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Trade and the Skill Premium Puzzle with Capital Market Imperfections

  • Roberto Bonfatti
  • Maitreesh Ghatak

An interesting puzzle is that 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 contrast with neoclassical theory, according to which trade should increase the relative return of the relatively abundant factor. We develop a simple model of trade with capital market imperfections, and show that trade can increase the skill premium in both the North and the South, and both in the short run as well as in the long run. We show that trade with a skill-intensive economy has two effects: it reduces the skilled wage, and thus discourages non talented agents out of the skilled labor force; and it reduces the cost of subsistence, thus allowing the talented offspring of unskilled workers to go to school. This compositional effect has a positive effect on the observed skill premium, possibly strong enough to counterweight the decrease in the skilled wage.

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File URL: http://sticerd.lse.ac.uk/dps/eopp/eopp20.pdf
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Paper provided by Suntory and Toyota International Centres for Economics and Related Disciplines, LSE in its series STICERD - Economic Organisation and Public Policy Discussion Papers Series with number 020.

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Date of creation: Nov 2010
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Handle: RePEc:cep:stieop:020
Contact details of provider: Web page: http://sticerd.lse.ac.uk/_new/publications/default.asp

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  1. Ranjan, Priya, 2003. "Trade induced convergence through human capital accumulation in credit-constrained economies," Journal of Development Economics, Elsevier, vol. 72(1), pages 139-162, October.
  2. Chesnokova, Tatyana & Krishna, Kala, 2009. "Skill acquisition, credit constraints, and trade," International Review of Economics & Finance, Elsevier, vol. 18(2), pages 227-238, March.
  3. Kenneth Kletzer and Pranab Bardhan., 1986. "Credit Markets and Patterns of International Trade," Economics Working Papers 8612, University of California at Berkeley.
  4. Ranjan, P., 1999. ""Credit Constraints and the Phenomenon of Child Labor"," Papers 98-99-12, California Irvine - School of Social Sciences.
  5. Wacziarg, Romain & Seddon, Jessica, 2000. "Trade Liberalization and Intersectoral Labor Movements," Research Papers 1652, Stanford University, Graduate School of Business.
  6. Muendler, Marc-Andreas, 2007. "Labor Reallocation in Response to Trade Reform," University of California at San Diego, Economics Working Paper Series qt3cm38535, Department of Economics, UC San Diego.
  7. Nancy L. Stokey, 1990. "Human Capital, Product Quality, And Growth," NBER Working Papers 3413, National Bureau of Economic Research, Inc.
  8. Attanasio, Orazio & Goldberg, Pinelopi & Pavcnik, Nina, 2003. "Trade Reforms and Wage Inequality in Colombia," CEPR Discussion Papers 4023, C.E.P.R. Discussion Papers.
  9. Das, Satya P., 2006. "Trade, skill acquisition and distribution," Journal of Development Economics, Elsevier, vol. 81(1), pages 118-141, October.
  10. Ranjan, Priya, 2001. "Dynamic evolution of income distribution and credit-constrained human capital investment in open economies," Journal of International Economics, Elsevier, vol. 55(2), pages 329-358, December.
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