Escaping the Losses from Trade: The Impact of Heterogeneity on Skill Acquisition

While trade openness generates aggregate welfare gains, it can have unequal effects on the wage of skilled relative to unskilled workers. In this paper, we ask how heterogeneous the welfare gains of trade openness can be in the short and the long-run. To do so, we build a dynamic heterogeneous-household life-cycle model of international trade with incomplete credit markets. The model incorporates an endogenous costly skill acquisition, which allows unskilled workers to invest in education and escape the short-run losses of trade openness. We calibrate the model to match trends in trade openness in the United States between the late 1980s and 2010. We find that poor households take the longest to acquire skills and are therefore the last to experience positive gains from trade openness, which in some cases may not realize within a life-time. We also argue that welfare for all workers increases in the long-run, and that physical capital accumulation is essential for this result.