Labor Market Adjustment to
Globalization with Heterogeneous
Agents
Carl Davidson1,2, Steven Matusz1,2
and Susan Zhu1
1Michigan
State University
2GEP, University of Nottingham
Large Literature on Firm and Plant
Level Adjustment to Globalization
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Based on Bernard and Jensen 1999; Roberts
and Tybout 1997
Only a fraction of firms export and those that
do export only a faction of output
Exporting firms are bigger, more capital
intensive, pay higher wages
There is “imperfect persistence” in the decision
to export
Openness and Productivity
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Openness enhances productivity in export
markets -- could be due to “learning by
exporting” or market share reallocations in
favor of more productive firm
Openness leads to exit of weakest firms in
export markets
Within-firm productivity gains in importcompeting markets
Our Goal
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To take a similarly disaggregated look at labor
market adjustment to globalization
We emphasize: Firms are different by choice
(adopt different technologies, employ different
skill mixes of workers, pay different wages)
Need heterogeneity on both sides of labor
market
Our Goal
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With imperfect labor markets, qualities of the
firm-worker matches may depend on a variety
of factors, including trade position
Focus is on how globalization affects the
performance of the labor market and the
distribution of wages
Some Reasons to Add Worker
Heterogeneity to New Trade Models
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Firms that adopt different technologies hire
workers (in terms of skill), pay different wages
Impact of liberalization on dislocated workers
varies greatly
Underemployment a serious concern
(especially lately with outsourcing of high-skill
jobs)
Framework
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High and low skill workers search for jobs
Ex ante identical firms choose what type of
technology to adopt
In equilibrium, firms are different
Low-tech firms pay low wages (can use both
types of workers)
High-tech firms use high-skill workers and pay
high wages
Key Feature of the Model
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If revenues generated by the two types of firms
are not too different, high-skill workers accept
low-tech jobs if they find them first (there is
underemployment)
Yields suitable framework to analyze how well
the labor market sorts workers across firm
The Model
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Labor market based on Mortensen and
Pissarides (REStud 1994)
Heterogeneity based on Yeaple (JIE 2005) and
Albrecht and Vroman (IER 2002)
Trade extension based on Davidson, Matusz
and Shevchenko (JIE 2007)
The Model
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Product market is perfectly comp.
Labor market frictions
Firms create vacancies until exp. profit from
doing so = 0
Total measure of workers = 1
q = fraction with low-skills
si = skill level of worker i
Firms rent capital after filling vacancy
The Model -- Technology
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Low-tech production process:
k s
f (k , s )  
k s

L

j
1
L
1
M
s s
M
if
s s
if
s s
j
j
L
H
L
y  f ( k , s ); y  f ( k , s )
L
L
L
M
L
H
The Model -- Technology
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High-tech production process (note that HS
workers better suited for HT production
process):
0
f (k , s )  
k s
H
s s
H

