International trade regulation and job creation Updated

Reemploying displaced workers

The recent evidence from the China shock, as well as other trade liberalization episodes, suggests that labor markets adjust to trade changes very slowly. Imperfect labor mobility across jobs ties workers’ outcomes to their initial industry and region of employment, and implies long-term negative consequences on both employment and earning trajectories of displaced workers [4]. The experience of job displacement, however, varies in important ways depending on workers’ skill levels and education and the industry-specificity of their human capital. Initially, trade shocks seem to affect all workers similarly, but subsequently, being able to move out of the trade-affected sector is important, not least to avoid being hit by further import shocks. High-wage workers seem better able to do so than low-wage workers. Trade induced adjustment problems, finally, do not end when workers find jobs in growing sectors, but persist for those who lose a substantial part of their human capital in the new environment [6]. Human capital specific to the initial industry, in particular to manufacturing, is the main determinant of workers’ adjustment cost to an import shock.

Ultimately, however, the fate of displaced workers is in the hands of labor market institutions. In countries with active labor market policies, such as Denmark, trade shocks cause workers to move out of the trade-affected sectors and to seek further education, thereby potentially upgrading the supply of skill [6]. In Brazil, some of the trade-displaced workers from the formal sector are eventually absorbed by the informal sector, after years spent in non-employment [7]. In South Africa, a country with high unemployment rates, a small informal sector, and strong wage rigidity due to trade unions, workers displaced by trade liberalization saw an increased probability of becoming discouraged searchers (not actively searching but willing to work) or of exiting the labor force entirely (no longer willing to work) [8].

Hitting poor countries

There is no compelling evidence that trade liberalization disproportionately hits the weak and the poor in developing countries. First, workers at lower levels of education appear to be disadvantaged when coping with trade-induced displacement regardless of countries’ levels of development. Second, there are also cases where trade liberalization has produced more or less equal employment effects across all education levels, but worse effects for black/colored workers among the low-skilled ones, such as in the case of South Africa.

Increasing openness

In contrast to the pessimism emerging in the research on the China shock, a macroeconomic study shows that increasing openness lay behind much of the dramatic decline in the natural rate of unemployment in Singapore [9]. Introducing wage bargaining and trade unions into a specific-factors two-sector economy endogenizes the natural rate of unemployment. Between 1966 and 2000—when the openness ratio (the sum of export and import relative to gross domestic product (GDP)) increased from about two to nearly three—the relative prices of export goods increased, and there was a rapid accumulation of capital in the export sector. Both phenomena increased the marginal product (and, hence, the wage) of labor in terms of non-tradable goods and services, and helped to expand overall employment fourfold (as the population doubled).

The direct effects of the accumulation were larger than those of relative prices, although the latter, a natural consequence of trade liberalization, are arguably the key causal factor behind Singapore's experience. Even if entrepreneurs invested first and then sought markets for their goods, as some have maintained, the home market could never have absorbed the increased quantities, so trade liberalization was the key to selling large quantities without having the price fall.

Overall, the empirical results on trade policy and aggregate (un)employment suggest little systematic effect [10]. But there is a tendency for studies relating openness to employment to find a positive relationship between them.

Sectoral reallocation

For developing countries, it is perfectly plausible that both export- and import-competing sectors expand with trade liberalization: industrialization draws workers out of low-level subsistence agriculture and into measurable employment in more easily observed and often more formal sectors. At least at first, this transfer is not curtailed by wage increases. For countries that have already passed the surplus labor stage of development, by contrast, the predicted reallocation, coupled with fairly stationary aggregate employment, is more likely.

Worker migration in response to labor market shocks is very modest, and so it makes sense to expect most sectoral reallocations to be at the level of the local labor market.

Unlike the previous literature, recent research on the impact of the China shock on the local labor markets in high-wage economies does, indeed, show evidence of sectoral reallocation. US imports from China caused job losses in tradable sectors exposed to import competition. These losses, however, were largely offset by US exports to the rest of the world, which created jobs in non-exposed and non-tradable sectors [5]. This latter result can be explained by the increasing number of non-manufacturing jobs in (former) manufacturing firms, driven by high-skill service professions such as design and engineering, or by increased marketing or other management services replacing the physical manipulation of material inputs.

