International Trade and Income Inequality*

Abstract

Abstract We propose a simple theory that shows a mechanism through which international trade entails wage and job polarization. We consider two countries in which individuals with different abilities work either as knowledge workers, who develop differentiated products, or as production workers, who engage in production. In equilibrium, ex ante symmetric firms attract knowledge workers with different abilities, and this creates firm heterogeneity in product quality. Market integration disproportionately benefits firms that produce high‐quality products. This winner‐take‐all trend of product markets causes a war for talents, which exacerbates income inequality within the countries and leads to labor‐market polarization.