Trade Liberalization, Wage, and Unemployment: Theory and Evidence from Chile

We developed a theoretical model that incorporates a fair wage model into a trade model with heterogeneous firms to analyze the effects of trade liberalization on wages and unemployment rates. By introducing a unique setting for the determinant of average wage and different fixed production costs between exporting and domestic firms, the model predicts that lower trade costs lead to lower prices of intermediate inputs, which reduces the production costs for final-goods firms and stimulates their labor demand. Consequently, the model predicts that trade liberalization leads to higher average productivity, thereby raising wages and reducing unemployment rates. The empirical analysis employing exogenous variations in exposures to regional trade agreements (RTAs) across local labor markets in Chile from 2000 to 2006 supported our theoretical predictions. Exploiting industrial variations in tariff reductions derived from the RTA schemes, initial differences in industrial compositions across local labor markets, and the lack of inter-local labor mobility, we found that a reduction in input tariff rates expectedly increased local wages and decreased unemployment rates. These findings were robust to the inclusion of various controls, the control for the endogeneity of the input tariffs, and the use of different regional units of analysis.