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Skill Premium and Trade Puzzles: A Solution Linking Production and Preferences

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  • Caron, Justin
  • Fally, Thibault
  • Markusen, James R.

Abstract

International trade theory is a general-equilibrium discipline, yet most of the standard portfolio of research focuses on the production side of general equilibrium. In addition, we do not have a good understanding of the relationship between characteristics of goods in production and characteristics of preferences. This paper conducts an empirical investigation into the relationship between a good's factor intensity in production and its income elasticity of demand in consumption. In particular, we find a strong and significant positive relationship between skilled-labor intensity in production and income elasticity of demand for several types of preferences, with and without accounting for trade costs and differences in prices. Counter-factual simulations yield a number of results. We can explain about half of “missing trade”, and show an important role for per-capita income in understanding trade/GDP ratios, the choice of trading partners, and the composition of trade. Furthermore, an equal rise in productivity in all sectors in all countries leads to a rising skill premium in all countries, with particularly large increases in developing countries.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8999.

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Date of creation: Jun 2012
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Handle: RePEc:cpr:ceprdp:8999

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Keywords: gravity; income; missing trade; non-homothetic preferences; skill premium;

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Cited by:
  1. Claudia Bernasconi, 2013. "Similarity of income distributions and the extensive and intensive margin of bilateral trade flows," ECON - Working Papers 115, Department of Economics - University of Zurich.

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