How does trade policy affect the labor market?

Trade regulation can create jobs in the sectors it protects or promotes, but almost always at the expense of destroying a roughly equivalent number of jobs elsewhere in the economy. At a product-specific or micro level and in the short term, controlling trade could reduce the offending imports and save jobs, but for the economy as a whole and in the long term, this has neither theoretical support nor evidence in its favor. Given that protection may have other—usually adverse—effects, understanding the difficulties in using it to manage employment is important for economic policy.

There is evidence that better performing firms tend to enter international markets. Internationally active firms are larger, more productive, and pay higher wages than other firms in the same industry. Positive performance effects of engaging in international activity are found especially in firms from less advanced economies that interact with partners from more advanced economies. Lowering barriers to the international division of labor should therefore be part of any pro-growth policy.

Women consistently work less in the labor market and earn lower wages than men. While economic empowerment of women is an important objective in itself, women's economic activity also matters as a condition for sustained economic growth. The political debate on the labor market impacts of international trade typically differentiates workers by their educational attainment or skills. Gender is a further dimension in which the impacts of trade liberalization can differ. In a globalizing world it is important to understand whether and how trade policy can contribute toward enhancing gender convergence in labor market outcomes.

Economists have shown that international trade increases economic growth, with trade liberalization and integration having characterized the last 50 years. While trade can increase national welfare, recent estimates from both developed and developing countries show that labor market adjustment costs matter. Regulating trade, defined as adding or removing tariffs and other trade barriers, is not the best way to help lower-income workers who suffer from trade-induced losses. Policies that reduce adjustment costs may increase aggregate welfare more than regulating trade flows does.

Economists have long recognized that free trade has the potential to raise countries’ living standards. But what applies to a country as a whole need not apply to all its citizens. Workers displaced by trade cannot change jobs costlessly, and by reshaping skill demands, trade integration is likely to be permanently harmful to some workers and permanently beneficial to others. The “China Shock”—denoting China’s rapid market integration in the 1990s and its accession to the World Trade Organization in 2001—has given new, unwelcome empirical relevance to these theoretical insights.

Imported products tend to have lower prices than locally produced ones for a variety of reasons, including lower labor costs and better technology in the exporting country. The reduced prices may lead to wage losses for individuals who work in the production of a local version of the imported item. On the other hand, lower prices may be beneficial to households if the cheaper product is in their consumption basket. These welfare gains through consumption, on average, are found to be larger in magnitude than the wage effect for some developing countries.