Trade and the Skill Premium Puzzle with Capital Market Imperfections

An interesting puzzle is that trade liberalization in the 1980s and 1990s has been associated with a sharp increase in the skill premium in both developed and developing countries.This is in contrast with neoclassical theory, according to which trade should increase therelative return of the relatively abundant factor. We develop a simple model of trade withcapital market imperfections, and show that trade can increase the skill premium in boththe North and the South, and both in the short run as well as in the long run. We showthat trade with a skill-intensive economy has two effects: it reduces the skilled wage, andthus discourages non talented agents out of the skilled labor force; and it reduces the cost ofsubsistence, thus allowing the talented ospring of unskilled workers to go to school. Thiscompositional effect has a positive effect on the observed skill premium, possibly strongenough to counterweight the decrease in the skilled wage.[...]