j
M
y  f (k , s )
H
H
H
1
H
if
s s
L
if
s s
H
j
j
The Model – Matching
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Matching Function: m(u,v)
CTRS: m() with  = v/u
The arrival rate of vacancies for workers is
m()
The arrival rate of workers for firms is
z()=m()/
We assume m’() >0; z’()<0
The Model -- Matching
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 = fraction of vacancies that are low-tech
 = fraction of unemployed with low-skill
Low-skill workers find jobs at rate m()
High-skill workers find jobs at rate m()
Low-tech firms fill vacancies at rate z()
High-tech firms fill vacancies at rate
(1-)z()
Additional Assumptions
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Wages determined by GNBS (wages increasing
in the size of the surplus and the worker’s
outside option)
High-skill workers accept low-tech jobs if
surplus to be split is positive (takes into
account outside options and search costs)
Firms export if doing so increases the surplus
to be split with the worker
There is a fixed cost to exporting
The Export Decision (Firm Adj.)
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Initially, all firms sell output at p in the closed
economy
Now, allow firms to export and get the world
price p* > p
There is a fixed cost of exporting
The high-tech firms (the largest, most
productive, most capital intensive firms) face
the strongest incentive to export since they gain
the most from exporting
The Export Decision (Firm Adj.)
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Get entry by HT firms and as they leave to
serve foreign market also get entry by LT firms
to serve domestic market
Relatively more entry by HT firms ( falls)
In export markets industry-level productivity
rises as market shares are reallocated towards
high-tech firms
But, there are no within-firm productivity
changes
The Export Decision (Firm Adj.)
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Can get imperfect persistence for low-tech
firms
Low-tech firms might change their export
decision when the skill mix of its employee
base changes if replacing a low-skill worker
with a high-skill workers allows them to cover
the fixed cost of exporting
Results on Labor Market Adjustments
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Wage effects
 High-skill workers at high-tech firms gain
(surplus higher, bargaining position
improves since  falls)
 High-skill workers at low-tech firms gain
(outside opportunities better)
 Low-tech workers could gain or lose (higher
surplus but bargaining position erodes)
Wage Effects -- Predictions
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Falling trade costs should increase wages of the
most highly skilled workers the most and may
decrease the wages of the least skilled workers
Increase in inequality within the firm
This contrasts with Yeaple’s prediction (which
assumes perfect competition in the labor
market) in which middle level workers are
harmed the most
Wage Effects -- Evidence
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Exporting increases the wage gap (BJ 1997,
Harrison and Hanson 1999)
As markets have become more open, wage gap
has increased (Baldwin and Cain 2000)
Predictions on Labor Market Adjustment
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In terms of match quality, now get less
underemployment of high-skill workers
Labor market functions more efficiently (a new
gain from trade)
Can get complete labor market separation if
revenues spread sufficiently so that low-tech
firms cannot afford to pay high-skill workers
enough
Predictions on Productivity
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With separation, get within firm productivity
losses in weakest firms in export markets
Industry wide productivity still rises due to
market share reallocations
Import Competition
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If the model applies to an import-competing
industry, openness lowers the price received by
all firms
This reduces the gap between the revenues
earned the two types of firms
If high-skill workers will not accept low-tech
jobs in the closed economy, they may be
willing to do so in an open economy
Import Competition
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Can go from perfect labor market separation to
equilibrium with underemployment
Labor market is less efficient due to trade (a
new loss from trade)
Note that low-tech firms become more
productive (can attract better workers) so there
are within firm productivity gains for the
weakest firms in the industry
Results – Assortative Matching
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Big issue in literatures on marriage markets
and imperfect labor markets – should the
“good” types match with other “good” types
and does this actually occur (Becker 1972)?
Here, good workers are better suited for hightech employment so we want positive
assortative matching
Results – Assortative Matching
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Our model predicts that openness to trade
affects what is likely to occur
Increased openness makes positive assortative
matching more likely in export-oriented
markets but less likely in import-competing
markets
Openness affects the degree of assortative
matching
Match Quality -- Predictions
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Model yields several testable hypotheses about
labor market adjustment to globalization
One particular prediction worth highlighting:
Openness may alter the types of job matches
that we observe
Openness may cause separation in exporting
industries, mixing in import-competing
industries
Conclusion
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Acemoglu’s 1999 AER model has similar
features (heterogeneous workers, initially
identical firms, labor market frictions)
Two types of equilibria (separating and
pooling)
Acemoglu presents evidence that middling jobs
have been disappearing and have been replaced
by the types of jobs that would be offered in a
separating equilibrium
Conclusion
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Our logic suggests that openness could cause
this in exporting industries, and have the
opposite effect in import-competing industries
Acemoglu does not break his industries up into
groups based on trade position nor does he
control for openness – we should try this
Conclusion
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Abowd and Kramarz (2004) test for positive
assortative matching in France and the US
using linked employer-employee data
They find little or no evidence in favor of the
theory that “good” workers match with “good”
firms
Conclusion
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Our theory implies that the trade position of an
industry matters: positive assortative matching
is more likely in export-oriented markets
Abowd and Kramarz do not control for the
effects of international competition; we hope to
do so
Conclusion
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Note also: Abowd and Kramarz are looking for
the type of matching (good firms with good
workers versus good firms with weak workers)
With imperfect labor markets, get some
mismatch
We argue that trade affects the extent of
mismatching – trade alters the degree of
assortative matching