Looking for the Losers in New-New Trade Theory

Neither are the losers from trade liberalization nor the quantum of their losses correctly identified in much of trade theory and policy. This is the argument from a forthcoming article by economists Mary Amiti and Donald Davis.

Building on the work of Harvard economist Marc Melitz and others in the development of what is often termed “new-new trade theory,” Amiti and Davis develop a general equilibrium model featuring firm heterogeneity across productivity, trade in final and intermediate products, and firm-specific wages to assess the impact of trade liberalization on labor.

The authors find that the effect of trade liberalization on wages is neither uniform nor unidirectional: it depends on the “mode of globalization” of the corresponding firm. That is, how much the firm exports and how much of its input is imported:

In short, liberalization along each dimension raises wages for workers at firms which are most globalized and lowers wages at firms oriented to the domestic economy or which are marginal globalizers.

The authors test their model on Indonesian firm-level data from 1991 to 2000, a period of substantial trade liberalization in the country. (On average, output and input tariffs dropped from 21 percent to 8 percent and from 14 percent to 6 percent, respectively.) The data are strongly supportive. Compared to firms operating at low modes of globalization, “exporters pay 8 percent higher wages, importers pay 15 percent higher wages, and firms that import and export pay 25 percent higher wages.”

The introduction of firm heterogeneity and distinguishing impacts of reductions in tariffs across final and intermediate goods are critical. The authors’ findings suggest that liberalization policies need not necessarily put downward pressure on wages. On the contrary, such policies may very well benefit select portions of the labor force, as they did in Indonesia.

As Amiti and Davis conclude, “[t]he model predicts that the wage consequences of liberalization vary qualitatively and quantitatively with the nature and magnitude of the firms’ global engagement via exports and imports.”