International competition, returns to skill and labour market adjustment

Does increased import competition lead to higher returns to skill within an industry and, therefore, to greater incentives for skill acquisition? Does it also induce skill upgrading by the industry's existing workforce? To answer these questions, we follow individual workers across skills/occupations, firms and industries using a longitudinal matched employer–employee data set covering virtually all workers and firms in Portugal over the 1986–2000 period. To identify the effects of international competition, we use two exogenous measures at the industry level. First, a quasi-natural experiment based on the strong appreciation of the Portuguese currency in 1989–92 period and pre-existing differences in trade exposure across industries in a differences-in-differences estimation. Second, source-weighted real exchange rates defined at the industry level. Based on both empirical strategies, and on two different skill definitions, we show that international competition increases returns to skill and induces skill/occupation upgrading within an industry.