Skill Distribution, Trade and Aggregate Income: A Tractable General Equilibrium Model

Purpose his paper presents a tractable 2-2-2 general-equilibrium model, which provides a unified account for both inter-industry and intra-industry trade. Design/Methodology/Approach We consider trade between two countries, which have the same endowment quantity. For analysis, we incorporate firm heterogeneity into a Heckscher-Ohlin model, and show that trade still occurs although two countries have the same endowment quantity. Within our framework, labor is heterogeneous in skill, and the heterogeneity determines effective factor prices like in Leamer (1999). There are two sectors, the primary sector (independent on institution) under perfect competition and the manufactured sector (dependent on institution) under monopolistic competition. Findings In the manufactured sector, firms of lower-skill workers cannot produce. Due to firm selection, unskilled workers move to the primary sector. The manufactured sector expands when the country is abundant in high-skill workers. In this case, the primary sector has comparative disadvantage in the country because the primary sector absorbs high-skill workers and raises the wage for the primary sector. In a country being relatively abundant in high-skill workers, the size of the manufactured sector is larger. Then, the country exports more varieties, imports less varieties (two-way trade), and has more well-paying jobs than another country, which has comparative advantage in the primary sector. Due to comparative advantage, the primary good is exported from one country to another (one-way trade). Research Implications Trade equalizes the prices of the primary good and the sectoral wage between countries. Aggregate price level is the same for both countries. However, aggregate income is larger in the country, where is relatively abundant of skills, because well-paying jobs are more available. With providing a new framework, our paper can contribute to the literature of skill distribution and trade, or North-North trade.