Trade and the Skill Premium Puzzle with Capital Market Imperfections

41 Pages Posted: 14 Mar 2011

See all articles by Roberto Bonfatti

Roberto Bonfatti

University of Nottingham, UK; University of Padua

Maitreesh Ghatak

London School of Economics (LSE) - Department of Economics

Date Written: March 2011

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.

Keywords: credit market frictions, Latin America, skill premium, trade liberalization

JEL Classification: F16, O15, O16

Suggested Citation

Bonfatti, Roberto and Ghatak, Maitreesh, Trade and the Skill Premium Puzzle with Capital Market Imperfections (March 2011). CEPR Discussion Paper No. DP8286, Available at SSRN: https://ssrn.com/abstract=1782580

Roberto Bonfatti (Contact Author)

University of Nottingham, UK ( email )

United Kingdom

University of Padua

via Del Santo 33
Padova, 35123
Italy

Maitreesh Ghatak

London School of Economics (LSE) - Department of Economics ( email )

Houghton Street
London WC2A 2AE
United Kingdom
44 20 7852 3568 (Phone)
44 20 7955 6951 (Fax)

HOME PAGE: http://sticerd.lse.ac.uk/dps/adds/ghatak/cv-lse-sept02.pdf

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