci (1999) considers asymmetric countries by analyzing 1rms location decision when technology differ across countries (Ricardian type of comparative advantage). The paper derives interesting results on 1rm’s location which are for the most part consistent with the 1ndings of the present paper. The type of countries asymmetry (i.e., di-erence in technologies) does not however provide insight on within-countries skilled–unskilled inequalities. Notably, by introducing consideration of Heckscher–Ohlin trade theory in new economic geography models, Amiti (2001) and Strauss-Kahn (2001) study 1rms location across countries that di-er in their factors endowment. 9 I specify equations of the model for the domestic country. Symmetric equations hold for the foreign country. Because the core elements of the model draw from Venables (1996) and Helpman and Krugman (1985), the model is highly stylised. The full derivation of the model is available upon request.

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Consumers maximize utility subject to their budget constraints. Given homothetic preferences and recalling that the price of the home produced good is one, it yields the demand for domestically produced and imported 1nal goods, − ; cdi = IPd−1 pdi

∗ − 1− mdj = IPd−1 (pdj ) d ;

(3.4)

where I is the sum of all employed and unemployed incomes within a country. 3.2. Firms The manufactured sector is monopolistically competitive (Ra la Dixit and Stiglitz, 1977) and is composed of two industries or stages that are vertically linked through an input–output structure. At each stage, di-erentiated goods are produced under increasing returns to scale. The upstream industry uses only unskilled labor, L, as input. An upstream 1rm i chooses a quantity xui to maximize its pro1t, taking other 1rms quantities as given. It chooses unskilled labor, Li , to minimize its cost. The 1rst-order conditions yield the total demand for unskilled labor and the standard result that equilibrium prices are a constant mark-up over marginal cost,    ; (3.5) pui = wL  −1 n u p u xu L= ; (3.6) wL where nu is the number of upstream 1rms located in the domestic country. 10 Downstream 1rms feature a production function de1ned over skilled labor, H , and a composite good, Cu , made up of varieties of upstream goods. Following Ethier (1982), upstream goods contribute in a symmetric fashion to the production of a downstream good with a constant elasticity of substitution across varieties. Cu , the aggregate upstream good, is de1ned as (3.2). Dual to the aggregate upstream good is the upstream (i.e., intermediate) good price index Pu . The production function is Cobb–Douglas with share 1 −  of skilled labor and share  of aggregate upstream good Cu . The share  of intermediate inputs in production is a key parameter because it re4ects the vertical linkages between the two sectors. The higher is , the more upstream goods are used in production of a downstream good and hence the stronger are the forces that in4uence downstream and upstream 1rms to locate close to each other. Downstream 1rms face the same optimization problem as upstream 1rms. The downstream 1rm i chooses quantity xdi to maximize its pro1t in a monopolistically competitive framework. Downstream 1rms’ demand for labor and intermediate goods is obtained by cost minimization. 11 It yields     1− ; (3.7) pdi = Pu wH  −1 10 The total cost function is TC = MC( + x ) where MC stands for marginal cost and x for output. For i i i simplicity, as traditional in the literature, I choose units of measurement such that  = ( − 1). 11 For simplicity, as standard in the literature, I assume that  and  are the same in both industries. Allowing them to di-er changes the scale of production but does not a-ect the results.

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V. Strauss-Kahn / European Economic Review 49 (2005) 299 – 320 − ; cui = nd pd xd Pu−1 pui

∗ − 1− muj = nd pd xd Pu−1 (puj ) u ;

(3.8)

and H = (1 − );

(3.9)

where cui is the demand (summed over all domestic downstream 1rms) for upstream good i produced domestically and muj is the demand for upstream good j produced abroad. Finally, I assume that there is free entry and exit at both stages. With a large number of symmetric 1rms in each stage, in equilibrium each 1rm’s pro1t is driven to zero.

4. General equilibrium 4.1. Market-clearing conditions Product market equilibrium requires that demand equal supply for each good in each manufacturing industry and for the home produced good. xh = ch + m∗h ;

h = u; d;

∗ ∗ xhp + xhp ; = chp + chp

where xhp and chp are the production and consumption of the home produced good, respectively. In the labor market, wages wH and wL are given and hence employment is such that marginal productivity of labor equates wage. In equilibrium, employed and unemployed skilled (resp., unskilled) workers sum up to the skilled (resp., unskilled) labor endowment. In order to avoid corner solution, endowments are assumed to be always higher than the equilibrium employment level, i.e., HP ¿ H

and

LP ¿ L:

(4.1)

Using the factor demand equations (3.6) and (3.9) in equilibrium yields LP ¿ nu and HP ¿ (1 − )nd pd =wH . Thus, the number of 1rms in a location is restricted by the endowments levels. These hereinabove inequalities provide interesting constraints on the relative wage when evaluated at the autarkic equilibrium. 4.2. The general equilibrium Using products and factors market conditions and free-entry and market-clearing conditions for domestic and foreign countries simultaneously yields the equilibrium number of 1rms, employment levels and prices. In the following sections, I study how these equilibrium values change as trade costs decrease. I analyze the autarky situation, ( = ∞), the vertical specialization situation, (low ), and the agglomeration situation (“intermediate”  in between).

