Self-selection, labour markets and capital markets

grantor: University of TorontoSelf-selection is a market allocation mechanism that is pervasive. Workers sort into jobs, firms sort into product and factor markets. My thesis analyses what effects self-selection mechanisms have on microeconomic phenomena such as the trade pattern and earnings inequality, and on macroeconomic phenomena such as the exchange rate and the capital account. The current work horse trade models are based on relatively simplistic labour market assumptions. In my first essay, I propose a model which instead incorporates a rich labour market model of worker sorting, the Roy (1951) model. This model unites the long-run production and trade predictions of the Heckscher-Ohlin model with the short-run political economy predictions of the specific factors model. In addition, it shows how even North-North trade can be based on endowments, being driven by differences in endowments inequality. In my second essay, I test this model empirically. I focus on the determinants of within-industry earnings inequality during the 1980s and 1990s using data from the CPS and the Bartelsmann-Becker-Gray database on productivity. The results overwhelmingly confirm the importance of skill-biased technological change in the rise in within-industry inequality during the sample period. In my third essay, I turn to the macroeconomic effects of firms self-selecting into export markets and into the international capital market. Only the most productive firms are able to export into foreign product markets and only the most productive among these exporters are able to borrow on the international capital market. In such a setting, capital account liberalisation has not only the standard effects on macroeconomic variables such as the exchange rate, but also on microeconomic variables such as aggregate firm productivity, firm exit and entry. The predictions generally match the developments in developing countries, most notably in Chile in the late 1970s and early 1980s. The analysis raises a note of caution: since capital account liberalisations have usually taken place concurrently with trade liberalisations, studies which correlate firm productivity with trade liberalisation have to be interpreted carefully.Ph.D