International trade and employment: Theory and evidence from Korean firms

We extend the small country trade model with firm heterogeneity (Demidova and Rodriguez-Clare, 2013) to incorporate offshoring (along with final goods trade). We derive the firm-level employment implications of output and input trade and trade costs to provide a guide for our empirical work using Korean firm-level data for the period 2006-2016. A key theoretical result is that the impact of a change in offshoring cost on employment depends crucially on the net substitutability between inputs where net substitutability is the difference between the elasticities of input substitution and output substitution. Empirically we find that a decrease in the input trade cost reduces employment and the impact is stronger the greater the net substitutability between inputs. Exporting almost always leads to higher employment. Our 2SLS results with firm-level imports (in place of trade costs) do not contradict our results with trade costs. However, using propensity score matching, we find that being an importer, on average, is associated with greater employment, with the magnitude of this positive employment effect being greater for exporting firms and in industries with lower net substitutability among inputs.