Trade Between Symmetric countries, Heterogeneous Firms and the Skill Wage Premium

This paper examines the effects of trade liberalisation between symmetric countries on the skill wage premium. I use a model of monopolistic compe-tition with heterogeneous firms and two factors of production: skilled and unskilled labour. I introduce a correlation between productivity and skill in-tensity in the production process, which generates the empirically observed link between firm size, export status, wages and skill intensity. The entry and exit of firms following trade liberalisation has non-trivial effects on the demand for both types of labour, and therefore on their wages. I show that the impact of trade liberalisation on the skill premium depends on the type of trade costs considered, and on their initial size. While a decrease in the fixed costs of trade has a potentially non-monotonic effect, a drop in the variable trade costs yields an unambiguous and substantial increase in the skill premium. The calibration of the model to the U.S. economy shows that a reduction of the iceberg costs of trade from 1.5 to 1.1 can account for an increase in the skill premium of more than 10 percentage points, which is about a fourth of the observed rise in the 1980s and 1990s