with a cyclical variation of RTS. When the volatility of the external shock is low, the correlation between RTS and the shock is also low or negative.

The relationship between the external shock and RTS might also be related to the degree of labor market flexibility. A negative relationship is found when the correlation between the external shock and RTS is graphed against two indexes of labor market rigidity: rigidity of working hours and rigidity of employing workers. It seems that more flexibility on the labor market is related to a positive correlation between foreign demand shocks and RTS (see figure 3).

These facts suggest that economies with flexible labor markets and higher foreign demand volatility present a positive correlation between RTS and foreign demand shocks. When this is the case, an increase in foreign demand is related to an increase in RTS, and then in the wage-gap between skilled and unskilled workers.

# **5. Results**

It is worth analyzing the statistical significance of our cyclical RTS estimates. Table 2 contains the estimates for the specifications with a linear deterministic trend in wages and a linear deterministic trend in RTS. As shown in the last column, the cyclical components of RTS are jointly statistically significant (at the 10 percent level) in seven cases. They are not jointly statistically significant in Colombia, Ecuador, Honduras, Peru and El Salvador. The linear trend in RTS is significant in five countries, namely Argentina, Chile, Costa Rica, Peru and República Bolivariana de Venezuela.

For our purposes is important to take into account that not all deviations of RTS from its trend are statistically significant. This implies that, in our analysis, we need to account for the lack of precision of the estimates. Consequently, the results reported further below come from Weighted Least Squares estimations, where the inverse of the standard error of each deviation of RTS from its trend is used as weight for each observation.

As mentioned above, transitory RTS could be affected by different types of shocks. Economies can face foreign or domestic shocks, and within these categories, the shocks can emanate from financial markets or from the real sector. Therefore, for the econometric study we focus on: external real- sector shocks; domestic real-sector shocks; external financial shocks; and domestic financial shocks.

The external real-sector shock is related to changes in foreign demand for domestic goods. To capture the effect of fluctuations in foreign demand for domestically produced goods we used the gravity model of trade for each country to estimate the effect of changes in trading partners’ GDP on each country’s merchandise exports, after controlling for bilateral distance and the country’s own GDP.<sup>20</sup> In turn, we 20 Other variables included in the gravity model of bilateral trade flows are the following: import tariffs, (the log of) the distance between country _i_ and country _j_ , a dummy variable that takes a value of 1 if the two countries are contiguous, a dummy variable that indicates if the two countries share their official language, a dummy variable that indicates if the two countries have a preferential trade agreement, a dummy variable if country _j_ is landlocked, and a set of year dummy variables. To construct the preferential trade agreement variable, we used data from the WTO-Regional Trade Agreements Information System. This database contains information on the 12