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5. The autarky equilibrium If trade costs are in1nite, the price of a foreign good ph , h = d; u becomes in1nite and thus countries do not trade. It is the autarkic equilibrium. At high but 1nite trade costs, there is some trade but it is highly expensive to ship intermediate and 1nal goods from one country to the other and hence there is a positive number of both upstream and downstream 1rms in each country. This is the quasi-autarkic situation. As the autarkic equilibrium will be used as a benchmark in the present paper, I compute the corresponding number of 1rms and employment levels. As preferences are Cobb–Douglas in the home production good and the aggregate of downstream goods, a share  of income is spent on the latter. This implies that Cd =I=Pd , where Cd is the demand for manufactured goods. Using the aggregate downstream good (3.2), the price index evaluated at autarkic trade costs, Pd = nd1=(1−) pd , and the market clearing condition, and substituting yields nd as de1ned hereinbelow. Similarly, as downstream 1rms use a Cobb–Douglas composite of skilled labor and upstream goods, a share  of total cost is spent on the latter. Moreover, the zero pro1t condition implies that total revenue equals total cost, therefore, Pu Cui = pd . Also, in autarky, Cui = nu=(−1) =nd . 12 Using the price index evaluated at autarkic trade costs, Pu = nu1=(1−) pu , the autarkic number of downstream 1rms and substituting yields nu as de1ned hereinbelow. nd =

I ; pd

nu =

I : pu

Using the factor demand equations, (3.6) and (3.9), and the above expressions for nd and nu yield the autarkic equilibrium levels of employment L=

I ; wL

H=

(1 − )I : wH

In autarkic equilibrium, it can be shown that total income is such that I = !IP where ! = (1 − (1 − 1 ))−1 (see the Appendix). Substituting back provides the autarkic equilibrium number of 1rms and employment levels in term of the exogenous variables. Using the expressions for nd and nu in the endowment constraints (4.1), assuming that LP ¿ HP , and rearranging yields the interesting result that relative wage should be greater than the relative share of skilled labor in 1nal goods production, i.e., wH =wL ¿ (1−)=. Intuitively, if it were not the case downstream 1rms would exhaust the endowment in skilled labor and we would reach a corner solution.

12 C is the aggregate of di-erentiated upstream goods demanded by a downstream 1rm i. In equilibrium, ui pu is constant over varieties. A representative downstream 1rm therefore demands the same quantity of =(−1) i i , is the demand of a downstream 1rm i for a cuk , where cuk each variety k. Thus, in autarky Cui = nu i , where c variety k of the domestic upstream good. Also cuk = nd cuk uk is the total demand for variety k. In =(−1)

equilibrium, cuk = xuk = 1 and thus, Cui = nu

(1=nd ).

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6. The vertical specialization equilibrium At low trade costs, access to market (i.e., being close to the demand for 1nal goods) and vertical linkages in4uence only partially a 1rm’s location decision. The price of the immobile factors is the force that matters. Because downstream and upstream 1rms di-er in their intensities of labor-factors, stages of production tend to locate in di-erent countries—vertical specialization occurs. Variations in the number of 1rms shift labor demand and hence modify employment levels. I 1rst de1ne the levels of trade costs at which vertical specialization is the unique equilibrium, then I analyze the change in the equilibrium number of 1rms and employment levels with respect to the autarkic situation. For clarity, it is useful to de1ne the following ratios: 1=(1−)    (nu =n∗u )#L1− + 1− wL wH Pu #L = ∗ ; #H = ∗ = and $ = : wL wH Pu∗ (nu =n∗u )#L1− 1− + 1 If trade incurs low costs, 1rms 1nd it pro1table to locate where their production costs are the lowest. Thus, as shown in Proposition 6.1, for some low , all upstream 1rms locate in the foreign country—where unskilled labor is cheaper. The intermediate goods are shipped to the domestic country where all downstream 1rms locate because of cheaper skilled labor in such location. Downstream 1rms satisfy the world demand in 1nal goods. Di-erent stages of the production process locate in di-erent countries— vertical specialization occurs. Proposition 6.1. For su:ciently low value of , such that #L ¿  and #H−1 $− ¿ , vertical specialization is the unique equilibrium, i.e., nd ¿ 0, n∗d = 0, nu = 0, n∗u ¿ 0. Proof. See the Appendix. Owing to specialization and gain from trade, the number of downstream (resp., upstream) 1rms in the domestic (resp., foreign) country is higher under vertical specialization than under autarky. Changes in the number of 1rms translate to employment levels and, as a result, employment inequality increases in the domestic country and decreases in the foreign country. 13 Comparing numbers of 1rms and employment levels under vertical specialization equilibrium and autarkic equilibrium con1rms such assertions. In what follows, superscripts a and v, respectively, denote variables under autarky and vertical specialization equilibrium. As for the autarkic equilibrium, we can compute the number of 1rms in the vertical specialization equilibrium and express income in term of endowments. It yields nd =

(I + I ∗ ) (I + I ∗ ) and n∗u = pd wL∗

with I + I ∗ = !(IP + IP∗ ):

13 Recall: Employment inequality is de1ned as the di-erence between the share of skilled employed in skilled population and the share of unskilled employed in unskilled population.

