Trade Liberalization and Labor Market Institutions



Leonardo Baccini, Mattia Guidi, Arlo Poletti, Aydin Yildirim


The notion that open international markets make societies better off has become increasingly contested in recent years in many advanced economies. The rhetoric and trade policy initiatives of the Trump Administration are perhaps the most visible examples of this trend. The imposition of unilateral traderestrictive measures against China and the European Union, the withdrawal from the Trans-Pacific Partnership (TPP), and the ongoing boycott of the World Trade Organization, amongst others, are all part of a broader strategy explicitly designed with a view to making US trade policy more responsive to the frustration of American citizens who could not see clear benefits from international trade agreements (United States Trade Representative 2017). But the result of the popular referendum in the UK advocating for a Brexit and the vocal opposition in many European Union member states against the Transatlantic Trade and Investment Partnership and the Canada-Europe Trade Agreement also tell of the mounting disquiet that the prospect of trade liberalization generates among the wider public in many advanced economies.

Central to these discussions about the merits of trade liberalization seems to be a widespread popular perception that globalization has generated greater wealth for a small group of individuals and firms while making the majority of citizens worse off. These perceptions are in line with the recent research in international trade that has found that, indeed, the benefits of trade liberalization are highly concentrated in the hands of few “superstar” exporting firms. Differently from earlier theories of trade policy predicting distributive consequences affecting either entire classes or specific industries (Hiscox 2001), these studies highlight that trade liberalization may generate stark distributive conflicts, pitting firms against each other. These works show that firm-level differences in size and productivity can account for their heterogeneity in export performance, which in turn explains why trade liberalization can generate uneven reallocation of profits across firms (Melitz 2003; Baccini et al. 2017; Osgood et al. 2017; Kim 2014; Bernard et al. 2007). Thus, both critics of globalization in the political arena and the recent literature converge in depicting trade liberalization as a policy choice that contributes to the concentration of wealth in the hands of the few, at the expense of the many (Osgood 2016).

At the same time, there are significant differences in the extent to which protectionist sentiments rise and affect the political debate across countries. While in some countries popular concerns over the welfare effects of trade liberalization are widespread and have generated marked protectionist responses by elected representatives, in other cases opposition to trade liberalization has been much less intense. This observation underscores the importance of assessing whether, and eventually how, domestic institutional factors influence how the welfare effects of trade liberalization are distributed in different societies. The comparative political-economy literature has long noted that different domestic institutional setups can affect the distributive consequences and politics of trade in systematic ways (Katzenstein 1985; Rogowski 1987; Milner and Kubota 2005; Kono 2009). Yet, the literature on firmheterogeneity and trade politics has so far only investigated patterns of firm income redistribution within single countries, largely focusing on the welfare effects of trade liberalization on US firms (Baccini et al. 2017; Bradford Jensen et al. 2017; Osgood 2016; Kim, 2017; Osgood et al. 2017; Kim et al. 2017). In short, we know virtually nothing about how domestic institutional factors influence which firms win or lose from trade liberalization. This is an important oversight, since this type of analysis could help shed light on the observed variation in patterns of interest aggregation and political action across different countries over the merits of trade liberalization.

This paper contributes to the expanding literature on firm heterogeneity and trade politics by incorporating domestic institutional differences into the analysis of the inter-firm competitive dynamics generated by trade liberalization. To do so, we draw on insights from the Varieties of Capitalism (VoC) literature (Hall and Soskice 2001) and develop an argument that highlights how variations in labor market institutions affect the distribution of welfare effects of trade liberalization across firms. In particular, we focus on how the configuration of labor unions and employers interactions, encapsulated in different wage bargaining institutions, affects the relative cost of employing one factor of production, i.e., labor, which, in turn, influences the ways in which the gains and losses of trade liberalization are distributed across firms at different productivity levels.

