Smoothing the adjustment to trade liberalization
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Smoothing the adjustment to trade liberalization Wolfgang Lechthaler1 · Mariya Mileva2 Accepted: 29 October 2020 © Springer Science+Business Media, LLC, part of Springer Nature 2020
Abstract We use a dynamic general equilibrium trade model with comparative advantage, heterogeneous firms, heterogeneous workers and endogenous firm entry to analyze economic policy meant to compensate the losers of trade liberalization and reduce the ensuing wage inequality. We consider wage taxes, consumption taxes, profit taxes, firm entry subsidies, worker sector-migration subsidies and training subsidies, and find that the re-distributional and distortionary effects of these instruments differ very much. The most potent instrument to reduce the wage inequality after trade liberalization are training subsidies. They increase the supply of skilled workers and thereby reduce the skill premium. Keywords Trade liberalization · Wage inequality · Adjustment dynamics · Redistribution JEL Classification E24 · F11 · F16 · J62
1 Introduction Trade with China has recently been identified as an important driver of wage inequality in developed countries (see, e.g., Ebenstein et al. (2014), Pierce and Schott (2016) or Autor et al. (2013)). This literature shows that workers employed in sectors that are exposed to competition from Chinese imports suffer lower wages and lower employment. In this way trade liberalization creates winners and losers which is a factor that has contributed to considerable opposition to free international trade. Mariya Mileva thanks the European Commission for financial support through the project WWWforEurope. We are grateful to Danvee Floro and Richard Franke for their excellent research assistance. All remaining errors are our own. * Wolfgang Lechthaler Wolfgang.Lechthaler@ifw‑kiel.de 1
Kiel Institute for the World Economy, 24105 Kiel, Germany
2
California State University, Long Beach, CA 90840, USA
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Empirica
The rise of populist right-wing parties in Europe, the British vote to leave the European Union, the election of Donald Trump to be the 45th US president, and his ’trade wars’ are also related to these increasingly negative attitudes toward international trade. In order to counteract these trends and sustain an open and rules-based economic order the gains from international trade have to distributed more equally. Indeed, survey-based empirical evidence suggests that the political support for free trade is higher when trade liberalization is accompanied by a compensatory mechanism (see Hays et al. (2005) for OECD countries and Ehrlich and Hearn (2013) for the U.S.).1 The question arises, what is the best way to compensate the losers of trade liberalization and to reduce the ensuing wage inequality.2 To answer this question we extend the model developed in Lechthaler and Mileva (2019) to include a variety of policy instruments that can be used to redistribute the gains from trade. Our analysis shows that training subsidies are the most potent instrument to reduce the wage inequa
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