Working Paper: CEPR ID: DP8286
Authors: Roberto Bonfatti; Maitreesh Ghatak
Abstract: An interesting puzzle is that trade liberalization in the 1980s and 1990s has been associated with a sharp increase in the skill premium in both developed and developing countries. This is in contrast with neoclassical theory, according to which trade should increase the relative return of the relatively abundant factor. We develop a simple model of trade with capital market imperfections, and show that trade can increase the skill premium in both the North and the South, and both in the short run as well as in the long run. We show that trade with a skill-intensive economy has two effects: it reduces the skilled wage, and thus discourages non talented agents out of the skilled labor force; and it reduces the cost of subsistence, thus allowing the talented offspring of unskilled workers to go to school. This compositional effect has a positive effect on the observed skill premium, possibly strong enough to counterweight the decrease in the skilled wage.
Keywords: credit market frictions; latin america; skill premium; trade liberalization
JEL Codes: F16; O15; O16
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| trade liberalization (F13) | increase in skill premium (J24) |
| trade reduces skilled wage (F16) | discourage non-talented individuals from entering skilled labor force (J24) |
| trade lowers cost of subsistence (F16) | allows talented offspring of unskilled workers to pursue education (J24) |
| increase in average quality of skilled labor force (J24) | upward pressure on observed skill premium (J24) |
| trade (F19) | increase in average quality of skilled labor force (J24) |
| degree of talent misallocation prior to trade liberalization (F16) | moderates effect of trade on skill premium (F16) |