The Effect of Skilled Labor Growth on Business Services Trade : an Analysis of South Korea and the United States

Abstract

Trade in services represents a growing portion of world trade, yet it is unclear if traditional trade models can be successfully applied to services. This paper addresses this issue by examining whether and to what extent relative skilled labor levels affect trade in services. First, the paper presents a two-country, two-firm model which predicts the decisions on trade that a firm will make given different relative skilled labor levels in the trading partner country. The model predicts that at given tariff rates, there is an amount of foreign skilled labor that makes it more profitable for a firm to stop exporting, and instead move production to the foreign country. Second, this paper contains an empirical analysis that regresses both service exports from the United States to South Korea and United States FDI in South Korea against the relative amount of skilled labor in South Korea. The regression results indicate South Korea's GDP is positively correlated with US trade in business services at a statistically significant level. The regression analysis also suggests that the output of South Korean service firms is positively correlated with the relative supply of skilled labor in South Korea. This study concludes that both South Korea's market size, in terms of GDP, and its relative amount of skilled labor may increase the output of South Korean service firms, and increase the amount of trade in business services from the US, in the form of exports and FDI. At the firm-level, economies of scale also play a vital role in the decisions that firms make regarding production location.