Trade, Welfare, and International Labor Market Spillovers

This paper develops a two-country new trade theory framework with two types of labor (skilled and unskilled) and an imperfect labor market arising from country-specific real minimum wages. It examines welfare implications of trade liberalization and spillover effects of labor market shocks in a global economy. The model identifies two key forces that shape the results: i) external scale effects generating employment expansion among unskilled workers, and ii) wage effects arising from intensive use of skilled workers. The model provides three clear predictions. First, the introduction of trade results in a rise of wage inequality in both countries. Second, trade enhances welfare by lowering unemployment across countries only when external scale effects dominate. Last, when wage effects outweigh external scale effects, a country will be better off if the other country raises its minimum wage, but both countries will be worse off under unduly strong external scale effects in the global economy.