Margins of labour market adjustment to trade

Rafael Dix-Carneiro, Brian Kovak 23 August 2017

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A recent but growing body of work has consistently shown that foreign competition can have substantially different effects across regions within a country. If industries face different degrees of import competition, then local labour markets specialised in more exposed industries will experience relative declines in economic conditions such as wages and employment rates. Prominent examples of this work include Topalova (2007), Kovak (2013), and Autor et al. (2013), who have analysed the unequal effects of increasing import competition on economic outcomes across regions in India, Brazil, and the US, respectively. But how do individual workers adjust to these trade-induced local labour market shocks? We attempt to answer this question by studying the adjustment process that followed the Brazilian trade liberalisation episode of the 1990s.

Trade liberalisation in Brazil

Trade liberalisation in Brazil involved large decreases in tariffs (taxes on imports) that were phased in between 1990 and 1994. Average tariffs fell from 30.5% to 12.8% during this period, with some industries facing very large tariff reductions and others facing much smaller changes. As in most large and diverse economies, different regions in Brazil produce different types of products. Because tariff reductions were different across industries, each region experienced a different average tariff reduction by virtue of its unique mix of industries. For example, Rio de Janeiro faced a very large tariff reduction because it engages heavily in apparel manufacturing and food processing, both of which experienced larger-than-average tariff reductions. In contrast, Mata Grande in the state of Alagoas mainly produces agricultural goods, which experienced a small increase in tariffs. Our empirical analysis examines changes in labour market outcomes for workers in regions that faced larger versus smaller tariff reductions during liberalisation.

How did workers adjust?

Standard economic theory would predict that as incomes and employment rates decline in regions that are harder hit by foreign competition, workers in these regions would gradually migrate to less-affected regions. This adjustment process would eventually lead to convergence in economic conditions across regions in the long run. In Brazil, however, the working age population did not systematically respond to liberalisation-induced local shocks (Dix-Carneiro and Kovak forthcoming). So, how did workers in regions exposed to increasing import competition adjust?

We answer this question using administrative longitudinal data from the Relação Anual de Informações Sociais (RAIS) to follow workers across regions, sectors, and employers for 20 years following the start of liberalisation (Dix-Carneiro and Kovak 2017). We find that workers initially employed in harder-hit regions spend less and less time working in the formal sector relative to workers in other regions. Rather than contracting, this effect is actually amplified over time (Figure 1). These results are consistent with findings we previously reported which suggest that labour demand in harder-hit regions keeps falling for years following liberalisation (Dix-Carneiro and Kovak forthcoming). Workers initially employed in tradable sectors are more likely to locally transition to non-tradable sectors, but this response is not enough to offset the strong declines in formal employment in tradable sectors (Figure 2). Workers in non-tradable sectors in harder-hit areas are similarly affected, indicating large spillovers from tradable to non-tradable sectors.

Figure 1 Workers’ average months of being formally employed per year

Figure 2 Workers’ average months of being formally employed per year, tradable vs non-tradable sectors

Unfortunately, once a worker leaves the formal sector, the RAIS data lose track of her. We cannot tell whether the worker is unemployed, out of the labour force, self-employed, or informally employed. Note that informal employment accounts for approximately half of overall employment in Brazil. We consider a worker as informal if she is informally employed by a firm (off the books and invisible to the government) or if she is self-employed. In each case, the worker does not receive the benefits or regulatory protections present in the formal labour market.

Although we cannot use administrative data to follow individual workers as they transition into informal employment or non-employment, we can use household survey data to study changes in the structure of local labour markets. We show that, relative to the national average, non-employment strongly increases in harder-hit locations in the years immediately following liberalisation, but that employment in these locations recovers in the longer run. This employment recovery is entirely accounted for by an increase in informal employment in harder-hit locations. In other words, after going through long periods of non-employment, trade-displaced formal-sector workers appear to eventually settle for the fallback option of informal employment.

Surprisingly, we find no statistically significant long-run effect of liberalisation on informal sector earnings or wages, which sharply contrasts with the formal-sector earnings results documented in previous work. In Dix-Carneiro and Kovak (forthcoming), we documented that regions that were harder hit by liberalisation experienced gradual but continuous declines in both formal employment and earnings. The long-run effect of liberalisation on earnings was three times as large as the medium-run effect. These divergent effects between the formal and informal sectors cannot be explained by the changing composition of workers across sectors. Instead, this unexpected finding could reflect increased demand by consumers in harder-hit regions for lower-quality goods, which tend to be produced by the informal sector. More work is certainly needed to understand why local formal and informal sector earnings responded so differently to liberalisation.

Policy implications

Taken together, our results have important policy implications.

  • First, we document a close integration between the tradable and non-tradable sectors.

These spillovers across sectors raise concerns about policies providing targeted compensation for workers in industries experiencing increased import competition, such as Trade Adjustment Assistance in the US. When regional labour markets are reasonably integrated across sectors, even workers whose industry did not directly face a trade shock experience the labour market effects of that shock, and policies with industry targeting will fail to address declining earnings and employment rates for these indirectly affected workers.

  • Second, our results indicate that during periods of economic hardship, the informal sector can act as a fallback sector for displaced workers. In turn, this suggests that governments may consider loosening the enforcement of labour market regulations in response to negative economic shocks to allow the informal sector to absorb unemployed workers.

This conclusion is not uncontroversial, because by allowing a substantial expansion of the informal sector in times of economic hardship, the economy may experience declining aggregate productivity, since informal firms are typically smaller and less productive (e.g. McCaig and Pavcnik 2017). We encourage future work to address these questions.

  • Finally, although we focus on a middle-income country with a large informal share of employment, with the emergence of the so-called ‘gig economy’ an increasing share of high-income country jobs come with minimal job security, no benefits, and possibly part-time work.

Our findings on informality are therefore increasingly relevant to the labour market effects of globalisation in high-income contexts as well. More generally, understanding these deeper interactions between labour regulations and changes in trade policies is an important avenue for future work.

References

Autor, D, D Dorn, and G Hanson (2013), “The China Syndrome: Local labor market effects of import competition in the United States”, American Economic Review 103(6): 2121-68.

McCaig, B and N Pavcnik (2017), “Export markets and labor reallocation in a poor country”, NBER, Working paper 22045.

Dix-Carneiro, R and B Kovak (2017), “Margins of labor market adjustment to trade”, NBER, Working paper No 23595.

Dix-Carneiro, R and B Kovak (forthcoming), “Trade liberalization and regional dynamics”, American Economic Review.

Kovak, B (2013), “Regional effects of trade reform: What is the correct measure of liberalization?”, American Economic Review 103(5): 1960-76.

Topalova, P (2007), “Trade liberalization, poverty, and inequality: Evidence from Indian districts”, in A Harrison (ed), Globalization and Poverty, University of Chicago Press: 291–336.

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Topics:  Competition policy International trade Labour markets

Tags:  trade liberalisation, regional labour markets, informal employment, Brazil, tariff reductions

Assistant Professor of Economics, Duke University

Associate Professor of Economics and Public Policy, Carnegie Mellon University; Faculty Research Fellow, NBER

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