Vertical Specialization and Wage Inequality: A Simple Model of Monopolistic Competition

Abstract

We analyze the relationship between vertical specialization and skilled unskilled wage inequality by using a monopolistic competition model in which firms can disintegrate their production activities between countries. We develop a new diagrammatic exposition to show that vertical specialization arises, i.e., a country produces final goods by using domestic labor with imported inputs and exports final goods abroad. We show that a country with a larger share of vertical specialization has greater wage inequality.