# **1 Introduction**

In recent decades the increased integration of national product markets has stimulated a large literature aiming to identify and explain its labor market consequences. Among the consequences of particular interest are adjustments in the market returns to different skills/occupations and changes in workers’ skill-acquisition decisions. The former were the early focus of this literature, in particular whether trade liberalization was an important driver of the increased wage inequality between skilled and unskilled workers observed in many high-income countries. The general consensus emerging from this literature seems to be that trade liberalization contributed to increase the skill premium, but played a small role relative to skilled biased technological change (Slaughter 2000, Acemoglu 2002, Machin 2003).<sup>1</sup> Other contributions argue that organizational change (Caroli and Van Reenen, 2001; Black and Lynch, 2004; Garicano and Rossi-Hansberg, 2006) and declining unionisation (Machin, 1997; Card, 2001) have also played an important role.<sup>2</sup> Work by Guadalupe (2007) reports a previously unnoticed driver of the increase in returns to skill: changes in the degree of product market competition. Theoretically, she shows that if product markets are imperfectly competitive, fiercer competition increases the sensitivity of profits with respect to production costs. Provided that skilled workers are more productive than unskilled workers, this induces a rise in demand for skills, which translates into higher returns. The causal relationship between product market competition and returns to skill is then empirically confirmed by individual panel data for the UK.<sup>3</sup> In this paper we note that by increasing returns to skill, fiercer international competition will also raise the incentives for skill acquisition. Indeed, theoretical work by Falvey et al. (2010)

> 1An important exception to this consensus is Wood (1998 and forthcoming). For surveys of the literature on globalization and inequality see Greenaway and Nelson (2002), Feenstra and Hanson (2003), Bardhan (2005), Goldberg and Pavcnik (2007 and 2016) and Messina and Silva (2017). Three points should be noted. First, the effects of trade on wage inequality can also occur through its interaction with technology—increasing imports from low-wage can contribute to the adoption of skill-biased technologies. Second, other factors linked to globalization also have contributed to inequality trends, including outsourcing (Acemoglu, Gancia, and Zilibotti 2015; Feenstra and Hanson 1996 and 1997) and exchange rate movements (Verhoogen 2008, and Brambilla, Lederman, and Porto, 2012). Third, while most of the empirical studies find statistically significant but limited (in terms of magnitude) effects of globalization on wage inequality, Autor et al. (2014), Topalova (2010), McCaig (2011), and Dix Carneiro and Kovak (2017) find large effects. The common factor across this set of papers is that they rely on regional variation in trade exposure to identify the causal effect of trade.

> 2Since the emergence of China in the 2000s, trade has received renewed attention as a driver of wage inequality. Autor, Dorn, and Hanson (2013) and Autor et al. (2014) document a substantial impact of import competition from China on earnings and unemployment of U.S. workers with larger earnings losses for individuals with low initial wages.

> 3Increased competition may also generate wage differentials between sectors by reducing monopoly rents (Krueger and Summer, 1988) and thereby increase workers’ incentives to switch industry.

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