Two core issues in international trade are the allocation of resources across economic activities and the distribution of incomes across factors of production. Recent research has emphasized the allocation of resources across heterogeneous firms, but has largely concentrated on heterogeneity in the product market (productivity and size) rather than the labor market (workforce composition and wages). Developing trade models that incorporate both product and labor market heterogeneity is therefore important for explaining firm data and understanding the consequences of trade liberalization. To the extent that wages vary across firms within sectors, reallocations of resources across firms provide an additional channel for international trade to influence income distribution.
In this paper, we develop a new framework for examining the distributional consequences of trade that incorporates this channel and captures three plausible features of product and labor markets. First, there is heterogeneity in firm productivity, which generates differences in firm profitability. Second, search and matching frictions in the labor market imply that workers outside a firm are imperfect substitutes for those inside the firm, which gives rise to multilateral bargaining between each firm and its workers. Third, workers are heterogeneous in terms of match-specific ability, which can be imperfectly observed by firms. Together these three components of the model generate variation in wages across firms within industries and imply that trade liberalization affects income distribution.
Our model accounts for a number of empirical findings from micro data on firms and workers. Wage dispersion within industries is closely linked to productivity dispersion (e.g., Davis and Haltiwanger 1991 and Faggio, Silvanes and Van Reenen 2007) and the model exhibits the empirically—observed employer—size wage premium (e.g., Oi and Idson 1991). Wage dispersion is also closely linked to trade participation, with exporters paying higher wages than non-exporters, as found empirically by Bernard and Jensen (1995, 1997) and many subsequent studies. This exporter wage premium is accompanied by differences in workforce composition across firms, as observed by Kaplan and Verhoogen (2006), Schank, Schnabel and Wagner (2007), and Munch and Skaksen (2008). Finally, the model is consistent with empirical evidence of search and matching frictions and frictional unemployment (e.g., Petrongolo and Pissarides 2001).
The key mechanisms underlying these properties of the model are as follows. Complementarities between workers’ abilities in the production technology imply that firms have an incentive to screen workers to exclude those of lower ability. As the strength of these production complementarities increases with firm productivity, more productive firms screen more intensively and have workforces of higher average ability than less productive firms. Search frictions imply multilateral bargaining between a firm and its workers, and since higher ability workforces are more costly to replace, more productive firms consequently pay higher wages. When the economy is opened to trade, the selection of more productive firms into exporting increases their revenue relative to less productive firms, which further enhances their incentive to screen workers to exclude those of lower ability. The open economy is therefore characterized by differences in workforce composition and wages between exporters and non—exporters. Search frictions imply that wage dispersion is combined with equilibrium unemployment, and workers with the same characteristics can be matched with firms paying different wages. Worker screening generates the noted variation in firm workforce composition despite random search.
In the closed economy, we derive a sufficient statistic for wage inequality, which determines all scale-invariant measures of wage inequality, such as the Coefficient of Variation, Gini Coefficient and Theil Index. This sufficient statistic depends on the dispersion parameters for worker ability and firm productivity as well as other product and labor market parameters that influence workforce composition. Greater dispersion of worker ability has ambiguous effects on wage inequality, because it affects both relative wages and employment levels across firms. In contrast, greater dispersion of firm productivity raises wage inequality, because more productive firms pay higher wages.
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