ILO Working Paper 12 October / 2020 X Trade and labour market outcomes Theory and evidence at the firm and worker levels Author / Benjamin Aleman-Castilla Copyright © International Labour Organization 2020 This is an open access work distributed under the Creative Commons Attribution 3.0 IGO License (http://creativecommons. org/licenses/by/3.0/igo). Users can reuse, share, adapt and build upon the original work, even for commercial pur- poses, as detailed in the License. The ILO must be clearly credited as the owner of the original work. The use of the emblem of the ILO is not permitted in connection with users’ work. Translations – In case of a translation of this work, the following disclaimer must be added along with the attribu- tion: This translation was not created by the International Labour Office (ILO) and should not be considered an official ILO translation. The ILO is not responsible for the content or accuracy of this translation. 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Reference to names of firms and commercial products and processes does not imply their endorsement by the International Labour Office, and any failure to mention a particular firm, commercial product or process is not a sign of disapproval. ILO Working Papers summarize the results of ILO research in progress, and seek to stimulate discussion of a range of issues related to the world of work. Comments on this ILO Working Paper are welcome and can be sent to [email protected]. Authorization for publication: Richard Samans, Director of the Research Department ILO Working Papers can be found at: www.ilo.org/global/publications/working-papers Suggested citation: Aleman-Castilla, B. 2020. Trade and labour market outcomes: Theory and evidence at the firm and worker levels, ILO Working Paper 12 (Geneva, ILO). ILO Working Paper 12 X Abstract The literature on the impact of trade on labour market outcomes has experienced a remarkable evo- lution in recent decades. Theory has moved on from oversimplified to more comprehensive models that take into account previously disregarded characteristics of firms and of product and labour mar- kets, such as firm heterogeneity and labour market frictions. Thanks mainly to the availability of high- er-quality data, greater computational capacity and improved econometric techniques, an increasing number of empirical studies provide valuable feedback that can be used for the continuous enhance- ment of the underlying theory. This working paper surveys the literature on the impact of internation- al trade on firms and workers, presenting the main theoretical and methodological frameworks, in- cluding the assumptions on which these are based and the results obtained. It also discusses briefly the challenges that need to be addressed in future research, such as the collection of more and even higher-quality data, and the development of new statistical indicators that better reflect the dimen- sions of decent work. X About the author Benjamin Aleman-Castilla is Professor of Economics at the Economic Environment Department of the IPADE Business School in Mexico City. He previously worked for 12 years in the Mexican public sector, within the financial branches at both the state and federal levels. He earned his PhD from the London School of Economics and Political Science (LSE) in 2007 with a thesis on trade, migration and labour markets. Linking individual-level and tariff data, his thesis focused on the impact of the North American Free Trade Agreement (NAFTA) on informality and wages. 01 ILO Working Paper 12 X Table of contents Abstract 01 About the author 01 Acronyms 03 Introduction 04 X 1 Theoretical trade frameworks and implications for the labour market 05 Neoclassical theory of comparative advantage 05 Ricardo–Viner specific-factors model 06 New trade theory: Economies of scale, product differentiation and imperfect competition 07 New-new trade theory: Dynamic industry models with heterogeneous firms 07 Worker heterogeneity 08 Labour market frictions 09 Informality 11 Global value chains: International outsourcing and offshoring 12 X 2 Empirical studies of trade and implications for the labour market 14 Structural approach 14 Employment and wages 15 Workers’ welfare 16 Informality 16 The quasi-experimental approach 17 Wages 18 Local labour market outcomes 19 Informality 21 Gender wage gap 21 Child labour 22 X 3 Notable achievements and challenges 24 Evolution of the theoretical frameworks 24 Empirical studies and the use of linked employer–employee data 25 Types of LEED and the advantages of using linked employer–employee data 25 Difficulties and challenges in using linked employer–employee data 26 Future considerations: Extending the analysis of labour market indicators 28 Concluding remarks 31 Annex 32 References 44 Acknowledgements 53 02 ILO Working Paper 12 X Acronyms CEPII Centre d’études prospectives et d’informations internationales (Centre for International Prospective Studies and Information) [France] EEWT employment in excessive working time ENEU Encuesta Nacional de Empleo Urbano (National Urban Employment Survey) [Mexico] ENOE Encuesta Nacional de Ocupación y Empleo (National Occupation and Employment Survey) [Mexico] FDI foreign direct investment GDP gross domestic product H–O Heckscher–Ohlin [theory/model] IAB Institut für Arbeitsmarkt- und Berufsforschung (Institute for Employment Research) [Germany] IBGE Instituto Brasileiro de Geografia e Estatistica (Brazilian Institute of Geography and Statistics) IMSS Instituto Mexicano del Seguro Social (Mexican Institute for Social Security) INEGI Instituto Nacional de Estadística y Geografía (National Institute of Statistics and Geography) [Mexico] LEED linked employer–employee data set MNC multinational corporation MNE multinational enterprise NAFTA North American Free Trade Agreement RAIS Relação Anual de Informações Sociais (Annual Social Information Report) [Brazil] RCT randomized controlled trial R&D research and development SUSENAS Survey Sosial Ekonomi Nasional (National Socio-Economic Household Survey) [Indonesia] TRAINS Trade Analysis and Information System (of the UNCTAD) UNECE United Nations Economic Commission for Europe UNCTAD United Nations Conference on Trade and Development WTO World Trade Organization 03 ILO Working Paper 12 X Introduction Over the past 40 years, the economic literature dealing with the impact of trade on labour market out- comes has experienced a remarkable evolution. On the one hand, theory has moved away from over- simplified country-level frameworks based on unrealistic assumptions to more complex but realistic industry- and firm-level models that take into account previously omitted characteristics of firms and of product and labour markets (for example, firm and worker heterogeneity, search-and-matching frictions) and are therefore better suited to explaining the actual patterns of trade and its implications for the labour market. These new models also reflect the changes that have occurred in the compo- sition of international trade, such as the increasing share of exchange taking place with or between non-rich countries as a consequence of international outsourcing and the offshoring of certain tasks within production processes (see figure 1 in the Annex). On the other hand, thanks to the availability of larger and higher-quality longitudinal and cross-sec- tional databases in many places around the world, along with the greater computational capabilities and improved econometric tools developed in recent years, there has been a surge in empirical stud- ies providing valuable findings on the effects of trade on various labour market indicators, some of which had previously been ignored by analysts (for example, informality, gender wage inequality and local labour market differentials), but which are important for the evaluation of trade policies in rela- tion to decent work. This working paper surveys the literature on the impact of international trade on enterprises and work- ers, presenting the main theoretical and methodological frameworks used, including their assumptions and predictions or results. It is intended to serve as a background paper for the project “Trade, enter- prises and labour markets: Diagnostic and firm-level assessment”, which is being jointly conducted by