Trade liberalization, wage rigidity, and labor market dynamics with heterogeneous firms

Abstract

Trade liberalization triggers substantial within-sector labor reallocation, a pattern captured by heterogeneous-firm trade models. We study transition dynamics of firms and workers in response to changes in trade costs, incorporating labor market frictions. Responses vary by firm productivity: high-productivity exporters expand employment, while lower-productivity firms exit, downsize before exit, or gradually shrink. As a result, jobs with similar initial wages differ ex post, with high-productivity firms offering higher wages and greater stability. Calibrating the model, we quantify adjustment channels and show that gains from lower consumer prices outweigh losses from wage cuts, job destruction, and capital losses, although these losses are concentrated among a subset of workers. Downward wage rigidity can improve welfare, creating a trade-off between worker displacement and income loss.