Brambilla, Dix-Carneiro, Lederman and Porto (2011). The authors also show that these skilled premiums can be attributed to differences in industry exports.

# **4. Quantifying Trade Adjustment Costs**

This section will summarize different efforts to quantify the costs of adjustment to trade policy. This summary will review the main results as well as the methods used to obtain those results. Section 4.1 covers the early approach while section 4.2 deals with the more recent, modern, approach.

# **4.1. The Early Approach**

In this section, I review the early estimates of adjustment costs.<sup>4</sup> A summary of the findings in listed in Table 1. One of the first papers to quantify the costs of adjustment to trade for the U.S. is Magee (1972). To measure the adjustment costs of a complete liberalization of trade, Magee calculates the foregone wage earnings of displaced workers. He first estimates the number of workers that would become unemployed due to the elimination of tariff protection (this is done by first calculating the value of displaced domestic production and, second, by transforming the foregone production into employment losses). Then, he approximates the loss of each unemployed worker with his average wage. He makes adjustments for the expected duration of unemployment and he also assumes that all unemployment would be reabsorbed completely within five years. The size of the adjustment costs is mixed, being quite large in the short-run, but relatively small in the longer run. For instance, assuming an intermediate discount rate of 7 percent, the short-run cost of adjustment one year after liberalization is equivalent to 17.5 percent of the gains from liberalization. Five years after liberalization, adjustment costs are equal to 12.2 percent of the gains. In the long-run, the costs of adjustment amount to only 2.8 percent of the total gains from liberalization.<sup>5</sup> Baldwin, Mutti and Richardson (1980) extend Magee’s calculations and include the cost of idle capital (analogue to unemployed workers).<sup>6</sup> They use a similar methodology, thus calculating forgone wage income for unemployed workers and forgone output due to idle capital. The authors allow wages to depend on the demographic composition of workers within industries. In consequence, if trade causes a sharper decline in unskilled intensive industries, differences in wages at different skills in different industries (as in Krueger and Summers, 1989; Goldberg and Pavcnik, 2004; Galiani and Porto, 2010; or Brambilla, Dix-Carneiro, Lederman, and Porto, 2011) would play a role in the calculation of the labor adjustment costs. To compute the capital adjustment costs, they first assume a unitary elasticity between industry output and capital utilization so that each percentage point reduction in production due to trade reforms translates into a similar percentage point reduction in capital utilization. Assuming a capital amortization period of 10 years, then 1 percent of the capital stock wears out every 1.2 months. Finally, assuming the oldest capital vanishes first after a reform, each 1 percent of the capital stock that become idle due to trade would carry an income loss equivalent to the value of output produced by that capital in 1.2 months. The findings indicate that, one year after the reform, the costs of adjustment would be equivalent to 41.7 percent of the efficiency gains from trade. In the long-run,

> 4 Similar surveys of this literature can be found in Matusz and Tarr (1999) and Francois, Jansen, and Peters (2011). 5 These estimates depend on the discount rate. For instance, with a discount rate of 10 percent, the costs of adjustment in the long-run are equivalent to 3.8 percent of the gains.

> 6 See also Bale (1976) and Monson (1978).

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