Global Value Chains and Inequality with Endogenous Labor Supply

We assess the role of global value chains transmitting global integration shocks to aggregate trade as well as distributional outcomes. We develop a multi-country general equilibrium trade model that features multi-stage production, with different stages having different productivities and using factors (occupations) with different intensities. The model also features a Roy mechanism, in which heterogeneous workers endogenously choose their sector and occupation. Country- and worker-level comparative advantages interact. A reduction in trade costs leads to countries specializing in their comparative advantage sectors and production stages. This specialization changes labor demand and also leads to more workers shifting to their comparative advantage sectors and occupations. With a special case of our model, we show that the intensity of the global value chain (GVC) magnifies the aggregate effects of trade liberalization, but it has a non-monotonic effect on the skill premia. We calibrate our model to the U.S., China, and the rest of the world in 2000 and we simulate a decline in China’s costs of trade, designed to mimic China’s entry into the WTO. Our simulation results imply an increase in the skill premium in both the U.S. and China, and the GVC, i.e., stage-level specialization, is critical to this outcome.