Globalization, the skill premium, and income distribution: the role of selection into entrepreneurship

This paper proposes a novel channel by which trade affects the skill premium and the household income distribution: the selection-into-entrepreneurship mechanism. Trade liberalization intensifies competition for profit, discouraging less able educated workers from sorting into entrepreneurship and increasing the skill supply. As a result, the return to college declines, leading college enrollment to decrease. We illustrate this mechanism with a simple trade model and show that while highly talented households optimally respond to export opportunities by engaging in entrepreneurial investment and moving up the income distribution, less able educated households self-select downward along the income distribution, which gradually results in household income polarization. Using Chinese household survey data, we employ a Bartik-type instrument for export expansion to investigate how globalization affects the return to college, the selection into entrepreneurship, and the income distribution. The analysis shows that regions facing more export exposure are associated with a larger drop in the skill premium, a greater selection effect on household business ownership, and a stronger polarization pattern in the household income distribution. The entrepreneurship angle highlighted by this paper offers another lens through which to study the broader impact of trade shocks on workers’ occupation sorting and the distribution of income.