International Competition, Returns to Skill and Labor Market Adjustment

This paper examines whether increased import competition induces domestic workers to skill upgrade and/or switch industries. The analysis makes use of a large unique longitudinal matched employer-employee dataset that covers virtually all workers and firms in Portugal over the 1986-2000 period. Our identification strategy uses two exogenous changes in the degree of international competition. First, we exploit the strong appreciation of the Portuguese currency in 1989-1992 and pre-existing differences in trade exposure across industries in a differences-in-differences estimation. Second, we make use of changes in industry-specific (source-weighted) real exchange rates. A bivariate probit model is used to analyse the impact of increased international competition on skill-upgrading and/or industry switching. Based on both empirical strategies, and on two different skill definitions, we find strong confirmation for the hypothesis that increased international competition increases the returns to skill and induces skill upgrading.