Input-Trade Liberalization and Formal Employment: Evidence from Mexico

This work investigates the role of input-trade liberalization on labor allocation between informal and formal employment in Mexico. Using individual household data for Mexico (1993-2001), we exploit exogenous input tariff changes applied to United States (U.S.) products when Mexico enters the North American Free Trade Agreement (NAFTA) in 1994. The theoretical mechanisms considered are the foreign input cost reduction that increases revenues in the formal sector and the foreign input-skilled biased channel, such that input-trade liberalization induces the reallocation of workers from informal to formal firms. Our findings confirm these mechanisms: individuals working in manufacturing industries experiencing the average reduction in input tariffs (12 percentage points) are almost 4 percent more likely to work in formal rather than informal occupations. This effect is concentrated on high-skilled workers which reinforces the input-skilled biased complementarity channel