Trade Liberalization and Regional Dynamics

We study the evolution of trade liberalization’s effects on local labor markets, following Brazil’s early 1990s trade liberalization. Regions that initially specialized in industries facing larger tariff cuts experienced prolonged declines in formal sector employment and earnings relative to other regions. The impact of tariff changes on regional earnings 20 years after liberalization was three times the size of the effect 10 years after liberalization. These findings are robust to a variety of alternative specifications and to controlling for a wide array of postliberalization shocks. The pattern of increasing effects on regional earnings is not consistent with conventional spatial equilibrium models, which predict that effect magnitudes decline over time due to spatial arbitrage. We investigate potential mechanisms, finding empirical support for a mechanism involving imperfect interregional labor mobility and dynamics in labor demand, driven by slow capital adjustment and agglomeration economies. This mechanism gradually amplifies the initial labor demand shock resulting from liberalization. We show that the mechanism explains the slow adjustment path of regional earnings and quantitatively accounts for the magnitude of the long-run effects. [Working Paper No. 488].