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Proposition 6.2. Under free trade, there are more upstream rms in the foreign country than under autarky and there are more downstream rms in the domestic country ∗a v a than under autarky, i.e., n∗v u ¿ nu and nd ¿ nd . Proof. See the Appendix. As shown in Proposition 6.2, international trade becomes more vertically specialized as trade costs decrease. In fact, several studies have evidenced such increase in vertical specialization for various countries (e.g., Campa and Goldberg, 1997; Strauss-Kahn, 2004; Yi, 2003). Proposition 6.3. Employment inequality, de ned as the di=erence between the share of skilled employed in skilled population and the share of unskilled employed in unskilled population, increases in the domestic country and decreases in the foreign country. Proof. See the Appendix. Proposition 6.3 shows that, in a context of 1xed wages, a decrease in trade costs results in an increase in employment inequality in the high unskilled-wage country. 14 This 1nding is consistent with the evidence presented in the Introduction. For example, it captures the fact that wages in France remained stable over the 1981–1994 period, whereas employment di-erential increased by 95% for the same period. Results on employment inequality are further discussed in Section 8. 7. The agglomeration equilibrium At some intermediate levels of trade costs, an agglomeration process occurs as a consequence of vertical linkages between upstream and downstream 1rms. If the use of intermediate goods by downstream 1rms is important (i.e., if  is high enough), the vertical linkages are strong and 1rms 1nd it pro1table to locate in the same place. Demand and cost linkages reinforce each other and their combination leads to a circular causality that entails the clustering of production activity in one location. Importantly, if relative wages di-er across countries, one may determine the country in which the agglomeration takes place. 15 Furthermore, and in contradiction with the literature, there is a broad range of trade costs at which the agglomeration equilibrium is unique. In this Section, I aim at examining the agglomeration process and identifying some elements that may help us understanding its mechanism. Although the dimensionality 14 Such result implicitly assumes that the share of skilled employed in skilled population is bigger than the share of unskilled employed in unskilled population in autarky. Data from the OECD Employment Outlook (1997) con1rm such assumption. The share of skilled employed in skilled population is 92.5% in France, 94.5% in Norway, 91.3% in the U.K. and 91.8% in the U.S. in 1981 whereas the share of unskilled employed in unskilled population is 80.3%, 83.1%, 71.7% and 69.8%, respectively. 15 Note that other asymmetries across countries (e.g., di-erence in factors endowments or factors productivities) would also allow the determination of the agglomeration country.

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of the model limits the extent of analytical results, I identify conditions under which agglomeration takes place. In the next section, simulations of the model corroborate the existence of such agglomeration equilibria and allow further analysis on the impact of globalization on employment inequality. There is a range of trade costs at which all upstream 1rms locate in the foreign country (Proposition 6.1). Within this range of , if the equilibrium share of downstream 1rms in the foreign country is higher than its autarkic equilibrium level, then there is agglomeration in the foreign country as the shares of both types of 1rms would have increased in that location. Dual to Proposition 6.1,  ¿ #H(−1)=(+1) is a necessary condition for downstream 1rms to locate in the foreign country. Thus, if #L ¿  ¿ #H(−1)=(+1) , all upstream 1rms locate in the foreign country and the necessary condition for downstream 1rms to locate in the foreign country holds. The following propositions shed some light on the agglomeration process. First, as shown by Proposition 7.1, the more upstream 1rms in the foreign country, the stronger the cost linkage attracting downstream 1rms in that country. Thus, if nu = 0, n∗u ¿ 0, the cost linkage is very strong and agglomeration in the foreign country is likely. Proposition 7.1. The lower the relative number of upstream rms, nu =n∗u , the stronger the cost linkage. Proof. The price of domestic intermediate goods relative to foreign intermediate goods, $=Pu =Pu∗ , is increasing in the relative number of upstream 1rms, i.e., @$=@(nu =n∗u ) ¡ 0. See the Appendix. Second, as stated hereinabove,  ¿ #H(−1)=(+1) is a necessary condition for an agglomeration equilibrium in the foreign country. A more stringent but also more intuitive necessary condition is that the cost linkages be stronger than the factors price forces (Proposition 7.2). Three factors make this condition more likely to hold: (i) high share of intermediate goods used in 1nal goods’ production (i.e., high ), because it re4ects strong vertical linkages, (ii) high relative unskilled wage, because it attracts a large number of upstream 1rms in the foreign country thereby reinforcing the cost linkage and (iii) low relative skilled wage, because it lessens the factors price force. Proposition 7.2. If the cost linkage is stronger than the factors price force, the necessary condition for an agglomeration equilibrium in the foreign country holds. Proof. The necessary condition for 'd∗ ¿ 'd is #H1− $ ¿ 1=. If #H1− $ ¿ 1, then the necessary condition holds. It is equivalent to    ∗ 1− Pu wH ¿ : ∗ Pu wH The relative price of intermediate goods, up to the share at which intermediate goods enter the production of 1nal goods, is greater than the relative skilled wage, up to the share at which skilled labor enters the production of 1nal goods.

