Adjusting to trade liberalization: Reallocation and labor market policies. V manuscript

Labor market responses to trade liberalization typically exhibit three features: slow net ab-sorption of labor by export-oriented sectors, large reallocation costs for displaced workers, and a disproportionate adjustment burden for older workers. To explain these features and to analyze alternative policy responses, I develop a two-sector small open economy model with overlapping generations, labor market search and matching, and sector-specific human capital accumulated through learning-by-doing. The model is calibrated to Brazilian data in order to study the dynam-ics of an economy in transition after trade liberalization. The calibrated model shows that search frictions alone cannot explain the sluggishness of adjustment. The interaction of search frictions with sector-specific human capital, on the other hand, can rationalize the observed slow adjustment to reforms. The model also helps to compare the distributional and efficiency effects of alternative worker-assistance programs in general equilibrium. A targeted employment subsidy that rewards mobility not only improves the distribution of income but also enhances efficiency gains from trade by facilitating faster formation of necessary skills during the adjustment period. The market failure corrected by the policy is the disincentives of experienced workers to invest in new skills which is in turn caused by the interaction of rent-sharing and intra-sectoral transferability of human capital to future employers. The paper contributes to a better understanding of trade-induced transitional dynamics and the labor market policies aimed at compensating the losers from trade