NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Skill Premium and Trade Puzzles: a Solution Linking Production and Preferences

Justin Caron, Thibault Fally, James R. Markusen

NBER Working Paper No. 18131
Issued in June 2012
NBER Program(s):   ITI

International trade theory is a general-equilibrium discipline, yet most of the standard portfolio of research focuses on the production side of general equilibrium. In addition, we do not have a good understanding of the relationship between characteristics of goods in production and characteristics of preferences. This paper conducts an empirical investigation into the relationship between a good's factor intensity in production and its income elasticity of demand in consumption. In particular, we find a strong and significant positive relationship between skilled-labor intensity in production and income elasticity of demand for several types of preferences, with and without accounting for trade costs and differences in prices. Counter-factual simulations yield a number of results. We can explain about half of "missing trade", and show an important role for per-capita income in understanding trade/GDP ratios, the choice of trading partners, and the composition of trade. Furthermore, an equal rise in productivity in all sectors in all countries leads to a rising skill premium in all countries, with particularly large increases in developing countries.

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Document Object Identifier (DOI): 10.3386/w18131

Published: "International Trade Puzzles: A Solution Linking Production and Preferences" With Justin Caron and James R. Markusen, Quarterly Journal of Economics, August 2014, Vol. 129 (3).

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