Labor Mismatch and Skill Premia

Abstract

Contrary to the predictions of the 2 × 2 × 2 Heckscher–Ohlin model, empirical evidence shows that trade liberalization causes the skill premium to increase in some developing countries and to decrease in others. This paper develops a North–South model in which complex and simple goods are produced. The former is produced using skilled workers, while the latter is produced using skilled and unskilled workers. Labor markets feature search frictions. In this context, trade liberalization increases the skill premium in the North, while the impact on the skill premium in the South depends on skill abundance. The higher the skill abundance in a developing country, the higher the average productivity among skilled workers compared with unskilled workers. This leads to a higher employment of skilled workers in simple occupations, or labor mismatch. Therefore, the increase in the price of the simple good in the South, due to trade liberalization, leads to an increase in the wage of the mismatched workers. This offsets any negative impact on the skill premium caused by the decrease in the wage of skilled workers in complex occupations or the increase in the wage of unskilled workers in simple occupations. The opposite impact on the skill premium takes place in countries that are less skill abundant in the South. A threshold empirical estimation, on 50 developing and developed countries, shows that there is a statistically significant skill abundance threshold, below which the coefficient on the relationship between openness and wage inequality is negative and above which the estimate is positive.