Human capital formation and international trade

Abstract

This paper develops a two-country, two-sector model of trade where the only difference between two countries is the cost of human capital formation. It is shown that this difference completely shapes the pattern of trade. Trade, in turn, affects the distribution of human capital both at extensive and at intensive margins, income distribution, and welfare in each country. Since not all agents gain from trade, the paper also investigates the conditions under which trade between two countries becomes possible if the final decision in each country is based on majority voting. Finally, the paper shows that lowering the cost of human capital in one country has asymmetric effects on human capital formation and the income inequality between skilled and unskilled workers across countries.