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Tariff reductions, trade patterns and the wage gap in a monopolistic competition model with vertical linkages

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  • Francesco Di Comite
  • Antonella Nocco
  • Gianluca Orefice

Abstract

In this paper we develop a three-country monopolistic competition model with variable elasticity of substitution and vertical linkages to study the impact of trade liberalization on trade creation, trade diversion and labor market outcomes. This framework allows us to identify a source of gain from trade often neglected in the literature: cost savings on capital investments. Our model is empirically motivated by the observation that trade liberalization stimulates trade between the integrating countries and diverts it away from third countries, but it is not associated with increases in exports towards the excluded countries. As for the labor market, trade liberalization is expected to: (i) lower unskilled employment in country-sectors with low export intensity and (ii) to increase the wage gap between skilled and unskilled workers. Trade liberalization is also expected to raise welfare. We test the model's predictions using a dataset on bilateral export flows from 17 OECD exporting countries towards 122 importing countries over the period 1996 to 2007. Our empirical analysis provides results in line with the theory and vindicates the inclusion of vertical linkages in future assessments of the impact of trade liberalization on trade flows, labor markets and welfare.

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  • Francesco Di Comite & Antonella Nocco & Gianluca Orefice, 2014. "Tariff reductions, trade patterns and the wage gap in a monopolistic competition model with vertical linkages," Working Papers 2014-02, CEPII research center.
  • Handle: RePEc:cii:cepidt:2014-02
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    More about this item

    Keywords

    PTAs; Vertical linkages; Wage gap;
    All these keywords.

    JEL classification:

    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation
    • F16 - International Economics - - Trade - - - Trade and Labor Market Interactions
    • J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials

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