Trade and Industrial Location with Heterogeneous Labor∗ Mary Amiti International Monetary Fund and CEPR Christopher A. Pissarides London School of Economics and CEPR this version March 2004 Abstract We show in the context of a new economic geography model that when labor is heterogenous trade liberalization may lead to industrial agglomer- ation and inter-regional trade. Labor heterogeneity gives local monopoly power to firms but also introduces variations in the quality of the job match. Matches are likely to be better when there are more firmsandworkersin the local market, giving rise to an agglomeration force which can offset the forces against, trade costs and the erosion of monopoly power. We derive analytically a robust agglomeration equilibrium and illustrate its properties with numerical simulations. Keywords: agglomeration, matching, spatial mismatch, inter-regional trade JEL Classification: F12, J41, R12, R13 ∗Amiti, Research Department, Trade Unit, International Monetary Fund, 700 19th Street, Washington DC 20431, Ph 1-202-623-7767, Fax 1-202-589-7767 , email
[email protected]. Pis- sarides: London School of Economics, Houghton Street, London WC2A 2AE, UK, tel. +44 207 955 7513, fax +44 207 831 1840, email
[email protected]. We thank Gilles Duranton, Gene Grossman, Diego Puga, Tony Venables and the editor and refeees for their comments. A previ- ous version of this paper was presented at the CEPR Workshop “The Economic Geography of Europe: Measurement, Testing and Policy Simulations,” Villars, 18/19 January 2002. In this paper we demonstrate that when labor is heterogenous and the match- ing of skills with jobs below first-best, the introduction of trade may lead to industrial agglomeration and inter-regional trade.