Di Giovanni and Levchenko (2009) examine the relationship between trade openness and output volatility using industry-level data. Their conclusion is that trade openness is positively related to overall output volatility. This result is explained by three components. First, sectors that are more open to trade are also more volatile. Second, trade is accompanied by increasing specialization and it increases output volatility. Third, sectors that are more open to trade are less correlated with the rest of the economy. This third factor reduces output volatility. Giovanni and Levchenko (2009) conclude that the net effect of these factors is to increase output volatility. Krebs, Krishna and Maloney (2010) use Mexican household data to study the relationship between trade policy (particularly tariff levels) and individual income risk. They found that trade policy has a significant short-run effect on income risk; income risk increases as tariffs fall.

Trade liberalization has also been associated with income inequality. In some studies, this relationship is explained by increases in the skill premium due to increases in labor demand for skilled workers.<sup>11</sup> Goldberg and Pavcnik (2007) offer potential explanations for this empirical observation, among them, “quality” upgrading, “outsourcing” or “global production sharing,” skilled-biased technological change, capital flows and complementarities between capital and skilled labor.

As noted above, the literature on the relationship between returns to schooling and economic activity does not take into account drivers of business cycles, which might affect sectors in different ways. For instance, a rise in economic activity (above trend) might be caused by fluctuations in foreign demand. This would have different effects than, say, changes in global interest rates that affect all firms’ access to credit.

The literature on exports and skill premiums is a good example. Brambilla _et al._ (2012) suggest that exports tend to be skilled-labor intensive, and thus a temporary rise in foreign demand could be associated with temporary increases in RTS. If so, export volatility might be related to RTS volatility.

As mentioned above, there is evidence that sector volatility rises with their exposure to international trade. If these sectors are also skilled labor intensive, output volatility in these sectors might provoke volatility on the wages of the skilled workers, and a pro-cyclical skill premium. Thus, trade openness might increase RTS volatility, which implies higher risk for human capital investments.

In sum, the existing literature has focused on high-income countries, with mixed results regarding the cyclicality of the relative wage of skilled workers. The literature on developing economies is both limited and equally ambiguous. Furthermore, neither has focused on the relationship between foreign demand and RTS. Finally, it is notable that the few studies that explicitly assess the cyclicality of Latin American skill premiums or returns to schooling have relied on Mincerian estimates of RTS using repeated cross sections of workers. The following section discusses our approach, which attempts to deal with the analytical weaknesses of the standard approach.

> 11 See Goldberg and Pavcnik (2007).

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