By contrast, trade liberalizations in middle-income countries show much less evidence of sectoral reallocation. The transitions observed are not from import-competing into export-growing sectors, but rather into low-wage service or informal sectors, which are widely perceived as lower quality jobs. These results are a direct challenge to the neoclassical view that the benefits of trade derive from shrinking import-competing production and expanding exportable production. They are explicable by the low geographical mobility of workers, which implies that even if long-term aggregate employment appears unaffected by trade policies, the adjustment process is most likely to be accompanied by a long and painful adjustment process at the level of individual workers (as noted above).

Of course, liberalizations vary in depth, nature, and context, so expectations of finding an ostensibly single uniform effect should not be too high! Did countries with greater labor market flexibility have greater reallocations? Apparently not [11]. But the active pursuit of policies to encourage intersectoral mobility was effective in achieving greater reallocation. Thus, while the failure of the simple theory about trade merely shifting resources between sectors and no more should certainly be noted, it is not clear that the theory's basic insights are flawed.

Intrasectoral reallocations and skill intensity

Recent theory and empirical work by international trade scholars has started to explore intrasectoral responses to trade reforms, which seems to be a perfectly natural outcome once it is recognized that firms differ—firm heterogeneity, in the language of trade scholars. Reallocations of labor occur from weaker to stronger firms, often accompanied by the latter's increased investment, higher productivity growth, and more diligent search for better labor. This allows strong growth in sectoral output without significant increases in sectoral employment. The analysis has also suggested that these interfirm but intrasectoral reallocations are frequently associated with an increased demand for skilled labor relative to unskilled labor.

A seminal study of Mexican firms shows that the export boom that followed the peso devaluation of 1994 induced stronger firms to improve the quality of their products and their workforces, and to pay higher wages [12]. In this study, as in many others, this effect was used to explain the widening skill premium rather than employment levels, but the basic insight clearly translates to employment.

Another study assesses the impact of the creation of a customs union, MERCOSUR, on Argentinean firms [13]. In a model where firms choose between two production technologies that differ in their skill intensity there are three types of firm in equilibrium: the skill-intensive exporters, the unskilled exporters, and the unskilled domestically oriented firms. A tariff reduction in an export market induces more firms to enter and upgrade to the skill-intensive technology, increasing the market share of more productive firms. The gains by these firms and their subsequent investment generate higher demand for skilled workers and increase the skill premium. This forces the least-productive firms to downgrade the skills they seek. Testing this model on Argentinean firm data and exploiting the differential reduction in Brazil's tariffs across sectors shows that small firms downgraded skills, while larger firms upgraded them in response to Brazil's tariff reduction. The net effect on the share of skilled labor is positive and implies that one-third of the increase in the employment share of skilled labor in Argentina between 1992 and 1996 was explained by the reduction in Brazil's tariffs.

Note that the analysis looks at the reduction of protection in Argentina's main export market, rather than in Argentina itself. But it is the nature of trade agreements such as MERCOSUR that in order to win concessions by partners, a country, Argentina in this case, has to offer to reduce its own protection. This will affect import-competing firms, and other results in the literature strongly suggest that increasing competition in these sectors will also tend to favor stronger over weaker firms, and skilled over unskilled labor.

Informal labor

One issue that has attracted policy comment is whether trade liberalization leads to greater emphasis on informal rather than formal labor markets. The question is fraught with difficulties because one needs to have a clear idea about exactly what informality amounts to, which varies by country and study.

Some recent works shed light on the relation between trade policy and the distribution of labor between the formal and the informal sectors. Exploiting variation at the level of local labor markets, Brazil's liberalization of the 1990s has been found to have caused larger increases in the share of informal workers in regions facing larger tariff reductions. This is a long-term effect, whereby the informal sector seems to have acted as a cushion to trade-displaced workers from the formal sector. A similar effect was not found in the case of South Africa, due to the higher rigidity of its labor market and the small size of its informal sector.

A positive export shock can, on the other side, induce a more efficient allocation of resources and spur transitions from the informal to the formal sector. The US-Vietnam Bilateral Trade Agreement led to large (virtually unilateral) reductions in US tariffs on Vietnamese exports which, in turn, led to an increase in the share of formally employed workers in Vietnam [14]. These results are consistent with models predicting intrasectoral reallocations, from less to more productive firms, from shocks which increase aggregate wages: in Vietnam the within-industry effects were largest in manufacturing, which experienced the largest tariff cuts. Younger workers and those in more internationally integrated provinces were the most likely to relocate, which is consistent with lower adjustment costs to trade shocks for workers with relatively lower mobility costs.