NATIONAL BUREAU OF ECONOMIC RESEARCH, INC.

Intellectual Merit of the Proposed Activity Traditionally, the key intellectual framework for examining the distributional consequences of trade has been the Stolper-Samuelson Theorem of the Heckscher-Ohlin model. Recently, however, several limitations have emerged concerning the use of this model as a framework for understanding the distributional consequences of trade liberalization. In particular, while the Stolper-Samuelson Theorem emphasizes the return to skills as the prime driver of income inequality, a substantial component of the recent rise in income inequality is accounted for by residual wage inequality that is unexplained by observed personal characteristics. Motivated by empirical evidence from micro datasets on firms and workers, the PI's have developed an alternative theoretical framework for examining the distributional consequences of trade liberalization. Their approach incorporates three key features that together enable one to better address the limitations of the neoclassical model: (1) heterogeneity in productivity across firms; (2) heterogeneity in unobserved ability across workers; (3) search and matching frictions in the labor market. The combination of these three features generates residual wage inequality and unemployment that helps in matching the patterns observed in the data. In this proposal the PI's plan to develop our research on the distributional consequences of globalization in three major directions. First, they propose to generalize their framework in order to allow for idiosyncratic risk faced by individual workers (which is assumed to be perfectly diversified within families in their previous work). This will allow them to study more realistic general equilibrium implications of globalization, and in particular its impact on earning volatility and occupational risk that is of major concern to policy makers. Second, they propose to examine empirical predictions of their theoretical framework using matched employee-employer trade data for Brazil and Sweden. In particular, they will use the model to study the impact of trade liberalization on inequality and unemployment. Third, the PI's will generalize their model to a dynamic framework in order to study the time pattern of reallocation of workers over time in response to trade liberalization: (1) across firms; (2) across industries; and (3) between employment and unemployment. Broader Impacts of the Proposed Activity This project will contribute to a better understanding of globalization, emphasizing individual income risks on the one hand and the required reallocation of workers across firms and industries on the other. It will also provide an analytical framework and a quantitative assessment of the impact of trade liberalization on inequality and unemployment, which are of major concern to policy makers.

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