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This condition, that links vertical linkages and factors price force, is interesting because it re4ects the trade-o- faced by a 1rm. If countries are asymmetric in their factors prices and 1rms are vertically linked, a 1rm’s location decision depends on the relative strength of the forces that drive location—namely vertical linkages and factors prices. 16 Thus, trade and production patterns depend on both trade cost levels and countries speci1cities. A country that has a comparative disadvantage in one of its factors (e.g., skilled wages are relatively high in the foreign country) may enjoy agglomeration of production within its border if (i) it o-ers a strong comparative advantage in another factor of production (e.g., unskilled wage is signi1cantly lower in the foreign country) and (ii) if trade costs are substantial (recall that low trade costs entail vertical specialization). Similarly, agglomeration in the domestic country may be an equilibrium if the cost linkage is weaker than the factors price force (i.e., #H−1 ¿ $ ). At high relative skilled wage, such inequality is a likely outcome. In fact, Proposition 6.1 shows that, at trade costs levels such that $− #H−1 ¿ , downstream 1rms 1nd it pro1table to locate in the domestic country.  ¿ #L is a necessary condition for upstream 1rms to locate in such domestic country. Thus, for $− #H−1 ¿  ¿ #L , agglomeration in the domestic country is likely to occur. 8. Discussion and simulation Simulations of the model are plotted in Figs. 1 and 2. They provide an overview of the equilibrium structures of production and employment levels as trade costs vary. In each 1gure, the two 1rst graphs sketch the relationship between the share of 1rms in the domestic country (i.e., the ratio of the number of type-h 1rms locating in the domestic country to the total number of type-h 1rms, where h= upstream or downstream) and the level of trade costs. The last graph sketches the relationship between the employment di-erential in the domestic country and the level of trade costs. In Fig. 1, the relative skilled wage is assumed largely above unity whereas the relative unskilled wage is assumed close to one. Fig. 2 presents opposite features. 17 Simulations con1rm the results discussed in previous sections. At high level of trade costs,  ¿ t1 , both the domestic and foreign countries produce both downstream and upstream goods and the shares of 1rms in each country do not vary signi1cantly. This is the quasi-autarkic situation. At low trade costs, t3 ¿ , location decisions depend on relative factors prices. In equilibrium, the share of downstream 1rms in the domestic country is higher than in autarkic, whereas the share of upstream 1rms is lower—vertical specialization occurs. Finally, for a range of intermediate trade costs, t1 ¿  ¿ t3 , the shares of both types of 1rms increase in one country as compared to their autarkic levels—an agglomeration process takes place. 16

Recent empirical evidences (e.g., Davis and Weinstein, 1998; Torstensson, 1997) support the relevance of both agglomeration e-ects and comparative advantage in a-ecting trade and production patterns. 17 The parameters’ values in the simulations are as follows:  = 0:7,  = 4,  = 0:55. These parameters are consistent with parameters used by Krugman and Venables (1995) and Venables (1996). In Fig. 1, ∗ = 0:5, whereas in Fig. 2, w =w ∗ = 2 and w =w ∗ = 0:8. wL =wL∗ = 1:15, wH =wH L L H H

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(1) Share of Downstream Firms in the Domestic Country nd/(nd+nd*) 1.2 1.0

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t ∗ = 0:5. Fig. 1. wL =wL∗ = 1:15 and wH =wH * Employment Di-erential in the Domestic Country is de1ned as the di-erence between the share of skilled employed in skilled population and the share of unskilled employed in unskilled population. Note: Area I corresponds to Quasi Autarkic Equilibrium, Area II corresponds to Agglomeration Equilibrium; Area III corresponds to Vertical Specialization Equilibrium. (a) represents the autarkic level.

In order to better analyze the di-erent equilibria presented in the simulation, it is important to clarify the trade-o- faced by the 1rms. Downstream 1rms face a trade-obetween a lower skilled wage in the domestic country and a lower intermediate goods price in the foreign country (the cost linkage). 18 Upstream 1rms face a trade-o18 The lower intermediate goods price in the foreign country is driven by the lower cost of unskilled labor in that location.

