Trade and Industrial Location with Heterogeneous Labor

IMF Working Papers, June 1, 2004

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Trade liberalization may lead to industrial agglomeration and interregional trade when labor is heterogenous.
Labor heterogeneity gives local monopoly power to firms and introduces variation in job-match quality.
Better matches are more likely when there are more firms and workers in the local market, creating an agglomeration force that can offset the forces from trade costs and the erosion of monopoly power.
The paper derives analytically a robust agglomeration equilibrium and illustrates its properties with numerical simulations.

Framework: a new economic geography model with heterogeneous labor.
Key mechanisms:
- Local monopoly power arising from labor heterogeneity.
- Variation in match quality between workers and firms.
- Agglomeration force: match quality improvements when local market size (firms and workers) increases.
- Countervailing forces: trade costs and the erosion of monopoly power with trade liberalization.

Analytical derivation of a robust agglomeration equilibrium.
Numerical simulations used to illustrate the properties of the agglomeration equilibrium.
Emphasis on how interactions between monopoly power and match-quality variation determine location and trade outcomes.

Trade liberalization can, under heterogeneous labor, produce concentration of manufacturing activity rather than dispersion.
Labor market heterogeneity and matching frictions are central to understanding spatial industrial outcomes following trade policy changes.
Policymakers should account for the potential for agglomeration when evaluating trade liberalization, especially where local labor–firm matching externalities are strong.