Trade, Inequality, and the Endogenous Sorting of Heterogeneous Workers

This paper presents a unified framework to investigate the effect of international trade on the increase of inequality in both high- and low-income countries. I embed workers’ Roy-like occupational choice problem into a multi-country, multi-industry, and multi-factor trade model to study the distributional effect of trade at a disaggregate level. Workers are heterogeneous in their industry- and occupation-specific productivities, and they sort into the industry and occupation in which they have a comparative advantage. International trade impacts this sorting mechanism and, as a consequence, makes gains from trade different across workers. I quantify the model for 33 countries, 5 worker types defined by educational attainment, 4 industries, and 5 occupation categories to examine the distributional effect of changes in trade costs and changes in China’s productivity between 2000 and 2010, using the microdata from household surveys of each country. I find that (1) trade increases between-educational-type inequality in both high- and low-income countries, which is a significant departure from the traditional Stolper-Samuelson prediction; (2) occupation-level labor reallocation is an important channel by which trade increases between-educational-type inequality in most countries; and (3) international trade contributes to the contraction of manufacturing employment and job polarization in high-income countries.