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(1) Share of Downstream Firms in the Domestic Country nd/(nd+nd*)

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t ∗ = 0:8. Fig. 2. wL =wL∗ = 2 and wH =wH * Employment Di-erential in the Domestic Country is de1ned as the di-erence between the share of skilled employed in skilled population and the share of unskilled employed in unskilled population. Note: Area I corresponds to Quasi Autarkic Equilibrium, Area II corresponds to Agglomeration Equilibrium; Area III corresponds to Vertical Specialization Equilibrium. (a) represents the autarkic level.

between a lower unskilled wage in the foreign country and a potentially greater demand for their goods in the domestic country (the demand linkage). The magnitude of the trade-o- determines the equilibrium. Such magnitude depends on the levels of trade costs and on the cross-country wage asymmetry. In the framework of Fig. 2, upstream 1rms make location decision in a context of large cross-country di-erence in unskilled wages whereas downstream 1rms face a small cross-country di-erence in skilled wage. In such situation, factors price forces a-ect upstream 1rms more strongly than downstream 1rms. Upstream 1rms 1nd it

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pro1table to locate in the foreign country. A downstream 1rm also 1nds it pro1table to locate in the foreign country if gains from lower inputs price (cost linkage) outweigh losses from higher skilled wage. In the framework of Fig. 1, downstream 1rms make location decision in a context of large cross-country di-erence in skilled wages, whereas upstream 1rms face a small cross-country di-erence in unskilled wage. Following the rationale mentioned hereinabove, downstream 1rms 1nd it pro1table to locate in the domestic country. Upstream 1rms also 1nd it pro1table if demand linkages outweigh higher unskilled wage. With these trade-o-s in mind, we can now investigate the features presented in the simulations. We will examine the equilibria, analyze the speci1cities of the 1xed wage assumption and discuss the two main results of this paper—the uniqueness of the equilibrium and the impact of lower trade costs on employment inequality. 8.1. On rms location Fig. 2 features equilibria where agglomeration and vertical specialization are total (i.e., all same-type 1rms locate in the same country). In contrast, Fig. 1 presents equilibria with a positive number of both types of 1rms in both countries. The di-erence between the two 1gures helps understanding how the 1xed factor price assumption matters. In Fig. 2, downstream 1rms 1nd it pro1table to locate in foreign if cost linkages overcome the relatively high skilled wage. Because of the 1xed factor price assumption, if one downstream 1rm choose to relocate in the foreign country, all downstream 1rms do and the relocation is total. In Fig. 1, upstream 1rms 1nd it pro1table to locate in the domestic country if demand linkages overcome the relatively high unskilled wage. Ceteris paribus, when more upstream varieties are produced in one location, the index price of the upstream good is lower so that local demand for each upstream good is smaller—the demand linkages lessen. In equilibrium, if more upstream varieties produced in the domestic country then the relative intermediate goods price, Pu =Pu∗ , is lower. For downstream 1rms, the cost of a higher skilled wage in the foreign country is equivalent to the cost of a higher index price of upstream good in the domestic country. There are some 1rms of both types in both countries. 19 Thus, if 1rms’ relocation modi1es the forces at play, full specialization and agglomeration do not occur. This feature is also true in a framework of 4exible wages where wages are endogenously modi1ed as numbers of 1rms vary in each location. More generally, it is interesting to compare this paper’s results with the results developed in the 4exible wage version of the model (Strauss-Kahn, 2001). In the 4exible wage model, countries di-er in their factors endowments and factors prices adjust to factors demand. Lower equilibrium numbers of 1rms result in lower demand for labor and hence lower wages. However, there is always full employment 19 In Fig. 1, the share of downstream 1rms in the domestic country follows a U-shape. The decreasing part corresponds to agglomeration equilibria whereas the increasing part corresponds to vertical specialization equilibria. Within the range of trade costs in which there is agglomeration, i.e., t1 ¿  ¿ t3 , a lower  implies weakened demand linkage and hence a lower share of upstream 1rms in the domestic country. Because of the cost linkage, some downstream 1rms locate in the foreign country and hence the share of downstream 1rms in the domestic country is lower. A similar rationale lies behind the increasing part of the curve.

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of both factors. Qualitative results on location are similar in both papers. There is a range of trade costs at which there is agglomeration—a lower range at which vertical specialization occurs. The main di-erence—besides getting insight on employment inequality—relates to the characterization of the equilibrium. If wages are 4exible, the number of same-type 1rms in a location matters not only because of its implication on vertical linkages but also because it a-ects factor prices. This feature tends to smoothen the pattern of equilibria. There are neither a jump from one equilibrium to the other nor total agglomeration or specialization. In search of analytical results, the 1xed wage assumption has however proved helpful. Using 1xed factors prices pins down 1rms cost and thus allows the determination of a unique equilibrium for a range of trade costs. In fact, whereas multiple equilibria are a standard result in the new economic geography literature, in this paper the equilibrium is unique for most levels of trade costs. The unique agglomeration equilibrium stems from the asymmetry in factor prices across countries. In Krugman and Venables (1995) or Venables (1996), agglomeration results from a combination of high trade costs and vertical linkages between 1rms. Firms 1nd it pro1table to locate in the same location; however, as countries are similar, the equilibrium is multiple. The model cannot predict whether the activity clusters in the domestic or the foreign country. In contrast, if countries are not symmetric, other forces than the vertical linkages are at play—in this paper, the di-erence in factors prices. A combination of trade costs, vertical linkages and relative factors prices in4uence a 1rm’s location decision and result in the 1rms’ trade-o-, as de1ned hereinabove. While the vertical linkages drive the agglomeration, factors price forces help determining the country in which the agglomeration occurs. Let us assume that countries di-er mainly in their relative unskilled wage and trade costs drop from autarkic levels to any levels in the [t2 ; t3 ] range. Even if downstream 1rms 1nd it pro1table to locate in the domestic country because of factor cost advantages, upstream 1rms rather locate in the foreign country because the large di-erence in unskilled wages overcomes the demand linkage. As the relative number of upstream 1rms increases in the foreign country, downstream 1rms 1nd it pro1table to locate in such foreign country because gains from cost linkages outweigh losses from factors price cost. Thus, the pressure that the relative unskilled wage puts on upstream 1rms (and thereby on downstream 1rms) is suWcient to guarantee that the agglomeration occurs in the foreign country. At high intermediate trade costs, t ∈ [t1 ; t2 ], the di-erence in relative unskilled wage is not suf1cient to overcome the demand linkage. That is, although countries have asymmetric factors prices, because of high trade costs, vertical linkages are strong and dominate 1rms’ location decisions. 20 This results in the familiar multiple equilibrium scenario. The intuition is reversed in the case of a prevailing di-erence in relative skilled wages. Finally, a sensibility analysis shows that higher values of —which re4ects large input–output coeWcient and hence strong vertical linkages—increase the range of trade costs at which agglomeration occurs in equilibrium. Lower values of —which re4ects 20

