1 Empirical Identification of Inter-Sectoral General Equilibrium Impacts on Wages from Changes in Local Composition of Sectoral Employment and National Sectoral Wage Premia in Mexican Cities 1990-2000

Are there in practice general equilibrium (G.E.) mechanisms through which sectors, even the seemingly unrelated ones, interact with each other? In this study we use Mexican census data to exploit geographical variation in composition of sectoral employment in Mexican cities over time to see whether sectoral wages systematically change with the cities‟ composition of sectoral employment and/or national sectoral wage premia. We find ample evidence on the existence of a G.E. mechanism through which sectoral wages in each city causally depend on the rents generated by the city as measured by the city‟s employment-share weighted sum of national sectoral wage premia. The magnitude of this relationship is substantially larger than the conventional measures of the impact of changes in the employment composition of a city on the city‟s average wage. According to our estimates for the Mexican cities during 1990-2000, a compositional change in a city that decreases the average wages in that city by one dollar keeping the sectoral wage levels unchanged (i.e., ignoring the G.E. impact on local wages according to the conventional composition-adjustment approach) will in the long-run result in more than three dollar decrease in the average wages in that city; an inter-sectoral G.E. impact on wages in local economies that is at least three times the conventional measures. An impact of this magnitude calls for excessive caution, especially in the less developed countries, in implementing industrial or trade policies that may result in severe loss of good jobs or enormous relocation of work force at the expense of high paying sectors. In addition, this finding emphasizes the need for a holistic approach in welfare analysis of such policy changes