Trade Shocks and Labor Adjustment: A Structural Empirical Approach

TLDR

The welfare effects of trade shocks depend on the costs workers incur when moving between sectors. An Euler‑type equilibrium condition from a rational‑expectations model of dynamic labor adjustment is used to estimate the mean and variance of workers’ switching costs from the US CPS. The estimated high switching‑cost parameters imply slow economic adjustment and sharp wage movements after trade shocks, yet import‑competing workers still benefit from tariff removal, which lowers their wages in the short and long run but increases their option value. JEL codes: E24, F13, F16.

Abstract

The welfare effects of trade shocks turn on the nature and magnitude of the costs workers face in moving between sectors. Using an Euler-type equilibrium condition derived from a rational expectations model of dynamic labor adjustment, we estimate the mean and variance of workers' switching costs from the US CPS. We estimate high values of both parameters, implying slow adjustment of the economy and sharp movements in wages in response to trade shocks. However, import-competing workers can still benefit from tariff removal; liberalization lowers their wages in the short and long run but raises their option value. (JEL E24, F13, F16)