Abstract
We argue that the narrative of variety-induced gains from trade in differentiated goods needs revision. If producing differentiated varieties of a good requires differentiated skills and if the work force is heterogeneous in these skills, then firms are likely to have monopsony power. We show that trade then has adverse labor market effects: It increases the monopsony power of firms and worsens the average quality of matches between firms and workers. We also show that international migration has the opposite beneficial effects. Our model can explain two-way migration among similar countries, a pattern that features prominently in migration data.
Highlights
Modern theory of international trade emphasizes four channels for welfare gains from trade based on product differentiation and increasing returns to scale
We propose an important qualification to the common narrative of of varietybased gains from trade
Traditional models of monopolistic competition stress the importance of a large resource base for a large degree of product differentiation, if production is subject to a non-convex technology
Summary
Modern theory of international trade emphasizes four channels for welfare gains from trade based on product differentiation and increasing returns to scale. If trade reduces the number of firms in any one economy, this has an adverse effect on the average quality of matches between workers and firms, which runs counter to the economies of large scale production emphasized by modern trade literature.5 Secondly, it aggravates the labor market distortion caused by monopsony power, meaning a larger markup between the marginal productivity of labor and the wage rate, which runs counter to the pro-competitive effects on goods markets highlighted in variable markup models of modern trade theory. Two-way migration does occur within groups of skilled individuals and migration helps solving a labor market imperfection In their model migration is driven by vertical skill differentiation among workers, whereas we focus on horizontal differentiation related to product differentiation, which, as argued in the introduction, is the hallmark of modern trade.
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