Two-Country Dynamic Model of Trade with Heterogeneous Firms and Comparative Advantage. WWWforEurope Working Paper No. 12

We develop a dynamic trade model with comparative advantage, heterogeneous firms and workers and endgenous firm entry to study wage inequality during the adjustment to trade liberalisation. We find that trade liberalisation increases wage inequality both in the short run and in the long run. In the short run, wage inequality is mainly driven by inter-sectoral wage inequality, while in the long run, wage inequality is driven by an increase in the skill premium. It is not a good idea to exclude certain sectors from trade liberalisation, because that greatly reduces the benefits of trade liberalisation, while failing to protect vulnerable workers.