The building block of our argument is the distinction between wage bargaining systems in liberal market economies (LMEs) and coordinated market economies (CMEs). In the former, the relationships between workers and employers rely heavily on competitive market forces. In the latter, the logic of market competition is tamed by the existence of wage bargaining institutions that facilitate and reinforce strategic coordination between trade unions and employers associations. These differences have important implications for how the gains and losses of trade liberalization are distributed across firms. By equalizing wages at equivalent skill levels across an industry, coordinated wage bargaining institutions contribute to taming the inter-firm competitive dynamics generated by trade liberalization. More specifically, we argue that trade liberalization generates a stronger reallocation effect from least to most productive firms in countries with liberal labor market institutions, and a weaker reallocation effect in countries with coordinated labor market institutions.

We test our argument using a firm-level dataset on European Union (EU) countries, which includes more than 800,000 manufacturing firms between 2003 and 2016. To capture the occurrence of trade liberalization, we rely on tariff cuts implemented by the EU with trade partners in all preferential trade agreements (PTAs) signed after 1995. Our identification strategy boils down to a triple difference-indifferences in which the distributional effect of firms productivity and tariff cuts varies across labor market institutions. We find that, for productive firms, gains from trade are twice as large in LMEs as they are in CMEs. For instance, our results indicate that the most productive British firms increase their revenue 20 percent more than the least productive British firms do as a consequence of tariff cuts. On the contrary, the most productive German firms increase their revenue 10 percent more than the least productive German firms do in the presence of preferential trade liberalization. Moreover, we show evidence of the mechanism highlighted in the theory: wages increase significantly more in LMEs than in CMEs as a result of trade liberalization.

We complement our analysis at the firm level with evidence at the individual level, using questions from the European Social Survey and a novel geographical measure of trade liberalization weighted on share of workers employed in very productive firms, which we geo-located at the level of EU regions. By exploiting the heterogeneous impact of trade liberalization across European regions, we show that there is a weaker demand for redistribution in CMEs compared to LMEs in case of preferential liberalization, given that gains from trade are more uniform in the presence of labor market frictions. Importantly, this effect is driven by low-income individuals, who are the likely losers from trade openness in developed economies.

Our paper speaks to three main streams of research. First, several empirical papers have documented selection and market share reallocation effects as a result of trade liberalization (Pavcnik 2002; Trefler 2004; Bernard et al 2006; Amiti and Konings 2007; Topalova and Khandelwal 2011). Recent studies have pointed out that a few large productive firms enjoy the lion’s share of the benefits from trade liberalization at the expense of smaller, less productive firms (Osgood et al. 2016; Baccini et al. 2017). Our paper shows that domestic institutions affect gains from trade and that labor market frictions make benefits from trade liberalization more uniform among firms.

Second, our paper speaks to a large literature on the effect of globalization on individuals’ preferences over policy (Scheve and Slaughter 2004; Walter 2010; Hainmueller and Hiscox 2006; Mansfield and Mutz 2009; Margalit 2012; Walter 2017). In particular, recent studies find that trade shocks trigger attitude in favor of economic nationalism and, in turn, affect voting behavior (Margalit 2011; Autor et al. 2016; Jensen et al. 2017; Ballard-Rosa et al. 2017; Colantone and Stanig 2018a, 2018b). Our paper shows that, in the case of trade liberalization, individual preferences over redistribution is heterogeneous among types of labor market institutions. In other words, domestic institutions may mitigate the backlash against globalization experienced by developed democracies.

Third, the findings of our paper informs the debate concerning the effect on inequality of globalization in general (Ruggie 1982, Katzenstein 1985, Rodrik 1998, Rudra 2002), and trade liberalization in particular (Hanson and Harrison 1999, Goldberg and Pavcnik 2004, Jensen and Rosas 2007, Topalova and Khandelwal 2011, Dix-Carneiro 2014). Much of this literature provides empirical evidence either at the macro level or from single countries. We are the first study to show the micro-foundation of the distributional effect of trade liberalization for a large number of developed economies. In doing so, we are able to unveil the mechanisms linking trade openness to inequality at the level of both firm and individual.


This is a working paper. To read the original report, click here.