Formal Education, Trade and Income Distribution

Purpose – The purpose of this study is to set up a 2 stage model and to explain how formal education produces human capital embodied in students with capital and how the segregation of labor by education changes the factor endowment of a country and how trade has a significant effect on the relative price of educated labor in terms of uneducated labor and employment of each labor. Design/methodology/approach - This study was designed to extend the standard trade model(HOS trade model) into the trade model, which contains multiple factors: land, uneducated labor, and human capital produced by formal education. To establish this trade model, a mathematical approach was chosen which can use algebra, geometry and calculus. Findings – According to the traditional trade model(HOS trade model), under free trade, it predicts that the return of the relatively abundant factor will be increased in each country and that factor prices will be equalized across countries. Based on the model set up in this paper, when trade is liberalized, if there is a difference in education capital between two countries, the relative prices of educated labor in terms of uneducated labor converge between two countries. If there is a difference in arable land endowment between two countries, the relative prices diverges between two countries. The trade effect on income distribution of two labors is ambiguous. Whether the relative wage converges or diverges, depends on the difference in “trade effect of education capital” and “trade effect of arable land.” It shows the possibility to explain why income inequality across countries are aggravated. Research implications or Originality – This model made an attempt to integrate labor market segregation through formal education into the trade model. It will be beneficial in explaining how education has an effect on the accumulation of human capital and segregation of a labor market, and how trade plays a decisive role on the determination of the relative wages of two labors or income distribution, based on those circumstances.