O- equilibrium, if some downstream 1rms start relocating in the domestic country to take advantage of relatively low skilled labor cost, the demand linkage overcomes the relatively high unskilled wage and upstream 1rms also relocate in the domestic country.

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small elasticity of substitution between varieties—have similar e-ects. On the contrary, a larger di-erence in factor prices increases the range of trade costs at which vertical specialization is the equilibrium. 8.2. On employment inequality Results on employment inequality appear to be consistent with the Continental Europe experience. Employment inequality is higher in the high-unskilled wage country (i.e., domestic country) under both vertical specialization and domestic-agglomeration than under autarky. As the share of skilled workers increases within-industry (recall that downstream and upstream productions correspond to di-erent stages of production of the same 1nal good), vertical specialization and domestic-agglomeration shift labor in a way observationally equivalent to that of skilled-biased technological change. 21 Whereas traditional trade theory fails to capture such observed within-industry changes, vertical specialization or agglomeration provide a trade explanation of the increased inequality. Several empirical studies actually con1rm the contribution of vertical specialization to the observed within-industry increase in skilled–unskilled inequality. In accordance with the 1xed wage assumption, Feenstra and Hanson (1996) and Gorg et al. (2001) examine the impact of vertical specialization on wage bills for the U.S. and Ireland respectively, whereas Brenton and Pinna (2001) and Strauss-Kahn (2004) estimate the vertical specialization’s impact on employment di-erential for Italy and France, respectively. The vertical specialization analysis does not however re4ect the experience of low-unskilled wage countries which also show an increase in skilled–unskilled inequality (in wage or employment). The fact that skilled-biased technological change and vertical specialization have opposite e-ects on skilled–unskilled workers inequality in low-unskilled wage country may help explaining this bad prediction as skilled-biased technological change is likely to be the dominant factor. In models where relocation of production implies improvement in production technology— as in Feenstra and Hanson (1996), which introduces capital movement, or Tre4er and Zhu (2001), which includes some technological catch-up—it is actually possible to capture the observed joint increase in inequality. 22 Importantly, we also observe an increase in skilled–unskilled inequality in the domestic country if in equilibrium the agglomeration occurs in the domestic country. Such a result is a consequence of the substitutability between skilled labor and intermediate goods in 1nal goods production combined with the cross-country di-erence in factors prices. The rationale is the following: owing to the di-erence in relative factors prices, downstream 1rms in the domestic country are more skilled-labor intensive than their foreign counterparts. If 1rms agglomerate in the domestic country, such country gains both downstream and upstream 1rms. Because of the relatively high price of 21 Skilled-biased technological change, caused by the di-usion of information technologies and computers as well as the adoption of new forms of work organization, is the other most likely culprit in explaining the within-industry increase in employment inequality between skilled and unskilled workers. 22 Note that, under some agglomeration equilibra, skilled–unskilled inequality increases simultaneously in both countries. While beyond the scope of this paper, analyzing such equilibria deserves further attention. Research in that direction is in progress.

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domestic intermediate goods, the demand for skilled labor increases relatively more than the demand for domestic intermediate inputs (i.e., for unskilled labor), resulting in an increase in the employment di-erential.

