Trade, Skill premium, and Skill Upgrading (TSS)

Abstract:

With globalization, many important economic issues have emerged from trade integration in many countries all over theworld, including Denmark. Two of such crucial and increasingly popular questions that researchers have asked are: 1)given domestic skill distribution, how does international trade affect a country’s wage dispersion among workers withdifferent skills (i.e., skill premium)?; and 2) how does this trade-induced changes of skill premium affect people’s skillupgrading behavior thus the country’s skill distribution? Existing literature has examined them separately (Costinot andVogel 2010; Egger and Kreickemeier 2009; Yeaple 2005; Maggi and Grossman 2000 to cite a few), but none has put thetwo pieces together both theoretically and empirically through their linkage of the skill distribution.1 Bombardini et al.(2012) provide empirical evidence about the impact of exporter’s skill distribution on trade and but leave an importantissue unresolved. While they openly acknowledge a reverse causality problem in their estimations, their analysis is rathersalient on the impact of trade on the mean and the variance of the skill distribution. This project is set out to fill this gap.In particular, we will develop a theoretical model and we will provide empirical evidence on how skill premium changesinduced through trade integration may significantly affect individual's skill upgrading decisions, which may in turn affectthe overall average skill level as well as skill diversity in the economy. Our theoretical model aims to first determine howskill premium is determined through trade integration, and second whether individuals adjust their skills as a result oftrade induced skill premium changes. Such a model then explains the dynamics in the distribution of skills in theeconomy over time. We then propose to test the reduced form predictions of our model for the case of Denmark, which isa highly developed industrialized country characterized by a small and an export oriented economy. Denmark providesan excellent study for our analysis for three main reasons: (1) In terms of trade activity, Denmark has been by far one ofthe most active economies and has documented detailed data entries, hence it provides us with an incredibly richempirical environment; (2) Traditionally Denmark’s trade has been concentrated with a few trading partners (about 70%of Danish trade was with 10 countries, mostly EU members) but more recently Denmark has also started to trade withemerging economies, such as the BRICs and the formerly communist countries.2 Thus despite the maturity of the Danisheconomy, the process of trade integration in Denmark is still evolving; (3) The fact that Danish government providesabundant subsidies for individual’s skill upgrading and the country has an extremely flexible labor market reduces thefrictions hindering the effects of skill premium changes on the skill composition.