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When Trade Compresses: The Impact of Liberalization on Wage Inequality

Author

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  • Victor Hernandez Martinez
  • Nicholas Kozeniauskas
  • Roman Merga

Abstract

We study the effects of trade liberalization on the full wage distribution, exploiting Spain's 1993 entry into the European Single Market. Using employer-employee data, we identify the causal effects of trade across the entire wage distribution, using a novel shift-share instrument embedded in an unconditional quantile regression. We find that the liberalization reduced wage inequality, leading to wage compression through earnings gains at the bottom of the distribution and wage losses at the top. We trace this compression to two asymmetric channels: import competition disproportionately harmed high earners, while export opportunities benefited low earners. The key mechanism is an import-driven “skill-downgrading.” A multi-region multi-sector model shows that the key insight for understanding these empirical results is that trade's distributional effects depend on the skill intensity of a country's tradable sector, and Spain's was relatively low-skill intensive back then.

Suggested Citation

  • Victor Hernandez Martinez & Nicholas Kozeniauskas & Roman Merga, 2026. "When Trade Compresses: The Impact of Liberalization on Wage Inequality," Working Papers 26-01, Federal Reserve Bank of Cleveland.
    • Handle: RePEc:fip:fedcwq:102314
    DOI: 10.26509/frbc-wp-202601
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    Keywords

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    JEL classification:

    • F15 - International Economics - - Trade - - - Economic Integration
    • F16 - International Economics - - Trade - - - Trade and Labor Market Interactions
    • J24 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Human Capital; Skills; Occupational Choice; Labor Productivity
    • J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials

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