9. Conclusion This paper provides a theoretical contribution to the analysis of 1rms’ location decision and to the impact of such decisions on relative employment levels. I hereby speci1cally consider asymmetric countries and multiple factors of production. The main results establish that, if 1rms are vertically linked and if stages of production di-er in labor-factor intensity, then at intermediate trade costs, the agglomeration equilibrium may occur in either countries and such equilibrium is unique for most intermediate trade costs. At low trade costs, a 1rm locates where the labor-factor intensively used in its production is the cheapest. Di-erent stages along the production process locate in di-erent countries—vertical specialization occurs. Wages are assumed to be 1xed in order to examine labor-market outcomes in a Continental Europe context and hence analyze the e-ects of international economic integration on skilled–unskilled employment inequality. Vertical specialization increases such employment inequality in the high-unskilled wage country. Agglomeration of 1rms in the high-unskilled wage country also results in increased employment inequality in that country. Such results are consistent with the experience of several Continental Europe countries. Some results on co-movement in inequality across trading partners emerge in the agglomeration equilibrium. While beyond the scope of this paper, such results would deserve further attention and research e-orts in the future. Acknowledgements This paper corresponds to the second chapter of my Ph.D. dissertation. I am especially grateful to Raquel FernYandez, my advisor, for her valuable advice and guidance. For helpful comments and suggestions, I thank Bart Hobijn, Kei-Mu Yi, as well as seminar participants at New York University, INSEAD, The London School of Economics, Carlos III, Bocconi and the University of Cergy.

Appendix. The autarkic total income level. Total income is the sum of all employed and unemployed income in the economy I = vL L + vH H + vL (LP − L) + vH (HP − H ) which is equivalent to I = (1 − 1 )(vL L + vH H ) + IP where IP = vL LP + vH HP . Using factor demand equations, (3.6) and (3.9), yield I = (1 − 1 )(vL nu + (1 − )nd pd ) + IP. The autarkic equilibrium number of upstream and downstream 1rms are such that vL nu = nd pd , implying that I = (1 − 1 )nd pd + IP. Substituting back in the expression for nd , it implies that nd pd = IP=(1 − (1 − 1 )) and therefore, I = !IP where ! = (1 − (1 − 1 ))−1 .

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Proof of Proposition 6.1. Upstream 1rms decide to locate in the foreign country if the potential pro1t of a single 1rm is higher in foreign than in home, i.e., 'u∗ ¿ 'u . A single upstream 1rm located in the home country produces a quantity xu = xuho + xufo . It sells a quantity xuho in the home country at price pu and a quantity xufo = in the foreign country at price pu . Its cost of production is (xuho + xufo )wL . If the upstream 1rm were to locate in the foreign country, it could always chose to sell the same quantities at the same price and therefore make the same revenue. To sell xuho unit of the good in the home country, an upstream 1rm located in foreign has to produce a quantity xuho . Its cost of production is therefore (xuho + xufo =)wL∗ . Since xufo wL ¿ (xufo =)wL∗ , a suWcient condition for the cost to be higher in home than foreign (and therefore for 'u∗ ¿ 'u ) is xuho wL ¿ xuho wL∗ which is equivalent to #L ¿ : For this range of , no matter the initial distribution of upstream and downstream 1rms, upstream 1rms would 1nd it pro1table to enter the foreign market. In equilibrium nu =0, n∗u ¿ 0. Downstream 1rms decide to locate in the home country if the potential pro1t of a single 1rm is higher in home than in foreign, i.e., 'd ¿ 'd∗ . Using a similar proof than above, 'd ¿ 'd∗ if (xdho +xdfo )wH∗(1−) Pu∗ ¿ (xdho =+xdfo )wH1− Pu . A suWcient condition is #H−1 $− ¿ : For this range of , no matter the initial distribution of upstream and downstream 1rms, downstream 1rms would 1nd it pro1table to enter the home market. In equilibrium nd ¿ 0, n∗d = 0. Evaluated at nu = 0 (i.e., for any #L ¿ ), the suWcient condition for downstream 1rms to locate in the home country is equivalent to #H(−1)=(1+) ¿ . Hence for any  such that #L ¿  and #H(−1)=(1+) ¿ , vertical specialization is the unique equilibrium. Proof of Proposition 6.2. The number of upstream 1rms depends on income and on the unskilled wage. Since (I v +I ∗v ) ¿ I ∗a (recall: I ∗a =!IP and I v +I ∗v =!(IP + IP∗ )) then ∗a n∗v u ¿ nu . The number of downstream 1rms depends on income and on the downstream 1− ∗ v(=(1−)) ∗a v a v and pda = good’s price. Since n∗v u ¿ nu then pd ¡ pd (recall: pd = wH wL nu 1−  a(=(1−)) v ∗v a v a wH wL nu ). Using I + I ¿ I it yields nd ¿ nd . Proof of Proposition 6.3. Since nvu = 0 then Lv = 0. Thus Lv ¡ La . The autarkic equilibrium levels of skilled employment and its vertical specialization equivalent are H a = (1 − )I a =wH and H v = (1 − )(I v + I ∗v )=wH . Since (I v + I v∗ ) ¿ I a , thus P ¿ (H a = HP ) − (La = L). P H v ¿ H a . Then, (H v = HP ) − (Lv = L) ∗v ∗v Since nd = 0 then H = 0. Thus H ∗v ¡ H ∗a . The one to one relationship between the number of upstream 1rms and the level of employment in the upstream sector, ∗a ∗v ∗a ∗v P ∗ ∗v P ∗ ∗a P ∗ (3.6), implies that n∗v u ¿ nu → L ¿ L . Then, (H = H ) − (L = L ) ¡ (H = H ) − ∗a P ∗ (L = L ).

