Labor Market Participation, Income Distribution, and Welfare Gains from Trade

This paper studies a household model in which households consume both goods available from the markets and a home good and allocate their time between working and home production. Households differ in their skills and hence income. The household model predicts a monotonic relationship between household labor participation rate and skill/income, and the direction depends on whether the market-good composite and the home good are substitutes or complements. We test the model predictions with Taiwanese household income survey data. The empirical evidence is in support of the theory for the case where the market and home goods are substitutes instead of complements. In contrast to the trade literature, in which most models feature inelastic labor supply, we study the role of the labor-participation mechanism by embedding the household model into the Ricardian trade model of Eaton and Kortum (2002). Our calibrated model suggests that the welfare gains from trade is only 46% of those in the Eaton-Kortum model, showing a strong dampening effect due to this mechanism.