Trade Shocks and Labor-Market Adjustment
Authors: McLaren John 
Published: July 2022

When international trade increases, either because of a country’s lowering its trade barriers, a trade agreement, or productivity surges in a trade partner, the surge of imports can cause dislocation and lowered incomes for workers in the import-competing industry or the surrounding local economy. Trade economists long used static approaches to analyze these effects on workers, assuming either that workers can adjust instantly and costlessly, or (less often) that they cannot adjust at all. In practice, however, workers incur costs to adjust, and the adjustment takes time. An explosion of research, mostly since about 2008, has explored dynamic worker adjustment through change of industry, change of occupation, change of location, change of labor-force participation, adjustment to change in income, and change in marital status or family structure.

Some of these studies estimate rich structural models of worker behavior, allowing for such factors as sector-specific or occupation-specific human capital to accrue over time, which can be imperfectly transferable across industries or occupations. Some allow for unobserved heterogeneity across workers, which creates substantial technical challenges. Some allow for life-cycle effects, where adjustment costs vary with age, and others allow adjustment costs to vary by gender. Others simplify the worker’s problem to embed it in a rich general equilibrium framework.

Some key results include: (a) Switching either industry or occupation tends to be very costly; usually more than a year’s average wages on average. (b) Given that moving costs change over time and workers are able to time their moves, realized costs are much lower, but the result is gradual adjustment, with a move to a new steady state that typically takes several years. (c) Idiosyncratic shocks to moving costs are quantitatively important, so that otherwise-identical workers often are seen moving in opposite directions at the same time. These shocks create a large role for option value, so that even if real wages in an industry are permanently lowered by a trade shock, a worker initially in that industry can benefit. This softens or reverses estimates of worker losses from, for example, the China shock. (d) Switching costs vary greatly by occupation, and can be very different for blue-collar and white-collar workers, for young and old workers, and for men and women. (e) Simple theories suggest that a shock results in wage overshooting, where the gap in wages between highly affected industries and others opens up and then shrinks over time, but evidence from Brazil shows that at least in some cases the wage differentials widen over time. (f) Some workers adjust through family changes. Evidence from Denmark shows that some women workers hit by import shocks withdraw from the labor market at least temporarily to marry and have children, unlike men.

Promising directions at the frontier include more work on longitudinal data; the role of capital adjustment; savings, risk aversion and the adjustment of trade deficits; responses in educational attainment; and much more exploration of the effects on family.