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Proof of Proposition 7.1 (Continued). @$ = (@$=@Nu )@Nu + (@$=@#L )(@#L =@Nu )@Nu

where Nu = (nu =n∗u );

@$=@Nu = $ =[(1 − )(Nu #L1− 1− + 1)2 ]#L1− (1 − 2(1−) ) ¡ 0; @$=@#L = $ =[(1 − )(Nu #L1− 1− + 1)2 ][Nu #L− (1 − )(1 − 2(1−) )] ¿ 0; |@$=@Nu | ¿ |(@$=@#L )(@#L =@Nu )| if #L ¿ Nu (1 − )@#L =@Nu which is always satis1ed. Hence @$=@Nu ¡ 0; @$=@#L ¿ 0; @#L =@Nu ¿ 0 and |@$=@Nu | ¿ |(@$=@#L ) (@#L =@Nu )|. References Amiti, M., 2001. Location of vertically linked industries: Agglomeration versus comparative advantage. CEPR Discussion Paper 2800. Benhabib, J., Rogerson, R., Wright, R., 1991. Homework in macroeconomics: Household production and aggregate 4uctuations. Journal of Political Economy 99, 1166–1187. Blanchard, O., Wolfers, J., 2000. The role of shocks and institutions in the rise of European unemployment: The aggregate evidence. Economic Journal 110, 1–33. Brenton, P., Pinna, A., 2001. The declining use of unskilled labour in Italian manufacturing: Is trade to blame? Paper presented at the European Trade Study Group (ESTG). Burstein, A., Neves, J., Rebelo, S., 2003. Distribution costs and exchange rate dynamics during exchange-rate-based-stabilizations. Journal of Monetary Economics 50, 1189–1214. Campa, J., Goldberg, L., 1997. The evolving external orientation of manufacturing: Evidence from four countries. NBER Working Paper 5919. Davis, D., Weinstein, D., 1998. Economic geography and regional production structure: An empirical investigation. NBER Working Paper 6093. Dixit, A., Stiglitz, J., 1977. Monopolistic competition and optimum product diversity. American Economic Review 67, 297–308. Ethier, W., 1982. National and international return to scale in the modern theory of international trade. American Economic Review 72, 389–405. Feenstra, R., 1998. Integration of trade and disintegration of production in the global economy. Journal of Economic Perspectives 12, 31–51. Feenstra, R., Hanson, G., 1996. Foreign investment, outsourcing and relative wages. In: Feenstra, R., Grossman, G., Irwin, D. (Eds.), Political Economy of Trade Policy: Essays in Honor of Jagdish Bhagwati. MIT Press, Cambridge, MA, pp. 89–127. Feenstra, R., Hanson, G., 2001. Global production sharing and rising inequality: A survey of trade and wages. In: Choi, K., Harrigan, J. (Eds.), Handbook of International Trade, Basil Blackwell, forthcoming. Fujita, M., Krugman, P., Venables, A., 1999. The Spatial Economy: Cities, Regions and International Trade. MIT Press, Cambridge, MA. Gorg, H., Hitjzen, A., Hine, R., 2001. International fragmentation and relative wages in the UK. Paper presentated at the European Trade Study Group (ESTG). Helpman, E., Krugman, P., 1985. Market Structure and Foreign Trade: Increasing Returns, Imperfect Competition and the International Economy. MIT Press, Cambridge, MA. Holmes, T., 1998. The e-ect of state policies on the location of manufacturing: Evidence from state borders. Journal of Political Economy 106 (4), 667–705. Krugman, P., 1991. Increasing returns and economic geography. Journal of Political Economy 99 (3), 483–499. Krugman, P., Venables, A., 1995. Globalization and the inequality of nations. Quarterly Journal of Economics 110, 857–880. Organisation for Economic Cooperation and Development (OECD), 1996–1997. Employment Outlook. OECD, Paris.

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Ottaviano, G., Puga, D., 1997. Agglomeration in the global economy: A survey of the new economic geography. CEPR Working Paper # 1699. Pfann, G., Van Kranenburg, H., 2003. Tax policy, location choices, and market structure. Journal of Law and Economics XLVI, 61–83. Ricci, L., 1999. Economic geography and comparative advantage: Agglomeration versus specialization. European Economic Review 43, 357–377. Strauss-Kahn, V., 2001. Globalization and wage premia: Reconciling facts and theory. INSEAD Working Paper 39/EPS. Strauss-Kahn, V., 2004. Does globalization participate in the French within-industry shift away from unskilled workers? In: Baldwin, R., Winters, A. (Eds.), Challenges to Globalization. Chicago University Press and NBER, pp. 209–230. Torstensson, J., 1997. Country size and comparative advantage: An empirical study. CEPR Discussion Paper 1554. Tre4er, D., Zhu, S., 2001. Ginis in general equilibrium: Trade, technology and southern inequality. NBER Working Paper 8446. Venables, A., 1996. Equilibrium locations of vertically linked industries. International Economic Review 37, 341–359. Yi, K.-M., 2003. Can vertical specialization explain the growth of world trade? Journal of Political Economy 111 (1), 52–102.