Abstract
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 apparent conflict with neoclassical theory, according to which trade should decrease the relative return on the relatively scarce factor, and thus decrease the skill premium in skill-scarce developing countries. We develop a simple model of trade with talent heterogeneity and capital market imperfections, and show that trade can increase the skill premium in a skill-scarce South that opens up to a skill-abundant North, both in the short run as well as in the long run. We show that trade has two effects: it reduces the skilled wage, and therefore drives non talented agents out of the skilled labor force. It also reduces the cost of subsistence, thereby allowing the talented offspring of unskilled workers to go to school. This compositional effect has a positive effect on the observed skill premium, potentially strong enough to outweigh the decrease in the skilled wage. In our framework, trade liberalization may trigger an increase in the skill-premium in both the North and the South.
Highlights
One of the most important results in Heckscher-Ohlin models of international trade, the Stolper-Samuelson theorem, predicts that when a country opens up to international trade - and its relative price of skill-intensive goods decreases - the return of unskilled workers should increase, relative to the return of skilled workers.[1]
When we look at the observed, average skilled premium in the economy, this talent re-allocation will make sure that trade always has a less negative effect on the skill premium than in a world with homogenous agents and no credit constraints
Our main results are contained in section ??, where we study the impact of trade liberalization on the observed skill premium in this economy
Summary
One of the most important results in Heckscher-Ohlin models of international trade, the Stolper-. We show that when this is the case, trade may improve the allocation of talent to the skilled labor force, both in the short and in the long run This compositional effect generates an upward pressure on the observed skilled wage, which can be strong enough to overturn the Stolper-Samuelson prediction of a lower skill premium in the South following trade liberalization. It reduces the cost of subsistence for unskilled workers, making it easier for their offspring to go to school Because many of these previously-excluded agents are highly talented, they may still find it optimal to join the skilled labor force despite the trade-induced drop in the skilled wage.
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