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Trade and the Skill Premium Puzzle with Capital Market Imperfections

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  • Roberto Bonfatti
  • Maitreesh Ghatak

Abstract

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.

Suggested Citation

  • Roberto Bonfatti & Maitreesh Ghatak, 2010. "Trade and the Skill Premium Puzzle with Capital Market Imperfections," STICERD - Economic Organisation and Public Policy Discussion Papers Series 020, Suntory and Toyota International Centres for Economics and Related Disciplines, LSE.
    • Handle: RePEc:cep:stieop:020
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    References listed on IDEAS

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    1. Eric A. Verhoogen, 2008. "Trade, Quality Upgrading, and Wage Inequality in the Mexican Manufacturing Sector," The Quarterly Journal of Economics, Oxford University Press, vol. 123(2), pages 489-530.
    2. Wacziarg, Romain & Wallack, Jessica Seddon, 2004. "Trade liberalization and intersectoral labor movements," Journal of International Economics, Elsevier, vol. 64(2), pages 411-439, December.
    3. Chesnokova, Tatyana & Krishna, Kala, 2009. "Skill acquisition, credit constraints, and trade," International Review of Economics & Finance, Elsevier, vol. 18(2), pages 227-238, March.
    4. Naércio Aquino Menezes Filho & Marc-Andreas Muendler, 2007. "Labor Reallocation in Response to Trade Reform," CESifo Working Paper Series 1936, CESifo Group Munich.
    5. Ranjan, Priya, 2001. "Credit constraints and the phenomenon of child labor," Journal of Development Economics, Elsevier, vol. 64(1), pages 81-102, February.
    6. Attanasio, Orazio & Goldberg, Pinelopi K. & Pavcnik, Nina, 2004. "Trade reforms and wage inequality in Colombia," Journal of Development Economics, Elsevier, vol. 74(2), pages 331-366, August.
    7. Kletzer, Kenneth & Bardhan, Pranab, 1987. "Credit markets and patterns of international trade," Journal of Development Economics, Elsevier, vol. 27(1-2), pages 57-70, October.
    8. 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.
    9. Nancy L. Stokey, 1991. "Human Capital, Product Quality, and Growth," The Quarterly Journal of Economics, Oxford University Press, vol. 106(2), pages 587-616.
    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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    Cited by:

    1. Bonfatti, Roberto & Ghatak, Maitreesh, 2013. "Trade and the allocation of talent with capital market imperfections," Journal of International Economics, Elsevier, vol. 89(1), pages 187-201.
    2. Santra, Sattwik, 2014. "Non-homothetic preferences: Explaining unidirectional movements in wage differentials," Journal of Development Economics, Elsevier, vol. 109(C), pages 87-97.

    More about this item

    Keywords

    Trade Liberalization; Skill Premium; Credit Market Frictions; Latin America;

    JEL classification:

    • F16 - International Economics - - Trade - - - Trade and Labor Market Interactions
    • O15 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Economic Development: Human Resources; Human Development; Income Distribution; Migration
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance

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