Over the last 40 years, trade barriers around the world have fallen to historically low levels. As part of this process, many developing countries abandoned import substituting industrialization policies by sharply lowering trade barriers, motivating a large literature examining the effects of trade liberalization on various national labor market outcomes such as poverty and inequality.1 The focus on national out- comes follows the approach of classical trade theory, which takes the country as the geographic unit of analysis. A small but growing literature takes a different approach, examining the effects of trade liberalization on labor market outcomes at the subnational level. The papers in this literature measure the local effect of liberalization using a weighted average of changes in trade policy, with weights based on the industrial distribution of labor in each region.2 In this article, I develop a specific-factors model of regional economies that yields a very similar weighted- average relationship between regional wage changes and liberalization-induced price changes across industries. The model provides a theoretical foundation for this intu- itively appealing empirical approach and provides guidance on important choices faced by researchers when constructing regional measures of trade liberalization.
The model shows that liberalization in a particular industry will have a larger effect on local wages when (i) liberalization has a larger effect on the prices faced by producers, (ii) the industry accounts for a larger share of local employment, and (iii) labor demand in the industry is more elastic.3 The model also incorporates the nontraded sector, showing that nontraded prices move with traded goods prices dur- ing liberalization. This finding supports omitting the nontraded sector from the local weighted average and suggests that an alternative approach implicitly assuming that nontraded prices are unaffected by liberalization will yield substantially upward- biased estimates when studying liberalization’s effect on wages.4
I empirically examine the model’s predictions in the context of Brazil’s trade liberalization in the early 1990s. Brazilian liberalization involved drastic reduc- tions in overall trade restrictions and a decrease in the variation of trade restrictions across industries, implying wide cross-industry variation in tariff cuts. Additionally, the industrial composition of the labor force varies substantially across Brazilian regions. This variation in tariff changes across industries and industrial composition across regions combine to identify the effect of liberalization on local wages.
The empirical results confirm the model’s predictions. Local labor markets whose workers were concentrated in industries facing the largest tariff cuts were gener- ally affected more negatively, while markets facing smaller cuts were more posi- tively affected. A region facing a 10 percentage point larger liberalization-induced price decline experienced a 4 percentage point larger wage decline (smaller wage increase) than a comparison region. I also investigate deviations from the weighted- average measure supported by the model and find that treatment of the nontraded sector is quite important in determining the magnitude of liberalization’s effect on wages, as predicted by the theoretical analysis. The model supports omitting the nontraded sector from the regional weighted average, and estimates obtained when doing so are of the expected magnitude. In contrast, estimates that implicitly assume that nontraded prices were unaffected by liberalization are more than four times larger.
Since the specific-factors model of regional economies is driven by price changes across industries, it is not limited to examining liberalization. It can be applied to any situation in which national price changes drive changes in local labor demand. As an example, consider the US local labor markets literature, in which research- ers use local industry mix to measure the effects of changes in national industry employment on local labor markets (Bartik 1991, Blanchard and Katz 1992, Bound and Holzer 2000). If the changes in national industry employment were driven by price changes across industries, the specific factors model would provide a theoreti- cal foundation for using local industry mix in that context as well.
The remainder of the paper is organized as follows. Section I develops the specific- factors model of regional economies, in which industry price changes at the national level have disparate effects on wages in the country’s different regional labor mar- kets. Section II describes the datasets used, and Section III describes the specific trade policy changes implemented in Brazil’s liberalization. Section IV empirically examines the effects of trade liberalization on wages across local labor markets, including an investigation of various alternative regional measures of liberalization. Section V concludes.