Dix-Carneiro and Kovak Trade Reform and Regional Dynamics

# **1 Introduction**

The reallocation of resources across economic activities is a key mechanism through which increasing openness leads to welfare gains. Prominent theories of international trade rely on the reallocation of factors across sectors or firms in order to generate production gains from trade. However, academic economists have traditionally paid little attention to the adjustment process, instead focusing on long-run models where reallocation is achieved without frictions. This focus has created a tension between academic economists advocating trade liberalization and policy makers concerned with the labor market outcomes of workers employed in contracting sectors or firms (Salem and Benedetto 2013, Hollweg, Lederman, Rojas and Ruppert Bulmer 2014).

Even though many countries underwent major trade liberalization episodes throughout the 1980s and 1990s (e.g., Brazil, Mexico, and India, among others), we still know very little about the medium- to long-run consequences of these policy reforms on labor markets, particularly for workers who were active when these reforms were implemented. Indeed, empirical studies of the labor market effects of trade liberalization have typically emphasized short- to medium-run effects. Frequently changing designs of cross-sectional household surveys forced researchers to focus on relatively short intervals to guarantee consistency over the periods analyzed (Goldberg and Pavcnik 2007). Furthermore, the lack of long and comprehensive panel data during periods of trade liberalization made it impossible to jointly study the short-, medium- and long-run effects of trade liberalization on individual workers’ employment trajectories.

We fill this gap in the literature by studying the empirical dynamics of labor market adjustment in response to a major trade liberalization episode. We use 25 years of matched employer-employee data from Brazil to study the dynamics of local labor market adjustment following the country’s trade liberalization in the early 1990s. We exploit variation in the degree of tariff declines across industries and variation in the industry mix of local employment across Brazilian regions to measure changes in local labor demand induced by liberalization. This approach, along with our detailed longitudinal data, allows us to observe labor market dynamics for 20 years following the beginning of the trade policy changes.

The results are striking. We find very large and slowly increasing regional effects on earnings, employment, and other labor market outcomes. Workers whose regions face larger tariff declines experience deteriorating formal labor market outcomes compared to workers in other regions (we discuss informal outcomes below). These effects grow steadily for more than a decade before beginning to level off in the late 2000s. This pattern is not driven by other post-liberalization shocks and is robust to alternative measurement strategies. These findings challenge the conventional wisdom that labor mobility would gradually arbitrage away spatial differences in local labor market outcomes, leading to _declining_ rather than _increasing_ observed regional effects of liberalization over time (Blanchard and Katz 1992, Bound and Holzer 2000). This suggests substantial barriers to 2