Artificial Intelligence, Competition, and Welfare

We study how market power in artificial intelligence (AI) shapes wages and welfare in open-economy general equilibrium by treating AI as a priced, imported factor. Across three models, we separate technical efficiency from the impact of upstream price setting. In a two-traded-goods benchmark, the incidence of AI price changes depends on how sectoral skill intensity changes with AI prices; non-monotone intensity can generate “double harm” for unskilled workers (lower real wage after a large decrease in the price of AI, and real wage decreases further when the AI price rises as a result of market power). With one non-traded sector, we observe that the classic “Dutch disease” effect here would arise when one sector gets more productive and draws labor away from other sectors, creating scarcity and raising prices; but this is not what we expect from the introduction of labor-substituting AI. In contrast, our last model considers two non-traded sectors and CES/free entry, and the opportunity for discrete adoption of technology that replaces unskilled labor from the AI-using sector. When AI reduces unit costs and increases variety, it will not pull U from non-tradables, instead it will displace workers from the AI-using sector and lower wage due to diminishing returns in alternative sectors. Strategic upstream pricing of AI then harms welfare through unit-cost (usage fees) and variety (access fees) channels, with income leakage abroad. We derive an adoption frontier tying feasible usage prices to displaced workers’ outside options and show a monopolist typically prices on this boundary; capping one instrument shifts rents to the other. Broad gains for the adopting country relies on pressure (or regulation) on both usage and access fees and as well as policy that supports productive absorption of displaced labor. The framework clarifies when AI can lower real wages and aggregate welfare despite efficiency gains.